Rent vs Buy - Not a Simple Decision!

May 3rd 2019 by Andrea Kirkby

Buying Your Home Financing Your Home

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The question of whether you should rent or buy your home is always a vexed debate. Some people assert that renting is "dead money", a waste of your resources when you could be investing in a property of your own; others say house prices are too high, and a mortgage ties you down when you could have more freedom renting. Who's right?

A Very Personal Choice...

There are two aspects to the question. One is your own personal lifestyle; do you value flexibility or certainty? If you're the kind of person who likes things settled, if you have a stable career, and aren't going to pull up your roots, then you're probably going to be better off buying.

But suppose you fancy the chance to work overseas for a few years. Or you might want to up sticks and travel for a while. Or your business is a feast-and-famine kind of job, so that some years you're rich, other years you're living like a pauper. If that describes your life, you might be better off renting. At least if you can't pay the rent, the worst that happens is you'll need to find somewhere else - you won't lose your investment.

Of course you could move overseas and rent your house out in the meantime. But that could have negative tax consequences. And property is not a liquid asset; it may not be easy to sell when you want to.

There's one advantage to buying, though, that not many people think about. It forces you to save money. If you're the kind of person who fritters away money if it's sitting in your account, you might be better off with a mortgage. Every time you pay your mortgage, you're saving and investing - even if it doesn't always feel like it!

Or Just a Financial Equation?

But there's another aspect that needs to be considered. That's the financial equation. And it's not quite as simple as saying that rent is "dead money" while buying your own home is an investment.

For a start, if you buy a house, the purchase price isn't all that you will pay. There will be a transfer tax and mortgage fees to consider. Stamp duty could be as much as 7% of the purchase price, if you're buying a property at more than $3m in NSW. More likely you'll be paying between 1.5% and 3% of the purchase price. There's a good run-down of stamp duty rates at Your Mortgage.

Then you'll need to factor in the running costs. Unlike a tenant, you'll need to pay for buildings insurance, property taxes, and maintenance. One rule of thumb for maintenance is that it could cost on average 1% to 1.5% of the property price every year. Some years there will be nothing to do; other years you'll need bigger resources to pay for repainting exterior woodwork or even re-roofing.

Besides, your mortgage payments are not just a repayment of the original loan. You're also paying interest. In the early years of a mortgage, pretty much everything you pay is interest. And that's "dead money" just like rent - it's money that will go to make someone else rich, in this case, your bank. There's a good article on this that shows how on a house worth $600,000, the cost of servicing a 30 year mortgage can mount up to well over $1m. That means that you'll end up paying one and a half time what you thought you were paying.

Purchasers with a mortgage do benefit from the effect of gearing on their investment. If house prices go up, you'll get a geared return on your deposit. Suppose you put down $100,000 on a $600,000 house, and the price goes up 10% to $660,000. That's a return of 60% on your initial investment! But if the price goes down 10% to $540,000, you've seen more than half of your deposit wiped out. It's easy to forget when the market is going up, but buying a house exposes you to capital losses, too.

Markets Change - So Does The Rent vs Buy Formula!

Let's go a bit further into financial modelling. To do that, we'll need to look at current rental levels as well as property prices and interest rates. Rental yield - that is, the percentage return if you let out a property at today's prices - needs to be compared with the interest rate you'd pay to buy the property.

The state of the market can vary immensely over the years. Right now, particularly in the capital cities, renting actually costs in from a financial perspective. That is, house prices are so high that you'd pay more money out on a mortgage than to rent the equivalent property. But that's not always the case. It's worth tracking the balance between rental yields and interest rates over the years - if it changes, that's often a good indication of where prices will go next.

Rent vs Buy Calculators can Help You Decide

Just for financials, you could use a "rent vs buy" calculator like to analyse your options. But don't forget that you need to think about that personal element to the decision, as well. If you're going to want to pack it all in after a few years and go to live on an ashram or drive a camper van round the world, buying might not be your best move!

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