Using Price-to-Rent Ratio to Decide Between Buying and Renting
This rule of thumb can help make your decision
If you've been saving to buy a home, it can be tough to know when is the right time to buy. There are many factors that play into that decision, but one tool you can use is the price-to-rent ratio in your area.
This ratio, which is calculated by dividing the median home price by the median annual rent, spits out a single number that you can use to see whether it makes more financial sense to rent or buy.
Let’s walk through the specific details of how the price-to-rent ratio is calculated. We'll also share what its limitations are, and how to use it with other information when you're trying to make an important decision like whether to buy a home.
- The price-to-rent ratio is calculated by dividing the median home price by the median annual rent.
- A price-to-rent ratio of 15 or less means it's better to buy.
- A price-to-rent ratio of 21 or more means it's better to rent.
- Use the price-to-rent ratio in combination with other factors when making a decision about whether to buy a house.
How the Price-to-Rent Ratio Works
The price-to-rent ratio is one way to judge whether it's better to rent or buy. First, you'll need to know how to calculate it to see how it works.
How to Calculate the Price-to-Rent Ratio
To calculate the price-to-rent ratio in your area, follow this formula:
median home price / median annual rent = price-to-rent ratio
To find these numbers for your area, you'll need to do a little internet sleuthing. You can find the figures on websites like Zillow, RentCafe, the National Association of Realtors, local news media, or even government organizations.
How to Interpret the Price-to-Rent Ratio
Price-to-rent ratios of 15 or less indicate that it's a good financial decision to buy (if you're able). On the other hand, price-to-rent ratios of 21 or more tell you that the housing purchase market may be overpriced, and it might be a financially smarter choice to rent instead.
For example, here is how to calculate the price-to-rent ratio for two very different areas in March 2021: Seattle, Washington, and Newberry, Michigan:
Seattle: $816,718 / ($1,873 X 12) = 36
Newberry: $69,814 / ($717 X 12) = 8
In this case, it's more financially sound to rent in Seattle than to buy. In Newberry, on the other hand, you may be better off buying than renting.
How to Use the Price-to-Rent Ratio to Make a Decision
You shouldn't rely on just the price-to-rent ratio alone when making a decision about whether it's the right time for you to buy a house. The price-to-rent ratio only measures whether the market as a whole favors renting or buying.
You, on the other hand, need to be ready to buy too, and that's entirely independent of what the market is doing. After all, the numbers might say it's a fantastic time to buy in general. But if you don't have enough saved for a down payment or you can't afford the higher ongoing expenses that come with homeownership, you could be setting yourself up for a lot of problems down the road. It's called being "house poor," and it's not a fun position to be in.
Here are some other things to consider when deciding whether it's time to buy a home:
- Can you afford property taxes, homeowners association (HOA) fees, and insurance?
- Would buying a house allow you to live a lifestyle that a rental can't?
- If you're upgrading into a bigger home, will you be able to afford higher utility bills?
- Do you have enough savings to cover a down payment, closing costs, moving fees, redecorating, new furniture, etc.?
- Are you prepared to handle home repairs and maintenance yourself, versus calling a landlord?
- Are you able (and can you remember) to set aside savings for home repairs and maintenance?
One useful resource for putting this all together is The New York Times' Is It Better to Rent or Buy? calculator. This tool also factors in what you might pay for a house versus a rental, but it further considers a wider range of elements, like how long you plan on staying in your house, how much property taxes will cost you, recurring home maintenance expenses, and more.
Grain of Salt
The price-to-rent ratio can be an important formula to help you decide whether market conditions favor renting or buying when looking through a purely financial lens. But it can't tell you whether it's a better money choice to rent or buy given your personal circumstances.
The ratio can't tell you whether buying or renting is better based on your lifestyle preferences, and how much more (or less) it would make sense to pay if the market isn't leaning in your favor.
Your area might have a high price-to-rent ratio that says it's better to rent, for example. But if you really want to get into woodworking, gardening, or archery, you can't easily do those things in an apartment, so it might be a quality-of-life investment to buy a home. Or, if you really want to be in the city and not be tied down by owning property, it might make sense to pay more for a high-priced rental when the market says you should buy.
Only you can decide whether to rent or buy. The price-to-rent ratio should only be one factor you consider when making that decision.