Should You Buy or Rent Your Home?
Buying versus Renting Your Home
In The UK, like in America, almost everyone aspires to own a house (or maybe a flat) This may date back to the efforts of the previous Tory government to make everyone a homeowner or ancient property-ownership based voting rights, but anyone who does rent a property will eventually get fed-up with being told of the financial stupidity of their actions. In this article I hope to address some of these financial myths and misunderstandings and show how to work out when is a good time to buy or rent. I shall also demonstrate the actual mathematics behind the pros and cons of renting versus buying a property. Over the long term it is rarely cheaper to rent than to buy (how else would the landlord make a profit) but over short durations and at certain times in the market cycle it can be cheaper and certainly less risky.
Disclaimer: Information in this and other linked articles is unregulated and for general information only and is not intended to be relied upon in making specific investment decisions. Appropriate independent advice should be obtained before making any such decision.
Myths and Sayings
"Rent is Dead Money"
i.e. The rent money just disappears and you get nothing for it, whereas with a mortgage...
In fact, rent buys you accommodation and a service (repairs, maintenance, buildings insurance and possibly other services in the case of some apartments, which you would otherwise have to pay for if you purchased the property) You are also paying someone else to take the risk of homeownership.
Mortgage however really is dead money - it even means that in French (Mort - gage. O.K. that's a bad translation, but it means dead pledge in old French) A mortgage is however rented money. The payments are to borrow the money to pay for some portion of the property. The risk is then taken by the homeowner, not the landlord.
"Renting is making a rich landlord richer"
You certainly might make the landlord (possibly an entrepreneur or small business person) richer, but (s)he also is taking the risk and providing a service. A mortgage is making a rich banker, mortgage broker, investment banker and a few other people richer and you are taking most of the risk.
"House Prices Always Go Up"
As we have seen recently that isn't true. In fact property prices move in long cycles oscillating about an average multiple of earnings and the cycle is closely linked to the credit cycle. An average house price of five times average earnings would be high and a value of two would be low. Inflation is usually positive and that is what makes house values appear to always increase.
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Now for the maths
When buying a property as an investment (e.g. a "Buy to Let") the profitability versus risk is very important. When buying a home for yourself and family the profit or loss versus renting is not the most important consideration, but the potential risk may be. There is far more to consider that just is the rent more than the mortgage.
What are the other costs and risks?
Deposit: How much will this cost in lost interest?
Mortgage: What is the best rate you can get and how much deposit do you need to get a good deal. What is the arrangement fee?
Stamp Duty:0% for properties under Â£175,0001% for Â£175,000 to Â£250,0003% for Â£250,000 to Â£500,0004% for Â£500,000 to Â£1 million5% for Â£1 million to Â£2 million7% for Â£2 million and above (unless you buy through a company in which case it is 15%)
Solicitors' fees: Extra costs incurred when purchasing the property
Service Charge: Serviced apartments may have an additional fee which will be included in the rent
Maintenance and repairs: What repairs or renovation needs to be done and what will the ongoing costs be?
Being forced to move home: Loss of job, illness, relationship breakup etc.
Forced selling of a property can result in having to sell at a low point in the market and therefore incurring a big unexpected loss. When renting this is unlikely to be such a big cost apart from possible loss of a few months rent.
See below for some examples for different scenarios
Scenario Number One: Healthy house-price growth
This example is for a half million pound apartment in London where prices are quite high, but rents surprisingly low. I have assumed a 6% house price growth (i.e. way above inflation) an average mortgage of 5% and a 7% return on the money not used for deposit (i.e. taking some risk, such as a stock market investment, to mirror the risk of home ownership)
House Price = Â£500,000
Deposit 25% = Â£ 125,000
Mortgage = Â£ 375,000
Mortgage Cost = 5% or Â£ 18,750 per year
Stamp Duty = 4% or Â£ 20,000
Service Charge= 1% or Â£ 5,000
Maintenance = 1% or Â£ 5,000
From the spreadsheet above you can see that despite healthy house-price growth of 6% per year, it actually takes 4 years to break-even versus renting and it has still cost Â£10K a year.
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Scenario Number Two: House Prices Stay the Same
The same property, but with zero house-price growth.
The rental situation is the same, but the propery ownership scenario is very bad: a Â£192k loss.
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Buy versus Rent?
Scenario Three: Falling House Prices
Now the same scenario with a 6% fall in house-prices.
Obviously this is an extreme scenario, but a real one for the current state of the UK house market and does demonstrate that sometimes, when there is a possibility of house price falls, the potential risks of owning property can outweigh the joy of ownership.
I couldn't add an interactive excel spreadsheet here, but if you want to model your own situation it is very simple to do, using a spreadsheet similar to the above (calculate each of the extra costs of home-ownership and add them together and subtract the house-price gain then compare with the rent of a similar property minus the profit accumulated on the deposit cash), or checkout the microsoft excel books listed below or this Excel Article...
Microsoft Excel Books
What house-price growth rate do you need to break even?
Some more Maths
Most articles on the subject of buying versus renting concentrate on just the mortgage rate versus the rental cost, but that is missing a lot of the cost and risks. Here is a more thorough analysis of which is cheaper, renting or buying your home:
Cost of Renting (R) = Time in Rented accommodation x Rent
where Rent = Rental Percentage (r) x House value (H)
R = trH
Cost of Buying (P) = Stamp-Duty (i.e. tax) + other one off costs + Time in accommodation x (House value x mortgage rate + other on going costs) - increase in value of property
P = H(S + t(Mm0 + Dd + m1 - g))
S = Stamp Duty Rate + other initial costs (as a %)
g = growth-rate (%)
m0 = mortgage rate
M = Mortgage percentage
D = Deposit percentage i.e. 1 - M
d = return on deposit (i.e. lost earnings from having spent your deposit)
m1 = percentage maintenance and other on-going costs
So, to break-even i.e. for renting and buying to be the same cost if d = m0 (a reasonable assumption since the deposit money should be invested in a higher risk and higher return asset than cash for an reasonable risk comparison) or for a 100% mortgage:
trH = H(S + t(m0 + m1 - g))
g = S/t + m1 + m0 - r
or growth rate required to break even when buying a property versus renting is the mortgage rate + maintenance rate (service charges in a flat + other costs) - rental rate + (Stamp-duty and other one-off costs) / time in property
For expensive London properties S = about 5%, m1 = 1% or more and at time of writing m0 = 5% (or significantly more if you assume a large loss of income on the deposit or a 100% mortgage) So for a short term let of 2 years
required growth rate to break even = 2.5% + 1% + 5% - 2% = 6.5% minimum
So a growth of significantly more than 6.5% would be required to compensate for the risk of ownership e.g. 10%
Add to that the fact that if the house price growth rate were to rise at 10% a year for any significant duration then the inflation rate would be high causing the interest rate to have to rise (i.e. the required growth rate to break even would increase)
Now for an example at the other end of the scale: inexpensive properties for which S = about 1.5% (no stamp-duty below Â£125,000), m1 = 2% or more and at time of writing m0 = 7% (assuming a near 100% mortgage), but rent is comparatively higher percentage of the value of the property (e.g. 5%) So for a short term let of 2 years
required growth rate to break even = 0.75% + 2% + 7% - 5% = 4.75% minimum
This may seem quite low, but house-prices have only beaten inflation by about 1% a year averaged over the last 70 years and a 7% growth rate would mean house-prices double every decade or approximately grow by 25,000% in a lifetime (i.e. growth rates consistently more than 1% above inflation are impossible and after periods of above inflation growth there would need to be a period of below inflationary growth)