Myself and my partner are currently looking to buy a house (to live in).
Was chatting with a friend recently about it. They asked if I’d considered renting for the next 10-15 years, so that I could “save” money and own a home (outright) sooner. Instinctively, this seemed silly. Surely rent money is dead money. At least a regular mortgage repayment is going towards home ownership, even if you do get slugged with interest.
“Nay”, said my financial adviser friend. And here’s how they explained it.
Let’s say you want to buy a $500,000 home (to live in), and borrow the full (or near full) amount, over the maximum term (usually 30 years). My friend said it’s much cheaper to merely rent a home worth $500,000, and put the “balance” of an equivalent mortgage repayment in to a term deposit. You’ll come out miles in front, with no debt, immunity from fluctuating interest rates and will accumulate enough cash to own a fully paid off house much sooner.
I’ve crunched a few numbers and this actually appears to make sense, if you have no, or a low, deposit.
I know people who’ve done rent-to-own on houses. It’s usually an agreement between the landlord and the tenant to buy the house out from them after a few years or so, and it works for people with shitty credit.
The problem with renting a home vs buying it is the rent is the same price (or higher) as a mortgage payment, not less. For your 500k home the mortgage will be 2000 a month, and that’s what the owner would be paying. Since landlords are in it for the money the rent would be higher than that. It will always be higher than the mortgage.
The only way to rent instead of own and come out on top is to rent really cheap, and be able to sock away money for a large down payment.
I’m not really asking about rent-to-buy. I’m more asking about what’s the best way to outright own a home as soon as possible? It seems rent-and-save is faster than buy-and-pay-interest.
But the rental amount is far less than the interest you pay. For eg, here in Australia, a home loan is currently going for about 7.6% per annum. On a $500,000 mortgage, that’s about $38,000 in interest per year, or $730 per week just in interest. You pay $730 in a given week, and your principal debt goes down by zero(!!).
A $500,000 home does not cost anywhere near $730 per week to rent. Not even close, it’s well under. Hence, it seems if you want to live in, and eventually own, a $500,000 home… it’s much cheaper in both the short and long term to just rent yourself a $500,000 home, and put the “balance” of an equivalent mortgage repayment in to a term deposit. In 15 or 20 years time, you’ve got yourself a home, much quicker than if you were getting pounded by interest.
Yep. If you’re willing to rent a place well below your means for a long time and save up for a large downpayment (say greater than 35%) then you will end up saving a lot of interest on the mortgage.
But that calculations works with buying as well. If you purchase a place well below your means and make extra principal payments every month, you’ll also save a ton of interest and pay off your mortgage much sooner.
No, what the OP is saying is that in his area, rents on a specific house are cheaper than the interest on a mortgage payment for the same house. If that is true, it is a consequence of a large runup in housing prices, throwing the rent vs buy calculations out of whack.
One thing to take into account is that rent goes up each year, while mortgage payments remain the same and only property taxes go up, so over a large number of years it will be closer than it first appears even if rent is less.
That said, if renting is well less than the whole mortgage payment it is really a poor idea to buy when you could rent- buying locks you into one place and there are large transaction costs to get out of the home.
You’re missing two piecs that work against you (or may):
First: You need to calculate the value of the tax shield and add it to the comparative cost of renting vs. ownig (or deduct it from the cost of owning, same thing)
Second: You have to account for the fact that a home that is $500,000 now may cost over 2 million 15 or 20 years from now.
The first item varies depending on your income and changes in law, the second is simply predicting the market, which is basically impossible - but if you look at home prices movements over most 20 year priods, you will see very strong increases. It is certainly a risk.
The other thing to consider is that buying (or mortgaging) a cheaper home you are able to invest in the property to add value faster than the market is rising.
So buy a small house for $200k, spend $10k on a new kitchen and $15 on a loft conversion, and you may sell it for $300k, meaning you’re up $75k within a year.
Repeat that a couple of times and you’ll have a hefty deposit for your $500k home, meaning you can buy it with a smaller mortgage (which as your salary will have risen over that time you can overpay to clear quickly).
Also I’d note your plan is fine as long as ownership is the only goal - you do, however, lose the stability that even a mortgaged home brings over rental in many areas. The main reason we opted to buy a house, even though the mortgage is similar to rental payments on a simlar property, is that we have no landlord who can decide with six months’ notice to sell from under us.
With a young family and and a wife at medical school we needed a guaranteed home for 5 years, and the financial hit we will take on saving for a bigger house is offset by my wife’s (future) increased earnings and the intangible benefits of a stable home. I guess it’s how you value those things in your situation though.
Repeat a couple times?? Where the heck do you live that an inexperienced real estate investor has a reliable shot at flipping a house like that even once?
That’s how many “normal” people progress up the housing ladder - the OP is talking long-term, remember, so 15-20 years is the timescale I was thinking of.
My parents basically did this… mid-20s bought a house in need of a lot of decoration, over a few years while we were living there they re-did each room, then added a small extension etc. Sold up 4-5 years later and moved to a bit bigger place, in a similar condition to their first house… repeated the process one more time, and then bought their “final” house which was again in need of a lot of attention but over 25 yrs they’ve added lots to the value of that one (which will then fund retirement).
Thing is, if you put a dollar value per hour against the time they’d spent working on each house they might actually have “spent” more on each house than they made back, but the only alternative would be to realise that value by working another job (which then adds to your deposit fund). So by effectively donating $1000s of labour into your home you can move towards the $500k house.
If you have at least a minimum down payment you can always pay back the 30 year mortgage early by making an extra payment or two a year. We have a 30 year mortgage but we make the equivalent of 13 monthly payments a year instead of 12. That alone cuts the length of the loan down by 4 or 5 years. If you can afford to pay more you can reduce the length of the loan by 10 or 15 years. In the mean time you deduct the mortage and property taxes against your income tax (at least in the US) and your home can appreciate while you are paying it off. I don’t really see how renting helps you get into a home faster.
As a very rough rule of thumb, rents are tied to property ownership costs. Among the costs included is the opportunity cost of the market value of the property. If I own a $500,000 piece of property, and I want to make 5% on my money, I’m going to calculate a couple thousand dollars a month into my rent number.
It’s not exactly that simple, of course. Market forces may require me to lower my rent; tax considerations may enable me to lower it, and so on.
To do the calculation from your side, you need to consider what it costs to rent, where you think prices are going to go, and whether or not you will actually save any difference between your total cost of renting and total cost of ownership. Renting does protect you from prices dropping, but it doesn’t protect you from them rising.
In recent years it’s become obvious that home ownership is overrated as a means of making money, but for decades prior it was a fabulous way to make money. Perhaps now, with prices backing off a bit and interest rates historically low, it’s a perfect time to buy. Perhaps not…
And the third thing that many people do not consider when making these calculations is that in most places rent is not fixed, but goes up over time, often dramatically. Whereas a mortgage payment is relatively, and often completely, fixed.
Right now rent might be less than a mortgage payment. Will that be true for the same house in twenty years if neither the renter nor the owner moves?
Just remember that a home is not an asset - it’s a liability. Your home costs you money through mortgage interest, taxes, maintenance, and a bunch of other things.
You need to find an asset to pay for the liability a home is. I would recommend buying a duplex and renting out the other half until you have a substantial down payment for the home, and then waiting until the potential rents and your down payment equal the cost of the mortgage.
You don’t have to fix toilets if you don’t want to - just make sure the management company cost is figured into your budget. Plus, if something should go wrong with your job or medical situation or something, that duplex income is fixed. And as rents go up, you’ll end up with more income every month beyond the mortgage costs.
This is going to be market by market and always a gamble. Personal examples: I own a house I rent out in Idaho. My mortgage+tax+insurance (including principal) is less than the monthly rent. I bought the house in 2004 and if I bought it today, I would pay less and get a lower interest rate. However, the house I live in California is different. We bought in 2007 and if we had rented for the last 4 years instead of buying, we could have saved a little money, but more importantly we could get the same house for a lot less money.
Generally, over time, the real cost of owning goes down, and the real cost of renting stays about the same. Saving and buying vs buying on credit is also dependent on interest rates. Right now, here in the U.S. you can get less than 5% on a mortgage if you have decent credit and a down payment, but savings accounts pay less than 2%.
Yeah, I thought this was basically the textbook definition of a speculative bubble, because it demonstrates that people are willing to pay more for a house than the house is currently worth.
This approach critically depends on finding equivalent houses that are renting for a pittance. There are certainly markets where this might happen – places where people fully own the house and there’s a lot of rental properties available so they can’t ask a lot for the property or areas where there are a lot of distressed homeowners who can’t sell and want to get * something * for their property. But certainly in the latter case, it’s not a long term stable rental.
However in the area I live, rentals were so scarce and of such poor quality that it made sense to immediately buy a house even though I hadn’t expected to when I started out.
I’m a huge fan of the Bogleheads when it comes to personal financial matters. Here’s a good article on renting vs. buying.
One thing that really bugs me is people still assume that a house is always a great investment. Housing was in a bubble for the past 10-15 years. That type of price appreciation is NOT the norm. Take a look at this chart of housing prices. On an inflation adjusted basis, housing prices are still on the high end. That isn’t to say there aren’t certain local markets where prices are reasonable, though. It depends on your area. A house is an asset similar to stocks, bonds, commodities, etc. If you’re a dedicated saver/investor it’s entirely reasonable to assume you could earn a better return in asset classes other than housing.
Would you rather spend the next 10-15 years in your home, or someone else’s?
Would you like to be able to paint rooms the color you want? Would you like to be able to make small improvements to the house and enjoy them the rest of your life? Would you like the security of knowing you may never have to move again, and your rent will never be raised?
If yes, you should buy.
Also worth noting, mortgage interest is tax deductable. This alone made it worth it for me to move from my apartment into my own house.
The other side of buying I always point out is not just that you can paint the rooms whatever color you like (which frankly I don’t care about) but that everything that breaks is YOUR responsibility. And I just never see that being calculated into the cost of buying. For the first time we are renting a house instead of an apartment and it’s a great look at the true costs of buying without being totally overwhelmed. Lawn equipment, maintaining the lawn, shoveling, and that’s without counting if the furnace breaks down (I call the landlord) if the plumbing needs something (Call the landlord), etc.
I am a lifelong renter so far. I may buy in another ten years. Maybe.