The Perennial Question: Should I Rent A House Or Buy A House?
Rent vs Buy
Should I rent my home, or buy it (with a mortgage)? This is a common question, and there is no clear answer as to which is definitely going to be better financially: it all depends on a lot of unknowable factors, especially house prices and rent levels in the future - not to mention your income and ability to earn in the future.
Still, it is something to think about, because there are good reasons for buying a home, and the real question is not usually just whether to rent or buy, but whether to rent until you can save enough to buy outright or with a deposit and a mortgage, or just to buy (with a mortgage) as soon as you can?
Reasons for owning your own home include the fact that you have control over it: you can decide whether to keep pets, what maintenance or improvements to make to it, and so on. There is no landlord or agent to chase when things need doing: you can do them yourself, and to your own satisfaction too. You can also to a greater degree choose the location of your home, and you have much more security: no landlord is going to turf you out arbitrarily because it is needed for something else. You also have the option of renting a room out for extra income, an option that is often not available with rented accommodation. On top of that, you can try to modernise or improve the property and sell it at a profit.
Another key reason for owning your own home, perhaps the main one for many people, is that it is an asset: it is a store of value for you, your family and your descendants (ideally). Once you have paid off the mortgage, it really is yours (to the extent that the government allows you to keep it - they may need the land for yet another road, after all, but in civilized countries at least they will pay you for it).
Generally, if we assume for the sake of example that rents and house prices stay constant, then it is likely to be cheaper to rent than to buy - but only up until such time as the mortgage would have been paid off if you had bought. Once the property is paid for, it is dramatically cheaper to live in, forever more. There will always be expenses, but they will never compare to the continuing huge expense that rent constitutes for most people. Ideally renters should not be paying more than a third of their income in rent, but in expensive cities like London, England, it is commonplace (in 2012) for people to be paying more than half, and sometimes even three quarters of their income, in rent. This is clearly just money down the drain, as such high outgoings make it extremely difficult to save up for a deposit on a house. And after the latest banking crisis, large deposits are required.
House prices in London and in many other places worldwide are also far too high at the time of writing. This is often measured by way of an “income multiple.” To purchase a house in England (for example), it used to be the case that you could not get a mortgage for more than three times the main wage-earner’s annual income. Three was the income multiple used to determine if the mortgage payments would be affordable. Later, as house prices began to accelerate, this rose to 3.5 times the main income plus 1 x the partner’s income. Later still, it rose in stages to 4 times both incomes... Before the Credit Crunch, it was possible to get mortgages for 8 times both incomes and even more: it was up to you how you paid for it. You could even ‘self-certify’ and simply state on a form that you could afford it: no thorough checks were made, or you could rely on (pay) a friendly broker to claim that checks had been made. The lenders pretended not to know about it and since the crash one or two scapegoats have been prosecuted, but the practice was widespread at the time. A lot of people gambled on rising prices to bail themselves out: they hoped they could sell at a profit and pay off the mortgages in a few years’ time. This worked for a couple of decades, where prices were rising crazily, but of course, the bubble has burst in the West, with other countries to follow in due course (China too probably, at some point). A lot of people are still in profit, but others now, particularly in the USA and parts of Europe at the moment, have “negative equity” - that is, the current price of their home is less than the capital repayments they still owe. In such situations, banks with financial difficulties of their own are inclined to foreclose on any late payers with even quite modest negative equity to try and limit their losses by selling the property themselves. Late payers with huge negative equity may get away with it if the bank thinks they’ll lose more by foreclosing than not, though. It varies.
So: the market is difficult at times, and unpredictable at best. What to do? Buy, rent and save up, wait for prices to fall or get in quick before they go up again? In reality, there is no knowing, and I think that other considerations have to take priority - how much you value your independence and control over your living conditions, plus on the practical side, affordability and cash flow. Whatever you do, it would be a good idea to try and arrange it so that you can keep paying the rent and save up at the same time, or keep making the mortgage payments (and save or invest more widely too, ideally). All options require you to try and maximise your income and minimise your unnecessary expenditure. Of course.
Generally, rent should be lower than mortgage payments for the equivalent property. This is not always the case when the markets are volatile, but there is little point in paying more in rent than you could buy a house for, so usually rates settle down after a time. Rents can be relatively high when mortgages are hard to obtain, such as right after a banking crisis...
On the financial side, it can help to be able to, roughly at least, calculate the costs so you can work out what or how to do what you want to do. An all-purpose rent/buy comparison calculator doesn’t exist, since tax laws differ from country to country. For instance in the USA mortgage interest and some maintenance or community living costs (service charges) get at least partial tax relief, while in the UK there is usually none. In some countries there may be capital gains taxes when you sell a home at a profit, in others, none if it is your primary residence. And so on. Furthermore, not all calculators that do exist work in the same way. Some assume that while renting you can invest your savings and get some compound interest after tax, making renting more viable, while others ignore this possibility. Some ignore tax reliefs, some take it into account without specifying exactly how... So you must find one that suits your particular country’s system and your personal requirements, or do the math yourself... Also, of course, they are only looking at the financial considerations.
There are some links to a few useful real estate rent or buy calculators on my website which you might want to try out. For now, let’s just do a basic calculation so you can see the general idea.
Example: Buy with 20% Deposit
This is the usual scenario: you have a deposit ready and take out a mortgage to buy a house or apartment. I’ve based the figures on typical prices in London, England, so substitute your own figures. The calculation works in exactly the same way for all currencies and is based on a 25-year repayment mortgage at the historical average interest rate of 7% per annum. The calculators linked to above will help with calculating some of these figures, and there are numerous mortgage payment and compound interest calculators available online.
Price of property £340,000
Deposit 20% £68,000
Mortgage Amount £272,000 (the capital that has to be paid back)
Cost of purchase, say 2% £6,800 (taxes, broker fees, estate agency fees, etc.)
Payments at 7% interest, 25 years £1923 per month
Total Payments £576,900 (capital & interest. Note: you pay for 2 houses!)
BUT, AFTER 25 YEARS:
Value of house at 2% pa growth £546,869 (assuming it grows - if not, you lose accordingly)
Net Worth: Assets £546,869 (the value of the property)
Liabilities: Nil (but you may have expenses like buildings insurance)
COMPARED WITH RENTING FOR 25 YEARS
Rent paid at £990pm + 2% pa £379,751 (rent assumed to increase by 2% each year)
Savings (saving a flat £1923 - £990 = £933 per month for 25 years, at 2% net compound interest)
Net Worth: Assets £365,783 (Savings)
Liabilities: Nil (but you must keep paying rent, or buy!)
As you can see, whether renting or buying, you (might) build up some net worth (a measure of your true wealth: your assets minus your liabilities). The outcome of either renting or buying depends, totally, on how the rent and property markets move, and on how prudent you are with your money and how much you can earn, and if you are a couple, whether you can stay together and in good health for that long! Nevertheless, if it all works out in an average sort of way, buying does increase your wealth more rapidly than renting in a growing economy. In a way, this is obvious, as if people were able to get too wealthy by renting, landlords would be able to put their rents up higher! So on this basis, the answer to the question of whether to rent or buy as soon as you can afford a deposit leans towards buying if (and only if) house prices are rising and interest rates are reasonable. By doing so, you build up your net worth more rapidly. However, do remember that house prices can move downwards as well as upwards, and sometimes they can move downwards for years or even decades - although such a long-term slide hasn’t happened in Britain or the USA since the Great Depression. But that doesn’t mean it can’t happen. In that case, as long as you can stay ahead of the falling value with your payments so you do not get into negative equity, even though you do not build up such a great net worth by buying, you do at least end up with a solid asset of some value at the end of it, and you can live in it relatively securely. And, once it is fully paid for, you may be able to save and invest elsewhere at a significantly increased pace.
The scenario above assumes that you can save the difference between your rent money and the amounts you would be paying towards mortgage payments. However, many people rent because they can’t afford mortgage payments, so saving up like this is a problem. In this case there is little choice other than to cut the cost of rent by living with relatives or sharing with other people (either subletting a room if you can persuade your landlord that that is the only way the rent is going to get paid, or living in a shared house of some sort). Increasing one’s income would help too, of course.