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Deciding whether to buy or rent a home is one of the most significant financial decisions that most people will make during their lives. It’s also one of the most complex, involving a range of factors and some challenging math.
In this article, we’re going to weigh up the costs of renting versus buying a place to live. It’s not the case that one is better than the other: both have advantages and disadvantages that you need to consider.
When you buy a house, you take complete ownership (even if you have a mortgage). This means that you can do whatever you like to your home, so long as you follow local planning permissions. You can put up pictures, change the decor, add an extension, refit the windows and have a new roof installed. In short, you can do pretty much whatever you like and change your home to suit your lifestyle.
When you rent, however, you’re essentially borrowing a home. You can live there, so long as you pay the monthly costs, but you’re not allowed to make significant alternations to the building. The landlord owns that.
For many people, not being able to change things doesn’t matter all that much. But for some with growing families or changing lifestyles, it could be a deal breaker. Owning in these situations may be preferable to renting.
Many people say that paying rent is money down the drain since you never build up equity in your home. However, the market is clever, and both renting and mortgage payments turn out to offer roughly the same chance to build up savings. But how? And why?
When people make mortgage payments, they’re doing two things: first they’re paying back the principle on the loan from the bank, gradually taking greater ownership of their property, and second, they’re paying interest. The interest goes to the bank’s shareholders and C-suite. The amount of interest that people pay over the lifetime of the mortgage can be a significant amount, sometimes as much as the mortgage loan itself, meaning that a lot of the money spent on mortgage payments “is money down the drain” anyway.
Renters know that they can never build up equity in the places in which they live. They just pay a basic fee to live there. The cost of the rent reflects the opportunity cost of the owner putting their money in some other asset, like the stock market. But landlords can’t charge too much, otherwise, they will provoke people to take out loans and buy their own homes. This means that the cost of rent is usually less than that of taking out a mortgage on a similar property.
Of course, working out which is cheaper is usually more complicated than this in practice. In some areas, the cost of taking out a mortgage is lower than renting, especially in the current climate of low-interest rates. In other places where rental demand is weak, prices can be lower.
It’s also worth pointing out that mortgage payments aren’t the only cost associated with ownership. If you own your own home, then you’ll also have to pay additional maintenance costs and fee which usually run at about 20 percent of the value of the monthly mortgage payments. When you rent, you don’t have to pay any of these expenses: the landlord absorbs them according to this military realtor.
In general, renting property works out to be cheaper overall, all costs considered. That means that people who rent should, in theory, have more money left over at the end of the month to invest.
One of the criticisms that many professional investors have of regular people is that too many put all their savings into the properties and not much into anything else. Ideally, people should have a portfolio split between say, 25 percent property, 25 percent bonds, and 50 percent equities. But the majority of people have no money invested in either bonds or companies on the stock exchange, and nearly all of their savings tied up in their homes.
Being in just one asset is not only risky, but it’s also not optimal. While it’s true that house prices rose over the last thirty years above inflation, this isn’t something that can continue forever, even with low-interest rates. Eventually, houses will return to their long-term average, in line with wages. The point here is that property is not a productive asset: it cannot grow in value indefinitely and, therefore, should not be treated as an investment. It’s more of a repository of wealth, rather than an asset that can generate new wealth. If anything, homes should depreciate as they get older and go down in value.
When people buy a house, banks want to make sure that they are unlikely to lose money if real estate prices fall. To do this, they ask people for a deposit: an upfront payment that covers part of the value of the house. When people put a deposit down on a house, it helps to act as a buffer between the equity that the bank must supply and the market value of the home.
The problem with deposits from a buyer’s perspective is the opportunity cost. That $50,000 that a family puts down on a house does nothing but buy a share of the equity. It can’t be put to work in the stock market.
Renting gets around this problem. People can use the money that would have gone down on a deposit on a house and invest it in productive assets that make real returns.
Taking out a mortgage is a long-term decision. When you have a mortgage, you have to ensure that you have good long-term job prospects and can continue to make payments over the course of many years. Is that something you want? Or would you prefer the freedom and short-termism that comes with renting?
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