As your savings build and your dreams of becoming a homeowner become a possibility, an important question develops:
Should I continue to rent or should I buy a home?
This is an age old question that goes back to the birth of the mortgage. There are in fact advantages and disadvantages to both options and It is extremely important to keep in mind that the decision between whether to rent or buy a home is totally dependent on your personal situation. The upfront costs of a down payment before monthly instalments are enough to dissuade people from purchasing a home, however renting does not allow for the buildup of home equity, meaning that your money spent on rent does not go towards building up an asset
This question treats renting as throwing money away, however in reality the decision is much more complicated than it appears. Renting is cheaper than paying monthly mortgage instalments however mortgage payments go towards building ownership (equity) in a home that you also live in. In other words, when you purchase a home, a percentage of your monthly payments go towards ownership of the asset versus renting which is money that purely pays your need for shelter, without leading to ownership.
Though it is more costly in the short term to buy a home versus renting, as you pay down the principal of your loan, you can leverage your home equity to make other large financial decisions.
Because renting has no risk apart from the cost to rent itself, it should be looked at as the most flexible option, however it is very possible that it is not the most profitable. One of the most overlooked disadvantages of home ownership is the maintenance required to preserve the asset which often requires time and capital to maximize the value of the home. When you rent a home you are only responsible for the cleaning and basic maintenance, making renting a much less labor intensive duty.
Because you are only bound by the terms and conditions in your lease, and the cost to buy a home is much larger than renting, by renting you free yourself to invest the extra capital you have saved as a separate investment. Opportunity cost refers to the value of the alternative that must be given up if a given decision is made.
For example by choosing to rent you are giving up an asset, however when you purchase a home you are less likely to move to a new city if there is a new job opportunity, hypothetically meaning giving up future income.
Though this particular situation is not true for everyone, it is much more common to see someone who rents their home, move to another place in comparison to someone who has purchased their home.
Because the equity in your home is available capital, given a rise in property value and the choice to sell, you (the borrower) stand to make money from your homeownership experience. Once again the best way to measure how effective of an investment this was is to compare the opportunity cost of renting and using the savings from renting versus paying interest to finance another type of investment.
Let’s assume a renter pays $2000 per month to rent a house that is worth $500,000
In comparison, let's assume a borrower chooses to put $25,000 down payment (5%) to purchase an identical $500,000 with a 3% fixed rate mortgage.
Including $15,000 CMHC insurance, the total amount borrowed is $490,000
When calculating all attributed monthly ownership costs including:
5 year 3% fixed mortgage = $2319
Annual maintenance = $500
Property Tax = $300
Home Insurance = $100
TOTAL = $3219 per month
Now if we calculate the difference between the renter and the borrower we learn that the renter saves $3219 - $2000 = $1219 per month that can be used for other investments. In this case the renter chose to invest the $1219 monthly savings into the stock market.
Let’s assume that after 25 years, the borrower chooses to sell his home, which he now owns completely. Who made the better financial decision?
This is where things become complicated. What if the borrower decides to move every 10 years? This will result in breakage penalties and more administrative costs?
What if the renter chooses not to contribute the $1219 difference monthly? It is much simpler to skip on voluntary contributions to an investment portfolio than on mortgage payments.
What if both people go through a divorce? The breakage penalty for the borrower’s mortgage could render the payments made towards a bad investment, whereas a renter will not have to incur those types of costs.
What if the value of the house went down instead of rising? This situation would result in a net loss for the buyer of the property this a bad investment.
What if interest rates go up after the first 5 year term? This would result in higher monthly mortgage payments for the borrower.
The point we are trying to make is that it is extremely difficult to determine whether renting or buying is a better financial decision without understanding all the variables and determining factors that are important to the renter/buyer.
Because a mortgage is an extremely low interest loan and allows the borrower to both live in their home and use the equity in their home to finance future decisions, we strongly recommend looking into purchasing a home, however please do your research to see if home ownership is the right choice for you as there are many situations where it may not be suitable. If you have any questions about the home buying process please feel free to contact us.