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Rent or buy a house?
The question to rent or buy a house is a complicated one. Ultimately it boils down to what you want out of life.
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In Australia the dream of owning "a quarter-acre block" persists (even if it was kind of a myth to begin with). Renting or buying doesn't seem up for debate.
But for all its frustrations, renting actually has some big upsides. If you want more freedom in choosing where you live and how you use your money, renting can work out better. It can even be more profitable.
Owning a home offers a form of stability and security, something more emotional than financial. But it means sinking an enormous amount of money into a property and absorbing some serious expenses, from mortgage interest to maintenance costs and stamp duty.
Let's dig into the upsides and downsides of the rent or buy dilemma.
The benefits (and downsides) of renting
Renting offers flexibility and tends to be cheaper per week than mortgage repayments.
Pros of renting
- Rent is often cheaper than mortgage payments on the same property.
- You don't have a large mortgage debt hanging over your head.
- The landlord pays the rates and body corporate fees on the property and is responsible for repairs.
- You can move more easily and live in areas which would be too expensive for you to buy in.
Because rent tends to be cheaper than owning a property you can use any extra money you may have to invest, save or spend as you see fit. This financial flexibility is one of the major benefits of renting.
Cons of renting
- Your rent money is paying off your landlord's mortgage and helps them build wealth.
- Your landlord can make decisions that affect your life, and may not fulfil all their responsibilities.
- Landlords tend to increase the rent regularly.
- Leases aren't permanent. Your landlord could decide to evict you if they want to sell the property.
Renting is an uncertain way to live. You can be evicted, landlords often fail to maintain their properties and you end up paying a lot of money that goes nowhere.
But if you find an affordable, good quality place to rent with a decent landlord you might find the convenience and flexibility are worth it. And you aren't tied to a mortgage and a single property for years.
The benefits (and downsides) of buying
Equity means the amount of a property you own (once the mortgage debt is subtracted). Properties are worth a lot and generally grow in value over time. So mortgage repayments are a kind of saving because you're building wealth. But it's a lot more complicated than that.
Pros of buying
- Your mortgage payments build up your equity with each payment.
- You have a roof over your head and no landlord to worry about.
- You can personalise and renovate your home to increase its value.
- Property values tend to increase in Australia.
- You can choose to rent out your property if you want to live somewhere else, so your tenant is paying off your mortgage.
But buying your own home locks you in to a major asset and comes with many costs.
Cons of buying
- You'll need to save a large deposit to cover the down-payment and fees associated with buying a property.
- You have a large debt hanging over your head, probably for decades.
- Interest charges on your loan can add up to hundreds of thousands of dollars.
- Property values can fall, decreasing the value of your investment.
- Stamp duty and real estate agent's fees can eat a huge chunk out of any equity you thought you'd built up if you decide to sell.
There's no guarantee that a property will rise in value. Sometimes prices fall and some areas get hit with significant price falls that take years to recover.
Is rent money really "dead money"?
Rent is money you'll never get back. You don't build equity and you don't own anything. But when you buy a property you need a mortgage. And the amount of interest you pay over the life of the loan can end up being very significant. And there are many other costs when you buy a property.
It's impossible to confidently state that renting is cheaper than buying, or vice versa. There are too many factors involved. In a market with rising rental prices but low interest rates a mortgage could cost you less than rent. But there are many cases where the reverse is true.
The costs of buying
Let's say you buy a $650,000 home in Victoria with a 20% deposit.
- Deposit: $130,000
- Loan amount: $520,000
- Mortgage: principal and interest loan with a 30-year loan term
- Interest rate: 3.70%
Your costs
- Land transfer (stamp) duty: $11,356 (this includes a concession for first home buyers)
- Interest costs over 30 years: $341,649
- Total costs (including deposit) = $1,003,005
And this isn't including maintenance costs, council rates, insurance and so on. This is a lot of money. Now of course your property will likely grow in value over time. This will partly offset the costs.
But when you sell the property you need to factor in costs such as real estate agent commission and stamp duty on your next property. This can erode some of your capital growth.
What about renting?
The maths here is very hypothetical because rental prices vary widely by property type, size, quality and location (the average Australian living in a capital city spends around 20–30% of their income on rent). Let's take the average weekly rent for a unit in Melbourne, which is $420.
- $420 times 52 = $21,840 a year
- Over 30 years that equals $655,200
That's $347,805 less than you'd spend on buying a property. That saving equals $11,593 a year.
Now, rent tends to increase over time, so this calculation isn't very accurate. But it would need to increase by at least $11,593 a year to make renting more costly than buying. Also, while we've chosen the average unit rent in Melbourne, we're comparing it to buying a $650,000 house. You could buy an apartment for less than this, and therefore pay less in interest. But it's a reasonable comparison: the average price of a house in Melbourne is much higher than $650,000, while the average rent for a house (not a unit) is $430, or $10 more than a unit.
What if you rent and invest the savings?
What if you took that extra $11,593 each year and put it into a low-maintenance investment product like an exchange traded fund (ETF)? According to recent ASX data the average return for an Australian ETF over 5 years is 6.83%. Investing that much per year, at that rate, would net you a profit of $786,909 over 30 years.
Of course, there's no guarantee future returns will equal this much on any particular fund (you can learn more about how to measure ETF performance here). But it illustrates how you can put your money to work as an alternative to a mortgage.
Rent or buy: The choice depends on you
The decision to buy or rent is not a debate, it's a question whose answer depends on your life goals and financial position. Here are some hypothetical scenarios.
I've got a young family and we like where we live
If you have a family and you want some stability and security then buying makes sense. If you're already established in a neighbourhood (maybe your kids are in school and are very happy there) and you can afford to buy there, even better.
We're a childless couple and we love living in an inner-city unit (but we can't afford to buy)
If you live in a pricey, popular neighbourhood and are happy there you might consider renting. You'll probably have more spare cash this way, although you may have to move apartments every once in a while. If you're interested in investing some of your disposable income then this approach is even better.
You could also consider rentvesting, which means renting where you want to live (expensive, trendy area) and buying a cheaper investment property somewhere else. This way you're building slow, steady wealth through a property investment while enjoying the flexibility of rent.
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