Thanks to a proliferation of financial "calculators" on the internet, consumers now make better-informed decisions on a wide range of subjects, from planning for retirement to refinancing a mortgage to estimating college costs. These tools allow consumers to apply well-designed financial models to their own circumstances, and they are increasingly popular with consumers who are not comfortable talking with a financial advisor and with those who do not want pay for personalized financial advice.
There are several housing-related calculators, including "rent versus buy" calculators that allow consumers to compare the financial costs of renting and owning. Since these calculators are starting to appear on many apartment firm web sites, NMHC decided to analyze some of the most popular versions to see if their recommendations are sound.
We found that most are seriously flawed, with a bias toward ownership. In fact, the cultural bias behind these calculators is clear when you consider that all of these products are designed to help renters decide whether they should buy instead; none are aimed at helping owners decide whether they might be better off financially by renting. The result is that consumers who rely on these tools may make one of the most important decisions of their lives based on misleading data, and apartment firms who include them on their web sites may be pushing would-be renters into ownership.
Rent vs. Buy Analytics
Deciding between renting and buying is not like figur-ing out what your mortgage payment will be at a certain purchase price and interest rate. It is a complicated and subjective exercise that requires consumers to make certain assumptions about the future-things like how much the home will appreciate, when the home will be sold, what rent increases are likely and what return renters could earn by investing their money in something other than a house downpayment. In this sense, the rent vs. buy comparison is much more like retirement planning-the outcome depends upon an uncertain future. Therefore, as with retirement planning, it is useful to consider a range of possibilities, something these simple calculators do not do or suggest.
The second complication is that an accurate analysis requires a lot of detailed information-information that many users may not know. For instance, users must know the property tax rates on single-family houses, approximate closing costs for buying and selling a house, and how much their deductions would be if they filed an itemized tax return. The calculators we reviewed have made clear tradeoffs between ease of use and accuracy. The result is misleading results for the end users.
The Rent vs. Buy Landscape
There are literally thousands of web sites featuring rent vs. buy calculators. The vast majority are rather crude and produce wildly inaccurate conclusions from just a few pieces of data. Even the more sophisticated calculators, which ask for more data and allow users to change many of the embedded assumptions, still make enough mistakes to invalidate their conclusions.
We selected four calculators to review for this issue of Research Notes. These four, Quicken.com, homestore.com, homeadvisor.com, and E-Loan, were selected because they are among the most popular and because they are representative of the errors commonly found. We have divided these into two categories-the "Quick and Dirty" versions and the "Elaborate" versions. NMHC has informed the sponsors of these calculators of the flaws we found. So far, none have committed to correcting the errors.
Before we begin with our specific analysis, we should note that we could not find even a single calculator that correctly estimates tax savings for homeowners. To receive a tax savings for owning a house, owners must itemize their deductions. In reality, only half of all owners itemize. The other half takes the standard deduction ($7,350 for a joint re-turn in 2000) because it is more than what they paid in mortgage interest and property tax (and other deductions) for the year. The calculators mistakenly assume that every user will get a tax benefit from buying. For those who do itemize, the calculators still overestimate their tax saving. The true saving is the amount by which total itemized deductions exceed the standard deduction, multiplied by the owner's marginal tax rate. All of the calculators in-correctly assume the tax saving equals the user's marginal tax rate multiplied by the full amount of mortgage interest and property tax paid each year. While this alone is enough to call into question any rent vs. buy conclusion, the catalog of online calculator mistakes goes well beyond this.
The "Quick and Dirty"
Two of the calculators we reviewed fall into the "quick and dirty" category. Both Quicken.com and homestore.com are very easy to use, but they collect very little information from the user, and they do not permit the user to change key assumptions. As a result, their conclusions are often wide of the mark.
The Quicken.com calculator, which is used on many sites, only asks for six pieces of information-current monthly rent; prospective house price; downpayment; annual income; tax filing status, and how long before the user moves-before rendering a verdict. This approach has numerous problems. First, it "hard codes" several assumptions (user's estimated tax rate, the mortgage type, home price appreciation, and the alternative investment rate) into the analysis, which prevents users from customizing them. It also excludes important items, such as the cost of selling the house. Finally, it hides many of the assumptions and provides little information with its recommendations, which makes it impossible for users to check the calculations and limits its educational value for consumers.
The homestore.com calculator also suffers from several design flaws. For instance, users are not asked how much downpayment money they have. This makes it impossible to correctly calculate both the monthly mortgage payment and the "opportunity cost" of homeownership, namely the return the renter could have earned by investing the downpayment funds in some other asset, like the stock market. It also ignores owners' maintenance and insurance costs as well as selling costs. Although it underestimates the costs of renting, leaving out renter's insurance and prospective rent increases, these errors are minor compared to the omission of owner information. Overall, the site's incomplete conclusions have a strong bias toward owning.
A few of the calculators provide a more detailed and sophisticated analysis of the rent vs. buy decision. They collect more information, and they allow greater user control in altering some key assumptions. The quality of their analysis is uneven, though. Some are both confusing and misleading, and even the best make some mistakes. Two examples in this category are homeadvisor.com and E-Loan.
Homeadvisor.com asks users for 16 pieces of information, including often-ignored items such as mortgage loan points and fees; house sales costs; maintenance and insurance costs; property taxes; and the return on alternative investments. Inexplicably, however, they fail to use all the information collected. For example, they do not consider home selling costs, mortgage points or alternative investment re-turns. Instead of using the user input for these fields to make an exact calculation, the calculator uses its own assumptions to estimate a calculation.
E-Loan similarly gives the user 14 fields to fill out. Unlike most other calculators, E-Loan actually shows many of the intermediate calculations used to make the calculation. This important information clarifies some of the details for consumers and presents them with a framework for understanding the recommendation. Here, too, however, there are important errors. Property taxes, maintenance costs, homeowners insurance and renters insurance are all fixed costs, rather than rising with the value of the home and/or with the overall rate of inflation. And E-Loan makes the same mistake in calculating home-owner tax savings that other calculators do, thereby overstating the benefits of homeownership.
There are many reasons to buy a home, but most of them are not financial. The investment potential and the tax savings associated with homeownership are often overstated, while the costs of ownership are frequently understated. Calculating the full cost of ownership is complicated, and online calculators that sacrifice accuracy for ease-of-use mislead consumers and perpetuate the myths about homeownership. Apartment firms who include these calculators on their web sites may be pushing away some of their best prospective residents.
Questions or comments on Research Notes should be directed to Mark Obrinsky, NMHC's Vice President of Research and Chief Economist, firstname.lastname@example.org 202/974-2329.
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