Win at the "Condo" Game

Ever think of the difference between renting an apartment for five years and owning a condo for the same? And what's the difference between an interest only mortgage and a 30 year fixed rate mortgage? This blog takes a look at just that and uncovers the best route to apartment life.

Let's start with the average price for a U.S. condo in 2007: $215,000. For purposes of this blog we're going to compare a traditional 30 year fixed rate mortgage with a 5/1 interest only mortgage at the published interest rates as of the writing of this blog. We're also going to assume a period of 5 years to hold the property (this is when the payment would increase using a 5/1 interest only mortgage).

30-year fixed rate mortgage: 5.94
5/1 interest only mortgage: 5.72

1) Using a mortgage calculator (the one at mortgage super search compares both mortgage types) we find out that the payments on our condo are as follows:

30-year fixed rate mortgage: $1,280.75
5/1 interest only mortgage: $1,024.83

2)Calculate the savings per month by taking the 5/1 interest only mortgage and the amount that can be made in risk free interest (5%) over the five year period:

Savings: $255.92 per month
Investment: $17,404.12

3) Compare the amount of equity you would accrue on the 30 year fixed rate mortgage (using the amortization table from the interest only calculator) to the amount you made from investing the savings over the same time period. Note: This assumes that the property is sold for no gain and doesn't take any fees, taxes, etc. into account.

Equity on a 30-year fixed rate mortgage: $18,672.67
Invested savings upon maturity: $17,404.12

4)At this point it looks as though the 30-year fixed rate loan is the better option. However, we didn't take into account the amount of money that was paid out during this time frame. If we take this number (from each mortgage) and subtract it from its respective gain (equity or investment) then we get our total living cost for the five year period.

30-year fixed rate mortgage: $76,845-18,672.67= $58,172.33
5/1 interest only mortgage: $61,489.80-17,404.12= $44,085.68

As you can see here, our living expenses (rent) over a five year period for a 30-year fixed rate mortgage is $58,172.33 and for a 5/1 interest only mortgage is $44,085.68. Although on the surface the 30-year fixed rate mortgage looks like the better option, mathematically the interest only mortgage is the better of the two.

5) In addition, let's take a look at what each one would look like in terms of rent. Another thing to keep in mind is the tax shield provided by mortgage interest. That's something that renters can't benefit from.

30-year fixed rate mortgage: $58,172.33/60= $969.54
5/1 interest only mortgage: $44,085.68/60= $734.76

As you can see purchasing a 1,056 sq. ft. condo with an interest only mortgage and holding it for five years (AND investing the monthly difference at a 5% return) ends up making your monthly living expense $734.76. Keep in mind that that is with no property appreciation. Should the property appreciate there is even more of a gain and makes this number either less of an expense or a profit!