Housing will be a major and constant expense in your life. You have two flavours in getting a roof above your head, each with their own pros and cons: buying and renting. A house you buy becomes your property. It is yours to keep, but also yours to maintain. A house you rent is someone else’s property that they are willing to let you use for a price. It is not yours to keep, but also not yours to maintain (up to a degree).
Rather than listening to commonly spread advice such as “renting is throwing money away”, learn about the pros and cons of buying versus renting and come to a decision that fits your life at the moment. There is no clear option that is always better than the other, and there is no option that is always better for you in every stage of life.
The “don’t throw money away” statement you often hear has to do with the rent disappearing from your bank account never to be seen again, and with buying a house, at least you pay off the mortgage and get to keep that amount in the value of your house. What is forgotten are the costs of owning a house. These are the unrecoverable costs of home ownership. That same mortgage you pay off also includes interest on the loan, which is also money disappearing never to be seen again.
Further, you buy a house in a certain state at 100% value. Over time without maintenance, your house will wear down. The paintwork will deteriorate and decrease the value of your home to, say, 95% of the original bought value. To bring your house up to 100% value again, you have to spend money on the paintwork, which is also throwing money away. You do not gain any money in the grand scheme of things, you simply bring the value of your house back to your bought price.
A forgotten cost is missing the growth of investment capital of your additional savings. The money you save by not having to own and maintain a house can be invested and make a profit. This difference can be invested by the renter, while the owner cannot. Sure, the owner can invest additional money above his monthly housing costs, but so can the renter invest the extra money as well. The owner is throwing away potential profit here.
So, yes, you do throw money away while renting. You also throw money away while buying. In return, you get a place to live, so maybe call the beast by its correct name: spending on housing. Throw away the “throwing money away” feeling. By calling it spending, you can now optimise for it. What is the best option in your case: renting or buying?
Here it gets interesting, as there will be many factors that eventually decide the financially best option. There are calculators available that ask you for your situation would you rent and similarly your input parameters would you buy. Numbers you should prepare are monthly rent, rent increase per year, security deposit, investment growth rate, expected years of stay, house price, down payment, mortgage interest rate, loan term, buying closing costs, maintenance costs, home value appreciation, home insurance, property tax, and some more.
A quick rule of thumb can be used before employing the whole calculator circus to decide whether it’s better to buy or rent. You have to know the price-to-rent ratio. To get this number, divide the price of the house by the annual rent. This ratio also works on median house values and median rent prices of comparable houses to check the general area that you’re interested in living in. Usually a price-to-rent ratio of 15 or less favours the buyer, while a ratio of 21 or more favours the renter1. The range in between is a grey area that requires further calculation. The in-depth calculation is always a good idea before making the final decision, but as a preliminary research the price-to-rent ratio is a fine tool.
While this is a chapter about financial health and decisions, and this focuses completely on the financial best decision, this is not the whole picture. There are valid non-monetary reasons for buying and renting. Renting can be more flexible, you can often cancel monthly and move somewhere else. With buying, you’ll have to sell your house first, which can take months, or choose to pay double for your new and old house. A bought house is yours to do with as you please, you can drill holes in the wall and have a place to live as you’d like with no fear of getting evicted. Consider both the monetary and non-monetary reasons to make a final decision on whether to buy or to rent.
- A low price-to-rent ratio suggests a cheap house compared to the high rent. Conversely, a high price-to-rent ratio tells you that you’re renting the house cheaply, as the house is worth way more than you’re renting it for. Disregarding other costs, which are crucial in the whole calculation, the price-to-rent ratio essentially gives you the amount of years after which buying becomes a better option than renting. ↩︎