Are You Wasting Money When You Rent a House Instead of Buying it?

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To buy or to rent, that is the question

You might have heard that when you rent a house, you’re effectively throwing money away. Is this true? No, it isn’t! Compare renting to buying: typically, the money paid for rent only manages to cover the cost of maintenance and the mortgage. Consequently, if the purchased house doesn’t appreciate in value then there wouldn’t be a difference financially between buying or renting. In fact, by buying a home you’re forced to stay in one place for at least a couple of years, if not longer. In the long run, however, investing in real estate has proven to have good returns in many growing cities.

To rent or not to rent?

Although it is commonly thought that renting is a waste of money, it definitely isn’t. A lot of the time, your rent barely covers the cost of owning a home.

Let’s say you want to buy a house. On average, you’d have to put down at least a 5% down payment on your home. To keep things simple, let’s assume that you borrowed the needed down payment amount as well. After all, you could have used that money in other investments. The cost of homeownership would then include the following: all interest payments + property tax + maintenance fees (e.g. condo fees). We don’t count payments towards your principle because that’s like forced saving into a savings account (that you can only draw from using another mortgage or a HELOC).

If you’re getting a condo apartment of $500k in Toronto (which is cheap!), with an estimated annual property tax of $1800 and condo fees of $400 and a mortgage rate or borrowing cost of 3.5%, homeownership costs would round up to about $2,000 per month. That’s not so different from the equivalent rent!

Another important factor that cannot be overlooked is the time and money you’ll spend maintaining and repairing your property. Your fridge breaks – whoops, there goes at least a thousand. When you add up all of these small costs, you end up having to spend a couple more hundred every month in time and money. At the end of the day, you would pay a similar amount to if you just rented. If the purchased property price doesn’t change over time, you wouldn’t save any money buying versus renting. In fact, if you sell your home very soon, you might even lose money because of all the fees you had to pay when buying and then selling your home again.

When should you consider buying a house?

As of 2016, 67.8% of the 14.1 million Canadian households owned their homes. The homeownership rate for the US is slightly lower than Canada at around 64.8% as of 2018. When is an investment in real estate via a home purchase something you should actively consider?

If you’re likely to stay in your current neighborhood for more than five years, especially in a city that is clearly growing such as Los Angeles or Toronto, an investment in real estate will likely pay off as more and more people look for homes in your area.

Are there any advantages to buying a home?

Ever wondered what you stand to gain from buying a property? There are two main advantages to owning your home:

  1. You get to save money with an interest rate much higher than the average savings account. Everyone knows how easy it is to spend all the extra money we have in our budget and how hard it is to save – with a mortgage, every payment you make deposits money into the piggy bank that is your home, and at an interest that’s much higher than you can get in a savings account.
  2. You can leverage your money much more than with other investments and without a significant risk of being forced to sell. With a 5% downpayment, you can effectively leverage your money up to 20x at an interest rate far lower than what you could get by borrowing from a bank or broker for an investment or margin line of credit. This means that if your property gains 10% in value, you get 20x the profit to 200% of your initial investment. In addition, while stockbrokers might liquidate your investments at any time, mortgage lenders are reluctant to foreclose as long as you’re able to keep making your payments. 

In summary

  1. If you think real estate will go up then buy a property since you can effectively leverage your money up to 20x. The interest on the loan is what you would be paying anyway as part of your rent.
  2. If you think the prices will decline, then you should be careful as leverage works both ways and can easily also drive you underwater on your mortgage. But as long as you keep making payments, your lender will rarely ever foreclose on you.
  3. If you don’t want to speculate or want the flexibility of being able to move around, then renting a home is not a bad idea and may even be better as the amount you would have to spend on homeownership costs would be similar to your rent. You might consider buying a home if you are sticking to one place and want the additional opportunity to save by putting it into your home and effectively earning an interest rate higher than any savings account available. 

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