Is it better to rent or buy? The big question.

Image result for london house

This is a question that I have seen various times on social media. I’ll get to the point. My feeling is that buying is an idea that has been pushed heavily over the years by those who have bought their house for very cheap and who have seen it appreciate heavily. In addition, the majority of retail banks’ business is in the mortgage market where they glean interest through mortgage provision. You only have to look to the most recent financial crisis to see how far reaching the mortgage business is.

I wrote a recent article on London house pricing and why they have increased so heavily. A basic summary is that a combination of banks allowing less leverage & therefore a bigger initial deposit has increased rate of renting while low interest rate policy, quantitative easing and low housing stock has caused the price rise. This has caused people to rent more, yet it seems their real goal is to own a home. Why?

This article was taken from here.

Dear Emily,

I’m 30 years old, and my husband and I are thinking about buying a house. He’s all for it, but frankly, I’m terrified of the idea of taking on a mortgage. I know a number of people who lost their homes during the financial crisis. The housing market seems like it isn’t the sure thing everyone said it was. And we have significant student loan debt as it is. So my question is—is homeownership really all it’s cracked up to be? And what should young people do when they’re already swimming in debt as is?

Dear Renter:

I distinctly remember the time in 2006 when a relative told me I should “definitely” buy a house because “the housing market always goes up.” This was obviously not good advice, though it certainly reflects prevailing wisdom at the time. And I can see why in the wake of the housing crisis, you’d fear that the housing market always goes down. Which is also not true.

There is one unambiguous argument in favor of buying a house: Sometimes it is hard to rent the house you want. In most places, if you want to live in a single-family detached house, there are not many rental options, certainly not long-term ones. So you may find yourself coming up short on good rentals, and buying may be the only way to get what you want.

However, let’s assume that you are happily renting someplace and your only motivation to buy is financial. Is it cheaper to rent or buy? In equilibrium, the answer is: The price to rent or buy should be about the same. Why is that?

Imagine that rents were so high that you could buy a place and rent it out and still have loads of money left over—even after paying the mortgage, maintenance, and everything else. If that happens, the market will adjust. People will start coming in, buying properties, and renting them out. But as apartment-hunters have more options to choose from, rental prices will fall. And they’ll fall to the point where the rental price just about covers the cost of owning.

Alternatively, if rents were so low that owners would lose money renting houses, they’d stop doing it. But as the number of available rentals goes down, the prices will go up. And they’ll go up to the point where the rental price will cover the cost of owning.

This is an example of what economists call “equilibrium” and it means that ultimately, it will likely cost you about the same to rent or to buy.

You can also try to do this calculation directly. Think about what it costs you to rent. Then think about what it would cost to buy the same quality house. Take into account the mortgage, of course, but also insurance, maintenance, foregone interest on the down payment, and the value of your time spent fixing things that the landlord would fix in a rental. I suspect you’ll find that the costs are about the same.

Given this reality, the only other strong argument for buying a house is the view that the “housing market always goes up,” so when you sell, you’ll make money. But you don’t have to go very far back in history to see that isn’t true, so it’s probably not a great argument. The housing market also doesn’t always go down, so that’s not a great argument, either.

As to your debt question: Student debt may limit your ability to get a mortgage, but it shouldn’t keep you from buying a house if you want to. Your housing debt is collateralized by your house, so unless the value of your house goes down so much that you’re underwater on your mortgage, it’s not debt in the same sense that your student debt is.

A final note: Time horizon matters. There are a lot of fixed costs with buying a house: you pay the realtor, closing costs, etc. If you are going to own a house for 30 years, these do not matter much. But if you’re planning to sell in a few years, they significantly raise the effective buying price. And if you rent, so much the easier to flee the coming war with Australia.

There are various reasons why someone may want to buy a home as seen above. I am of the opinion that the initial outlay of a down payment could be better invested elsewhere. Note that any 20 year period of investing (and reinvesting dividends) in the SP500 has only led to a profit. See here:

If the rationale for buying is that you have an investment in the end then in my opinion, it holds up as pretty weak. If you add in the costs associated with being a mortgage borrower (interest payments, maintenance, insurance, renovation etc), would you be able to achieve a 246% return in a 20 year period? This is one huge opportunity cost, as well as being a very illiquid one.

I understand the above is great hindsight analysis, but the fact is that no one has ever lost money over a 20 year period while investing in the SP500 (as long as we are calculating purely from the principle investment, and with dividends reinvested). Many people have lost money on home ownership due to it being an illiquid asset.

Of course, you are able to release equity in your home to finance other investments, however this is not necessarily a given investment strategy in the future due to no knowledge of future house price appreciation or viability for remortgaging. And this brings me onto the next point.

Buying may be seen as more attractive, but what % of your income does your mortgage take up? Rent may be £1500 and a mortgage £1300, but would your emergency fund be able to cover mortgage payments if you lost your job? What if you’re utilising 60% of your income paying a mortgage plus home ownership costs? Renting provides a certain flexibility in an economic climate where the future is very uncertain. If you lose your job, you can quickly move to somewhere with lower payments, and avoid a very big mess.

At the end of the day, there are personal circumstances that come into it. But always bear in mind opportunity cost and longer term costs that may not be associated with renting.


‘I refuse to pay someone’s mortgage’

But you don’t mind giving banks interest payments? Interesting (ha).

Remember, mortgage in French means ‘death pledge’. Obviously death in this sense means until the loan obligation ends, but there are funny connotations with it as well.

A mortgage is classes as a liability until it’s paid off. A house is not an asset until that obligation is fulfilled. In addition, considering buying a home as an investment is poor, since house prices have barely outpaced inflation over the last 60 years. This does not make it a poor purchase, however.


The following video gives a roundup of what I have said:

Note, the mortgage calculation equation is wrong. It should be E = P×r×(1 + r)n/((1 + r)n – 1),  where E = monthly payment owed to the bank, P$ = loan amount, r = interest rate of loan, n = amount of months loan is for

 

Let me know your thoughts in the comments, on Twitter and below.

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