!!Renting Versus Buying

Many people ask the question “am I better off renting or buying?”. The difficult truth is that there is no simple model that can provide an answer to this question for all people in all places at all times. Hopefully, we will soon provide an interactive Rent vs Buy calculator here that enables people to input their specific details and provide some output on how the decision will affect their future under a range of realistic future outcomes. Meanwhile, here are some thought provoking questions and some discussion of the implications of your answers.

1) Is it cheaper to buy than to rent a similar quality home in your current or target area?

If yes, you should seriously consider buying, after carefully assessing your intended length of tenure and the possibility that prices may fall. Typically, rent rises over time roughly in line with inflation, while purchasing more or less ‘locks in’ your housing costs. At the end of your mortgage, your housing costs will fall to very low levels, whereas the costs of renting would continue beyond this time, likely continuing to rise with inflation.

With rental yields at historic lows of typically 3% to 5% in capital cities, we’ll assume this applies to very few. For the rest, renting will be cheaper than buying.

2) Do you save / invest money without fail each week/fortnight/month while renting?

If the answer is no, you fall into one of two groups. Either you lack the discretional income to do so, or you lack the willpower. In the case of the first, why on earth would you think that you could afford to pay more in interest than you can in rent? Buying would be asking for trouble!

If it’s discipline you lack, you should either teach yourself to save (it’s actually rewarding once you get going) or seriously consider buying. Buying, if you have the capacity but lack the willpower, can be a handy form of forced saving. Sure, at the beginning a huge majority of your mortgage payment goes just to cover interest. But a small amount goes to principal payment and after 25 or 30 years you will own a home. If your alternative is renting and blowing your money on doodads or lifestyle costs, by all means consider buying.

If you answered “yes, I save / invest the difference between my rent and ownership costs” then congratulations! You’re in the enviable position of having options. Unfortunately for you, this makes the Rent vs Buy question much trickier. And this is where a calculator becomes particularly useful. You need to be able to input your specific details and assess your outcomes for a range of future scenarios. The New York Times feature one such interactive calculator at the following site:

http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?

If you would rather a more detailed calculator, here’s one we built in MS Excel that you can download and modify as you wish:

Rent_v_buy.xls (84.48 Kb)

But the uncomfortable fact is that the future is by its very nature uncertain. The best laid plans etcetera. The best you can do is make an informed decision.

Q3) What is the shortest time in which you can realistically expect to repay a mortgage?

Simply put, shorter is better. It costs the same amount per week to repay a $300k loan over 30 years as it does a $230k loan over 15 years. Interest payments are the killer. Typically, repaying a loan over 30 years means paying around 2.5 times the purchase price. 1.5 times goes just to interest. So by signing up to a $300k mortgage on a $300k home on which you’ll struggle to make minimum payments, you’re agreeing to pay around $750k for the home. If you have the capacity to repay more quickly, say 15 years, you’d pay just $450k for the same home.

Alternatively if you can buy something cheaper for $230k you’d repay it in just 15 years for the same weekly cost, saving $xxx in interest. Likewise if you buy the same $300k home with a $70k deposit and the same repayments. You’ll end up hundreds of thousands of dollars ahead who bought the more expensive home or just made minimum payments!

4) Is this decision dominated by ‘investment’ considerations?

If you only have one home, thinking of it as an investment is self-destructive. Even if it ‘goes up’ in price, it is likely that others will ‘go up’ also. You’ll still have just the one home, tradeable for just one other similar home. In fact, if prices rise for homes of your chosen location and quality, more desirable homes will likely rise more in price. This would leave you relatively worse off.

See also The Property Ladder Myth.

Q5) Do you value the ‘utility’ provided by buying at the price you are paying?

Ownership provides not only additional costs, but also benefits. Ross Gittins calls this ‘psychic rent’. The value you place on being able to make the garden grow how you want, to paint the walls whatever colour you desire. To put in picture hooks or even knock down a wall!

If renting costs you, say, $1,200/month and buying would cost $2,400/month, do you value these benefits at $300/week or more? Is the benefit of ownership more valuable than the other things you could buy with that money (including an early retirement)? If so, you should consider buying if your finances permit. It’s not enough to approach the issue purely from a cold, mathematical perspective. There is also a quality of life issue. But you do need to put a cold, mathematical value on this quality of life advantage that buying may (or may not depending on you situation/disposition) provide. If you can rationally offset these costs now and the implication on your future financial position/retirement age/whatever then buying may be the best option. Just be sure you are not using this excuse as a cover for buying with ‘investment’ motives in mind!

In summary, some people criticise the ‘howmuchamonth’ crowd, but this is misdirected. ‘Howmuchamonth’ is relevant to decisions based on the cost of renting. It is also relevant to decisions involving ‘psychic rent’. And most of all, it is relevant to decisions based on affordability – the cost of buying relative to income. If this cost makes sense relative to your income, relative to the cost of renting, relative to the non-financial benefits, then by all means, consider buying. The worst case scenario if you’re realistic about your ability to repay, is that prices might fall. But in that case, the value you’ve placed on ownership (in cold, mathematical terms) is unchanged. You’d still be getting precisely the same utility for precisely the same price that you originally valued it at. It just means that future buyers place a lower dollar value on this utility. That should not bother you. Providing you were honest about the purchase being a rational utility-based decision, not an investment…

One final note:

Suppose you’re leaning towards buying. Before you do so, get realistic about all the costs you may not yet have considered.

1) A repairs/maintenance budget

2) Council Rates

3) Water Rates

4) Insurance

5) Body Corporate?