My friends keep telling me paying a mortgage is always better than paying rent because the money goes toward equity in the property. They say money which is put into home ownership isn’t wasted. But what about all the money that goes into a home that doesn’t result in equity, like maintenance, property taxes, insurance, and mortgage interest?
If, on top of paying the mortgage, someone is paying $300 taxes + $400 in maintenance + $300 in interest = $1,000 total, isn’t that all money wasted? So renting an apartment for $1,000 or less would be cheaper than buying the house, even once you factor in the equity?
I believe I understand what you’re saying. Basically, you’re saying that paying $1,500 per month for a mortgage is better than paying $1,500 to rent a home. This is because with the mortgage you are paying for an asset you’ll eventually own and can live in cheaply or sell. Meanwhile any money a person pays in rent does not help your future self in any way, so it’s basically money thrown away.
However, if all the extra costs of home ownership (taxes, maintenance, insurance, interest) add up to more than the cost of a rented unit, then the person with the mortgage is throwing away more money than the renter.
In other words, if you’re paying $1,000 for a mortgage, plus $1,200 in extras each month, then it would make more sense to rent any housing unit with a cost less than $1,200 because the money “thrown away” would be less. I think that’s the argument being made here.
In the past we’ve talked about purchasing versus renting a home. We talked a little about the financial aspect, but mostly talked about the personal preference aspect and why some people might choose to rent over purchasing, regardless of the financial factors. Today, let’s talk more about the financial side of buying versus renting.
Let’s consider the above argument: if the “extras” that come with buying a house cost more than renting, then it could make sense to rent rather than buy. Both people are “throwing away money” that isn’t going toward equity, one is just doing it more. It’s a potent argument in favour of renting, at least in the short-term. However, buying a house is almost always done with a focus on a long-term timeline.
Let’s make up some numbers for an example. Let’s say my mortgage is around $1,200 per month and my house maintenance extras (mortgage interest, taxes, repairs) are $1,000. Then, in the short term, it makes sense to rent any apartment that costs $1,000 (or less) per month. Imagine I find a suitable place to rent for $900. Not only will I be saving the money I’d be putting into the home itself ($1,200) and hopefully investing it, but I’m also throwing away less money ($900) on rent than the homeowner is on their $1,000 of extras. So I should be at least $100 ahead, right?
Yes, in the short term. Over the span of a year, the renter could be considered at least $100/month ahead for a total of $1,200. The renter saved $100 on money that was going “out the window” and not being applied to ownership. So it seems like a good deal for the renter so far.
However, on a longer timeline things are likely to shift in favour of the person putting their money into home equity. The homeowner’s mortgage payments should stay steady. Their property taxes might go up slightly compared to their income, but their mortgage payments are likely to remain static. Meanwhile the renter is almost certainly to face regular increases in their costs. Someone renting is likely to see their costs go up at least 2% per year where rent protection is a factor and more than 2% in places without rent protection.
By the time the homeowner retires they should no longer be paying a mortgage or interest on the mortgage. They’ll just be paying property taxes and repair costs. These costs will likely grow in step with inflation, but probably not more than that. Meanwhile the renter’s cost will probably have at least doubled between the ages of 30 and 65, even in areas with rent protection.
When the renter retires, their costs will continue to climb while the homeowner will find their costs have dropped in their retirement years once their mortgage is paid in full. This makes home ownership an attractive option in the long run. In other words, the homeowner is paying more when they are (hopefully) making good money, but then living more cheaply when they retire. The renter pays less when they’re employed and then will likely pay more when they retire. This makes buying a home a more attractive option in the long-term.
One of the key factors to consider when weighing the pros and cons of renting versus buying is: what you are going to do with the money you save while renting? This is the part which tends to trip people. If you’re taking all the money you save from renting and putting it into good investments then you’re going to be in a relatively healthy position when you retire. But if you’re spending the money you save from renting on luxuries, vacations, dinners out, gifts, and entertainment then you’re still “throwing away” the same money the homeowner is without any of the equity benefits.
Getting back to our example, the homeowner is spending $1,200 on their mortgage, plus $1,000 on non-equity costs for the house, for a total of $2,200. Meanwhile the renter is spending $900 per month, all of it on non-equity. Assuming, for the moment, their utilities and other costs of living are similar, how much money should the renter save over the span of a 30 year mortgage?
If they’re simply saving the cash in a bank account, the renter saves $1,300 each month, 12 months per year, for 30 years. This is about $468,000 in total. Probably a bit less than what a house with a $1,200/month mortgage would cost 30 years down the road. However, if the renter invests their money at a conservative 5% interest rate then putting away $1,300 each month lands the renter a total of $1,059,988. This is probably going to be more than the house purchased at $1,200/month is worth at the end of its mortgage.
We could get deeper into the weeds on this issue and look at how much rent is likely to climb, but rent increases at such different rates in different locations and in different circumstances. Likewise, we could speculate on whether there might be another housing boom and the value of the house could skyrocket. It’s hard to predict the future.
Ultimately, I feel the issue of home ownership versus renting comes down to two key factors:
- personal reasons for wanting to rent vs buy.
- What do you do with the money you save in the short-term by renting? If you put it toward owning equity in something (stocks, bonds, businesses, land) then you’re likely to come out even, or even ahead of the homeowner. However, if the renter spends their saved money on luxuries or frivolous things then they are not only no further ahead financially, they are also missing out on owning (or having an affordable home) later in life.
In the end, the person asking the question is right: if a homeowner is putting a lot of money into non-equity related maintenance and taxes, then the renter comes out ahead on paper in the short-term. But it only works out in the renter’s favour in the long-term if they do something with their money which gains them benefits or equity in another way beyond what owning an asset like a home will be worth. Buying a house is the long-term purchase of an asset, so the renter (to get further ahead) will likely need to invest a similar amount of money in another type of asset to keep up financially.
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