BUYING VS RENTING, WHICH IS BETTER?
Is buying vs renting a home a complete waste of money or vice versa? We have all heard the sayings “Why pay the landlord’s mortgage, when you can get your own?” Or “if you are renting, you are just throwing your money away.” The truth is it is possible for a renter to end up with a larger net worth than someone who buys a home. But practically speaking, ownership has worked out better for most people over the long run.
To see why owning is not the only option that makes sense, let’s start from the very beginning. When you rent, you are not throwing your money away, you are getting something in exchange – a place to live. You are renting space for a period of time that doesn’t have future value after your payments stop. When you buy, you are still renting, but instead of renting space, you are renting money. The difference is that the money you have borrowed is used by an asset that will hopefully appreciate. You also happen to live in this asset. The mortgage payment consists of a rent on the money you borrowed (called interest) as well as payment against the balance you borrowed (called principal).
The buying vs renting debate has historically been black and white. Home ownership was perceived to be the pathway to financial freedom and success while renting was synonymous with financial struggles. The dream of homeownership is sold to us by everyone – family, friends, the government, banks, realtors, etc. The purchase of a home was an indication of one’s financial success. This may have been true over the last 30 or so years in Canada, when a lot of people had success with real estate. The Canadian economy was for the most part growing over that time period. The recent housing crisis has turned the tables on those who favour buying a home. People have realized that buying vs renting a home isn’t always the smartest decision. The increased cost of home ownership in big cities has caused a decline in home ownership rates. Over the past decade, according to 2016 census, home ownership rates have declined among people under the age of 35 down to just 50.6 per cent. Obviously, there is a debate going on in that demographic group about the wisdom of home ownership.
“They kind of have a backwards-looking perspective on it,” says Max Fawcett, who has written extensively on real estate topics; particularly on the topic of buying vs renting. He uses the phrase “religion of real estate”.
“If you look backwards over the past 30 years, buying has been a pretty good choice. But that doesn’t mean that buying vs renting is going to be the right choice going forward.”
In Max’s opinion, the problem is rooted in an “imbalance” of information fed to people by various sources. By realtors and bankers with a bias to sell homes. By well-meaning parents wishing their kids could benefit from the same returns they’ve enjoyed. By governments who attract first-time buyers with various incentives such as borrowing down payments from their RRSPs, claiming tax credits for home renovations, etc.
“It makes it difficult for people to accurately assess the information that’s in front of them,” Fawcett summarizes.
Millennials are turning more and more to renting rather than buying – they’ve figured buying is a “dumb money move that sounds smart.” However, in this article we will explore how both of these concepts may be wrong. Renting is not necessarily “throwing your money down the drain,” and buying is not always “an indication of financial success.”
WHY RENTING IS SMART
YOU INVEST THE “SAVINGS”
As you can see from the comparison exercise above, the biggest reason why renting could make more sense as opposed to buying is if you invest the money you save. The initial cost of renting is substantially lower than the initial cost of buying a home. Again, this only works if you are financially disciplined. In many cases, renters chose to rent a nicer home, spend more on going out, clothes and vehicles as opposed to investing into mutual funds or RRSP.
YOU KEEP A TIGHT BUDGET
The cost of buying a home continues to grow exponentially. Buying a home for many is no longer even a reality anymore. Although there are some areas where rent is comparably expensive, it generally holds true that renting is a cheaper alternative to home ownership. We see this as it takes the average Canadian two to four times as long to save up a 20% down payment.
As mentioned earlier, you save big on the initial costs when you rent rather than buying. You only need to produce the first month’s rent and a security deposit. You do incur other costs on the way such as utilities (if not included in rent) and renters insurance however, these expenses are still marginal in comparison to the expenses incurred by home owners.
Repairs and maintenance are an added cost of home ownership that is rarely talked about as a legitimate expense. Costs associated with things such as replacing roofing, furnace and water tanks, repairing plumbing or electrical issues can amount up to 3% of the total annual ownership cost. If you are renting, you simply have to call your landlord to have the repairs and maintenance addressed.
YOU HAVE RENT CONTROL
If you are lucky enough to live in a place offering rent control, your cost of living will remain relatively low. Rent control means landlords can only increase monthly rent by the rate of inflation. This means you have more money to continue to invest.
YOU DON’T WANT TO BE TIED DOWN
One of the other advantages of renting is that you’re free to move around and have a mobile lifestyle. The only caveat is you have to produce 30-60 days advance notice. After that you can go wherever you want. Whatever your need for relocation may be, a different city, a new job opportunity, you are not tied down by home ownership.
WHY BUYING IS SMART
When you buy a home, it forces you to become more financially responsible. If you do not pay your mortgage you can quite easily find yourself without a place to stay. This means you’re less likely to splurge on food, clothes and vehicles and instead allocate that money into a high interest savings account or other forms of capital investments. This forced saving helps you build equity and wealth over the long run.
AN INCOME SOURCE
To offset the high costs of home ownership in large cities, you can rent part of your property to tenants. This coupled with a frugal lifestyle means you’ll have higher income and lower expenses.
There is a lot of pressure from all around us leading us to buy real estate rather than rent. There are numerous incentives made available to attract more buyers. The Canadian government for example runs the “First-Time Home Buyer” Incentive Program. With this incentive, the Canadian government provides 5% or 10% of the total cost towards building a new home, and 5% for the purchase of a resale home. This applies to individuals with qualified annual incomes of $120,000 or lower.
When you buy, you don’t have to use all of your own money for the purchase. You cover the down payment, and the bank takes care of the balance. You pay it back, with interest, over the next typically 25-35 years.
The government offers tax deductions and credits. In some cases, there is no tax applied to the sale of your principal home.
Additionally, real estate as a rule appreciates in value in a growing economy. By the end of your mortgage term, you can come out with a property worth more than what you initially paid and have a liability-free asset.
The other advantage is that mortgage payments come to an end, eventually. Some people accelerate the timeline of their mortgage by putting down lump sum payments. Alternatively, when you are renting, the rent payments never end, they continue. There’s also the added risk of your landlord ending the rental agreement for whatever reason, such as selling the property. Suddenly your “dream home” is no longer available, and you are forced to search for another one.
At the end of the day, the debate on renting vs buying is completely subjective and scenario specific. On paper and by numbers, it might make more sense to buy a home at a certain price point compared to the monthly rental fee. On the other hand, if it drains you of your savings and leaves you with little to no “rainy day funds,” that would not be the smartest decision to make.
There are many factors that influence the decision to buy or to rent. For example, the duration of time you anticipate to stay in the home you buy. If you plan on living there for over 15 years, buying would make more sense. However, if you know you will be moving around for work or family, or whatever reason, renting would make more sense there. As demonstrated earlier in this article, it isn’t just about the numbers or what looks better on paper. There are way too many variables, which are hard to predict over the 25-35 years into the future. The Alberta economy and Canadian provincial and federal politics is a testament to this. If the calculator tells you buying is better if you can’t find a comparable property to rent under $2,000 that may sound right but if it drains you of everything you have, it’s definitely not the best decision to make.
As long as you are not overextending yourself financially to buy a new home or start living frivolously as a result of cheaper rent, either decision you make should be fine as it is yours to make.