Is it better to buy or to rent?

From our calculator's Instructions and Tips

February 22, 2022 by Pietro

This is a very common question which requires careful consideration. There are many factors to be take into account, some are related to personal circumstances and needs, other are strictly financial calculations. Sorting out all these variables can be overwhelming and it is hard sometimes to come up with a simple answer.

Fortunately this article is going to assist you in making a decision by guiding you through the process of choosing between renting and buying your own place.

First, we will make a list of the possible personal circumstances and factors to be considered when looking at the two options. This part is really subjective and somehow involves aspects of emotional choices.

Then we will look at a comparison between buying and renting strictly from a financial point of view. Finally, we will study a practical example on how to calculate the cost benefit or buying compared to renting.

Rent versus Buy – The personal circumstances

Below is a list of possible personal circumstances and considerations to be assessed when comparing buying versus renting:

How long you are planning to stay. Clearly if you are planning to stay in a place for a short period of time, you don’t want to go through the entire process of buying and selling. This makes sense if only for the initial costs of buying and for the management time and effort involved in the process of setting up the documentation. Selling also involves costs, such as advertising and real estate commissions. The time during which the property is for sale might become a passive loss if you have already moved out and you need to keep paying maintenance costs, bills, taxes and interests on your mortgage, until the property is sold. The rule of thumb is that buying is not a good move if you are planning to stay for less than five years.
Consider if the location and the house are right for you in the long term. If your circumstances change, then you might find yourself looking to live in a different location. For instance, you might want to live close to work and public transports, but your career path might lead you elsewhere. If you start a family you might want to move in a bigger house nearby primary schools. But when the kids grow up, you might want to stay close to secondary schools. Ultimately, you need to consider how important it is for you to be able to easily relocate in a different house, neighbourhood or city.
Sense of ownership and freedom to renovate. This is a very personal and emotional factor. For some people is very important to feel that they own the place where they live. They also like to feel free to change and adapt the house according to their personal taste and needs. When renting, people might be limited in the changes they can make to the house and they might feel like it is not worth investing in a place that doesn’t belong to them.
Future income and future interest rates. It is important to consider what would happen if your income fell, your expenses rose or the interest rates increased. If you have a mortgage and if any of these circumstances happen, then the ratio of income to loan repayments would drop. If it drops too low, you might find it difficult to pay your bills. This is called ‘mortgage stress’ and it’s expected to happen when people with relatively low income spends 30% or more of their pre-tax income on mortgage repayments.
Future market price. The property market price may rise and return a potential profit if you bought at the right time. Similarly, there is a risk that the property price drops leaving you with a loss. The future of property markets is very complex and hard to predict, even for the experts. But if you consider yourself a guru in this field, then you can include this aspect in your decision.
Your home might become a source of passive income in the future. It is quite common for people to buy a property and use it as personal dwelling for a number of years, before renting it out to earn passive income. If this is what you have in mind when you buy a house, then you should plan how this would work as investment property and how much it could give you as return. Keep in mind that you could lose any government incentive for ‘first home buyer’ if you rent out the property within a few years from its purchase. Also it is possible that the bank will charge a higher interest rate on the mortgage, since the property is no longer your principal place of residency, instead it’s now an investment property.
Down payment and opportunity cost. If you are considering to buy a property, you probably know that you will need a deposit (or down payment), to get a mortgage. When choosing between renting and buying, the amount of savings available for your deposit is critical. If the deposit is too low, the interest part of your monthly repayment could end up being higher than a monthly rent (see the next paragraph for a detailed example). Instead, if you choose to rent you could find an opportunity to invest your savings, accrue interests on your investment and have more savings available in the future.
Motivation to save money. Some people believe that buying their own house with a mortgage will motivate them to cut on unnecessary expenses in order to save money and pay off their loan sooner.
Management time. Managing a house is time consuming. Among the activities of a house owner are: participating in owners corporation meetings, dealing with maintenance and repairs, caring of the garden and paying property taxes.

Ultimately the choice depends on your own personal circumstances, and there is no single answer to this question. Nevertheless, from a financial point of view it is critical that you get your calculations right.

Our calculator can help you comparing the two options. Let’s see an example.

Buy or Rent– Calculation Example

Despite common believes, buying a property is not always better than renting from a financial point of view. Especially if you end up paying interests on your loan which are higher than the rent you would pay for a similar property.

Let’s assume you are currently renting a house for $2250/month and you are paying an average $400/month in utilities and bills. The landlord has let you know that she/he would sell you the house for the firm price of $525,000.

You would like a comparison between paying rent versus getting a home loan to purchase the property.

Let’s assume you have $130,000 in your savings. You have calculated that the costs of government fees, conveyance, agency commission, insurance etc. add up to $17,000. You have also noted that, if you became the owner of the house, you would have to pay Owners Association fees and City Council fees, for an average of $550/month, on top of your usual monthly bills. You have spoken to the bank and they offered you a loan with variable annual interest rate of 3.75%.

On the Mortgage Calculator Online, fill the loan input as following.

Property Price: $525,000;
Deposit: $130,000;
Loan Term: 30 years.
Annual Interest Rate: 3.75%.
Initial Costs: $17,000;
Monthly Costs: $550/month.

Note that we did not include the utility bills in our calculation, as these stay the same for both renting and buying. However, they will be considered eventually for the affordability of the total monthly payments.

The Mortgage Calculator Online calculates the monthly repayments as $2,458/month, which would be $208 more than the monthly rent. On the Chart of the ‘Typical Monthly Repayment Composition’ we read that, on the first year, the interest part of the monthly repayment is approx. $1266/month. If we add $550/month (home owner monthly costs), we can say that the total money we are ‘loosing’ each month is $1816. This seems a good deal compared to ‘loosing’ $2250/month in rent. Moreover, the interest part of the repayment will decrease over the years, while the principal part will increase.

There are other aspects to be considered to complete the comparison. For instance, the property market and the interest rate could change. Or you could choose to invest your savings to earn interests instead of buying the house, etc. Nevertheless, having a calculation tool at your use is highly beneficial for making a decision.