When Downsizing, Renting Often Beats Buying (U.S. News & World Report)

One of the financial cornerstones of many successful retirements is paying off mortgage debt before leaving the workforce. Life on a fixed income is a lot easier if you're not making that big payment every month to a bank or other home lender.

That's easier said than done in today's market. Still, many people with mortgages seek to sell their homes and live mortgage-free in a smaller, less expensive home during their retirement years. If this transition might be in your future, it makes sense to carefully consider whether you should buy or rent your new home. Renting looks better than you might think.

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Of course, you may never actually get to the stage of closely comparing the finances of owning or renting a home. There are major lifestyle, wealth, and estate issues that might decisively tilt the decision in favor of either renting or ownership:

1. Do you like tending your own home, including gardening, lawn work, and home maintenance? Or would you like to get out from many of these responsibilities?

2. Do you like the flexibility of an annual lease that gives you the freedom each year of living wherever you want? Or do you prefer to be a long-term member of a community and stay in the same home for a long time?

Even if your answers to these questions cause you to lean strongly toward being a homeowner or renter, it's still a smart idea to go through the process of evaluating the financial trade-offs of this decision.

[See the top-rated Fidelity funds from U.S. News.]

U.S. News Money reviewed nearly a dozen buy vs. rent calculators at leading personal finance websites. Most of them did not permit buying a new home for cash. None of them let us figure out the benefits to renters of investing the amount of the new home and using the earnings to help pay the rent.

To help make sense of the trade-offs, we've developed a downsizing case study. It assumes you will be able to sell your home and have $250,000 left over after paying off your mortgage and all closing costs. You can either buy a new home with this amount or put the $250,000 in a safe investment fund and use the fund's earnings to help pay your rental expenses.

Owners of a $250,000 home would need to pay roughly 2 percent of their home's value each year for property taxes and the amount that home insurance exceeds the cost of renter's insurance. That totals $5,000 a year. Set aside another $5,000 for annual home maintenance expenditures. Utilities--heating, cooling, water and sewage, cable, Internet, and phone expenses--would generally be higher for homeowners than renters. To make the comparison easy, tack on $2,000 a year for those higher homeowner utilities. The total of these higher expenses for homeowners is $1,000 a month.

Three other key assumptions:

1. Renters will earn 6 percent annual returns on their $250,000.

2. State and local taxes will be 20 percent on investment income.

3. Inflation will affect renters and homeowners equally.

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If that $250,000 earns 6 percent a year, the individual could withdraw $1,250 a month forever and still have $250,000 left in the account. That's $1,000 after paying 20 percent in taxes. Adding in the $1,000 a month in lower renters' expenses provides renters with a $2,000 break-even rental budget.

So, what kind of home can you get with $2,000 a month in rent? A pretty nice one. Moody's Analytics maintains a set of "buy to rent" ratios for more than 50 metro areas throughout the country. It uses home prices from the National Association of Realtors and rental information from Property and Portfolio Research.

For each metro area, the ratio compares the median price of a single-family home with the annual rental cost of a typical apartment. The higher the ratio, the more expensive homes are relative to apartments. (New York Times economics writer David Leonhardt has used these ratios for several years in annual rent versus ownership pieces.)

Moody's emphasizes that its ratios are of limited use. They do not, for example, have any way of comparing the quality of a market's housing stock. Perhaps the median-priced home is nicer than the average apartment, for example. Still, the ratios provide a rough idea of where you'd come out by renting instead of buying.

These ratios are most commonly used in comparisons of homes purchased with a mortgage. In such cases, according to Leonhardt and others, buying beats renting when the ratio is 15 or lower. But the advantages of buying at these ratios decreases in a downsizing scenario when a home is purchased with cash and there is no tax deduction for mortgage interest expenses.

Based on the most current set of ratios, the depressed housing market in Cleveland is the only metro area tracked by Moody's where the rental equivalent of a $250,000 home is more than $2,000 a month.

Interestingly, homes outside of these 50 metro markets are even more reasonably priced, with the median U.S. home costing slightly more than 13.8 times an equivalent rental unit. For our case study, this translates into $2,055 in monthly rent on a home equivalent to one selling for $250,000.

Here is the current list of buy-to-rent ratios as of the first quarter of the year. The ratio over the 15-year period from 1989 through 2003 is also listed. It will help provide a view of the long-term relationship of home prices and rental costs. Also, we've calculated the monthly rental in each market for a home equivalent to one costing $250,000.

In nearly all cases, renters would come out ahead, and still have their $250,000 as a retirement nest egg.

2011 Equivalent Rent for $250,000 HomeWashington, DC - Northern VA - MD

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Graduate School Debt Often Curtails Plans of Nonprofit Work (U.S. News & World Report)

The Project on Student Debt's recently released report, titled "Student Debt and the Class of 2009," estimates that college seniors in 2009 graduated with an average of $24,000 in student loan debt. For those continuing on to obtain advanced and professional degrees, the situation is even more dire. For example, the American Bar Association's Legal Education Statistics for the academic year 2008-2009 indicate that the average amount borrowed by law school graduates attending public school is $66,045 and by private law school graduates is $100,002.

Put these grim statistics next to the fact that salaries for public service and government positions are stagnant, and you have an alarming trend: Many people who want to work in public service jobs will not be able to afford to pursue those careers.

[Read 10 things to know about applying for a nonprofit job.]

In 2002, Equal Justice Works, the National Association for Law Placement, and the Partnership for Public Service conducted a study "From Paper Chase to Money Chase: Law School Debt Diverts Road to Public Service" which found that law school debt prevented 66 percent of student respondents from considering a public interest job or government job. For example, entry-level civil legal aid lawyers earn on average $40,000 according to the NALP 2008 Public Sector and Public Interest Attorney Salary Report. Repayment under the standard 10-year plan, which would require a monthly payment of approximately $863, would be virtually impossible at that income level. Even under a 30-year repayment plan, the approximate monthly payment would be nearly $500 per month.

[Get tips and tools for managing student loans.]

Similarly, an ABA Commission on Loan Repayment and Forgiveness report, "Lifting the Burden: Law Student Debt as a Barrier to Public Service," came to the following conclusions:

-- As law school tuitions and student debt have sharply escalated, fewer and fewer law school graduates can afford to take comparatively low-paying public service positions.

-- Many law graduates who take public service legal jobs must leave after they gain two to three years of experience, just at the point when they have gained enough experience to provide valuable services to their employers and clients.

-- Public service employers report serious difficulty recruiting and retaining lawyers and have vacancies they cannot fill because new law graduates cannot afford to work for them.

These repercussions are not limited to the legal profession. Numerous professions demand advanced and professional degrees but do not provide salaries that reflect the educational debt graduates take on to obtain them. Examples include teachers, medical students who want to help their communities as primary care physicians instead of becoming specialists and, in many cases, government employees.

What are the consequences if graduates forego public service and government work?

For individuals, including some of the most energetic, entrepreneurial, and brightest of every generation, it entails deferring or giving up altogether their dreams of giving back to their communities at a nonprofit, a school, or in government.

On a social level, it means government and nonprofits are unable to recruit and retain people to do public service work. This means that fewer people will be working--to give a few examples--to improve education, preserve the environment, care for the sick and elderly, protect communities as prosecutors and police, or aid the underprivileged as civil legal aid attorneys. When these positions are unfilled, it is ultimately the poorest and most vulnerable among us who suffer the most.

Fortunately, in 2007 Congress passed the College Cost Reduction and Access Act of 2007 (CCRAA). Its two primary components, Income-Based Repayment and Public Service Loan Forgiveness, form the most powerful federal loan repayment assistance program in a generation.

Income-Based Repayment is a repayment plan that can substantially reduce the monthly student loan payments on federal loans. Public Service Loan Forgiveness provides complete forgiveness of any remaining Federal Direct loans after an individual has made 120 qualifying monthly loan payments while working in a qualifying public service position. Working in tandem, IBR and PSLF have the potential to relieve the burden of tens or even hundreds of thousands of dollars in educational debt for individuals committed to public service work.

[Get answers to reader questions about repayment.]

Will CCRAA provide an opportunity for a new generation to engage in higher levels of public service? If CCRAA had been available when you graduated, would it have changed your decision about where to work? And for those of you about to graduate or who have recently graduated, will it enable you take the job of your dreams? Or does more need to be done?

Let us know what you think!

Isaac Bowers is the senior program manager for Educational Debt Relief and Outreach at Equal Justice Works. He was previously an attorney at Shute, Mihaly & Weinberger LLP in San Francisco, where he focused on environmental, land use, and planning issues. A graduate of the New York University School of Law, Bowers also has extensive experience in nonprofit advocacy and outreach.

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