Renting versus buying a home is an age-old debate. Is it cheaper to buy or rent a house? You may have heard one or all of the following statements:
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- If you are renting, you are just throwing money away
- Homeownership is more expensive than renting
- Why pay the landlord’s mortgage when you can pay your own
- If a mortgage payment is equal to or less than what you would pay in rent, you should buy
Is there truth to these statements, and what is the right choice for you? This article will shed some light on various aspects of the renting vs. buying debate.
- Renting is the right choice if you need flexibility. It is quite easy to relocate when renting a property, if not locked in a lengthy lease. On the other hand, it could take months (sometimes years) for homeowners to sell their property, depending on the housing market.
- You are not liable for unexpected expenses. The landlord is responsible for all home repairs, maintenance, and improvement costs. Some of these expenses can run quite high.
- You can live in a better area with access to various amenities. As a tenant, you could live in an area that you could not otherwise afford to buy. Further, some rental properties offer amenities such as fitness centres and in-ground pools at no additional charge to the tenants. Similar facilities would cost a homeowner a fortune to install and maintain.
- Minimal upfront cost. Renters are typically required to pay a security deposit equal to one month’s rent instead of a 10% to 20% down payment needed to buy a home.
- As a renter, the rules of lease agreements may limit your freedom to use or renovate the property. It may be challenging to customize your space to suit your style, comfort, or needs.
- You may have limited housing security as there is no guarantee of lease renewal. The landlord may wish to sell or repurpose the property at the end of your lease, which will force you to find a new home.
- Rental payments never stop; they do not offer a return on investment, nor do they provide wealth creation.
- Unless you live in a city with rent control and your home is covered by it, you may have no control over annual rent fluctuations. This lack of control could make your long-term financial planning difficult.
- It provides a sense of stability as you do not have to report to a landlord or real estate agent. Plus, you have greater freedom to make alterations that suit your personality, lifestyle, needs, etc.
- Since a portion of mortgage payments go toward principal repayment, this creates a kind of a savings system for you.
- The value of your home will appreciate over time, and if you plan to own it for a long time, it can be an excellent long-term investment.
- You may rent out a part or all of your property to generate additional income to put towards the mortgage payments.
- Buying a home requires a significant financial outlay. You may need to have saved up a 10-20% down payment, plus money for other closing costs such as home inspection, land transfer taxes, title insurance, legal fees, etc.
- Homeownership comes with other financial responsibilities in addition to mortgage payments. These may include property taxes, maintenance costs, homeowners insurance, etc.
- It limits your flexibility in a few ways. You can only buy in the locations you can afford instead of renting that allows you to live in neighbourhoods you could not otherwise afford to buy. Buying could also limit your mobility as that may be dependent on selling your home, which can be a lengthy process.
- Depending on the location, homeownership carries the risk of not making a profit through resale. You could end up paying out of pocket if your home’s value has decreased, and you do not have enough equity to cover closings costs.
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THE APPLES-TO-APPLES COMPARISON OF RENTING VS BUYING A HOME
Comparing mortgage payments to rental payments for the same property type in terms of square footage and location is NOT a fair comparison. Comparing the unrecoverable costs of renting vs. buying would be more reasonable.
Unrecoverable cost: This is a cost that does not generate any future value. The benefit of making a payment is received immediately not carried into future periods.
Rent is a straightforward unrecoverable cost. Once you pay your rent, you receive the immediate benefit of having access to your home. There is no future value created after your payments stop.
The principal portion of your mortgage payments is a recoverable cost and is easy to identify on your loan amortization schedule. Principal payments are the equity piece of your investment. Should you sell your home down the road, you would receive this money back in the resale price.
THE UNRECOVERABLE COSTS OF HOMEOWNERSHIP
The unrecoverable costs of owning a home are not as easy to pinpoint. They primarily include the following expenses:
- Property taxes and maintenance cost
- Interest payments (or the cost of mortgage debt)
- The opportunity cost of equity
Property taxes and interest payments are easy to identify. For property taxes, your local government will send you the tax bills periodically. Interest payments are also easily identifiable from your loan amortization schedule.
The opportunity cost of equity, however, is more difficult to pinpoint. First, let us understand the nature of this cost.
Opportunity cost of equity is the incremental return on investment that you forego when you choose to buy a home rather than invest elsewhere.
For example, assume that instead of buying a home, you take the down payment money, and invest it in the stock market. Let us also say that your investment in the stock market could earn a 7% return annually. Further, let us assume that if you had bought a home, your home would appreciate at a rate of 4% annually. The difference between what you could earn on the stock market and your home investment is the opportunity cost of equity.
In our simple example here, the opportunity cost of equity is 3% (i.e., 7% minus 4%). By owning your home, you are potentially forfeiting earning an additional 3% return in the stock market.
A FAIR COMPARISON OF RENTING VS BUYING A HOME
Now we can finally have a fair comparison of renting vs. owning a home.
Unrecoverable cost of renting = rent
Unrecoverable cost of owning = property taxes and maintenance + interest payments + opportunity cost of equity.
If the unrecoverable cost of renting is lower than that of owning, renting is a good decision. Otherwise, if the reverse is the case, buying is the better decision.
There are various benefits and drawbacks to both renting and owning a home. However, the right decision for you ultimately depends on your unique circumstances. I hope this article will help you in making the best choice for you.
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“We become what we think about most of the time, and that’s the strangest secret.” ~ Earl Nightingale