Renting Vs Buying a House. Which One is Better?
One of the most common discussions about real estate in family and friends’ parties is the eternal debate between buying and renting a house. Is it more interesting to buy or rent a principal residence? This question, everyone asks one day or another and the answer is not as obvious as one might think. So, how to choose? There is always a fervent defender of purchasing a house that will not stop at any cost and another view will say about the freedom associated with renting a house. But can it be generalized? What was true 10 years ago; is it still viable? The price of houses, rent, and interest rates have changed over the years drastically.
You will find dozens of debates and articles on the web about this, but probably none will be quite related to your situation and doing the math yourself may seem difficult. However, there are some interesting tools available on the internet that can help you. This allows you to compare the costs between the lease and the acquisition, by incorporating the characteristics of the two options you are considering. So let us answer the age-old debate, is it cheaper to buy a house or rent a house.
So, what is the more financially advantageous, buying or renting? There is no firm and definitive answer to this question and it all depends on both your personal situation and the local real estate market.
A choice that does not always go without saying!
The renting of a home certainly requires you to pay a rent which can be considered as funds lost, but you also avoid many expenses associated with the ownership of housing! The personal contribution paid before the purchase, the interest of repayment of the loan, the property tax, the possible expenses of co-ownership, the work of small maintenance or the major repairs are as many incompressible expenses which make the accession to the property a very expensive adventure, and sometimes longer to make profitable.
For equivalent accommodation and apart from some exceptional circumstances, the monthly amount to be disbursed will always be higher in case of purchase rather than as part of a lease. This additional effort is counterbalanced by the fact that the owner gradually builds up a patrimony – and can, therefore, recover part of its sale by selling the property or even have a capital gain. The purchase always ends up becoming more profitable than renting, but sometimes after many years.
How to perform a simulation?
To determine if the rental will be more profitable than a purchase in your particular situation, the problem to be solved is the following question: “is it better to invest in the purchase of your principal residence, and pay the high price, or continue to rent an equivalent good by placing the money thus saved on the financial markets?”
Start by setting a time horizon, for example, ten or fifteen years.
Calculate all costs associated with the purchase: Calculate all the costs incurred by the purchase of housing (mortgage loan TEG, the amount of the initial personal contribution, property tax, expenses of co-ownership…) as well as a valuation hypothesis for your property in case of resale to term (0% if you want to be cautious).
Then determine the rent payable for equivalent housing, with expenses, and do not forget to take into account a realistic annual revaluation of this rent (1 to 2%). Finally, calculate how much you would bring back your savings on the financial markets (at a rate of 2 or 3% per year, for example), said savings being made up of the personal contribution – which you keep in your pocket if you rent! – And the difference between the rent paid and what would be your monthly payment in case of purchase.
The calculation as a whole is relatively difficult, and it is easy to forget a criterion inadvertently. To help you in your task, many loan simulators with amortization table exist and will allow you to get a quick response!
A situation specific to each real estate market
It is mathematical; the higher the rents are in proportion to the purchase price, and the sooner you will win by buying your home!
The latest studies on the issue present a very contrasting situation in the case of the major cities. In some cities, the purchase will prove, for example, more profitable than renting in less than two years!
In some cities, on the other hand, purchase prices have exploded in recent years, well above the average rate of increase in rents, which makes renting much more competitive by comparison. In general, the purchase of houses with a larger area is always getting profitable faster than that of a small home.
The common misconception
There is a common misconception out there that renting is just automatically throwing money out of the window. But you cannot deny there are a lot of very high-profile people who just decide to lease instead of owning a house. Now someone will do that? Let us actually do the math behind this to find out which factors matter the most and that you may figure out the best way of deploying your money; whether to rent or buy?
Most people look at the rent and then look at the mortgage amount and they think as the mortgage is only a little higher than the rent amount, why not buy the house. They think renting is an automatic waste when they could just own it and build equity and have it paid off in 30 years for just a little bit extra per month. However, the actual cost of ownership is much more than just the mortgage itself. Instead, it is also other associated items such as the property taxes, insurance repairs and anything else that goes along with owning that property. This does not even consider the opportunity cost of your down payment that you are now tied up in the property instead of investing it elsewhere.
For example, consider you are buying a $500,000 home with 20% down and that is $100,000 and let us discuss whether to rent or own this house. Your mortgage payment will be the primary cost when you are buying such a house. Now in a 30-year loan and four-and-a-half percent interest, your loan is going to be about $2,000 per month then you also have your property taxes. Considering it’s about one and a quarter percent of your purchase price this works out to be about $520 per month and then you have the insurance in case your home gets damaged. Let us assume all of that insurance is an additional $150per month and then there is another thing that many people miss and that is the cost of the repairs to be made during the 30 year period.
Over time this brings your total cost of ownership to $70 per month on a $500,000 home with $100,000 down and in 30 years you own this apartment outright. But that is not the total picture as even though it looks like on paper you have shed only $2870 per month when you pay your mortgage. Part of that is going towards interest, part of it is also going towards equity by paying down your loan and in the first year you have paid down your loan by $64000 or $5033 per month. You could then also write off the interest that you pay on your mortgage up to seven hundred and fifty thousand dollars against your income.
Now considering your tax benefits and all it looks like your net cost of ownership price can be calculated by considering the 20% down payment which has an opportunity cost. This is because you could have gone and invest that down payment money elsewhere and instead you are tying it up in the property. So, the out-of-the-pocket cost of your home is much more than you think.
Some key points to consider
Before deciding whether to buy or rent your home, always consider some of the key aspects. Whether to go for a rented house or buy it? Are the number of years you want to keep your property and your financial habits? Of course, these are just pecuniary considerations! In fact, no calculator can tell you if you are better off buying or renting, but rather which option is the most financially beneficial depending on the number of years of ownership.
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With the growth in property prices, some believe it is better to rent while waiting for a lull in the market, while others are convinced that they must buy their home now, prices are expected to climb again. A tip: it is better to take into account the number of monthly payments before making your choice.
An example: If you want to move into a beautiful five-room apartment in one of the most fashionable neighborhoods of Singapore. What should you do? Rent an apartment or buy a condo in the same neighborhood?
The majority of people are convinced that they would get richer automatically if they owned a property. Different surveys have confirmed that about 71% of individuals believe that it is more advantageous to own a property than renting one. Yet the reality is sometimes different!
It is Difficult to compare costs
If homeowners, who resell their homes, sometimes make a large capital gain during years of high real estate inflation, this is not always the case. According to experts, the capital gain is not the only element to consider when buying a property.
Depending on the sector and the type of dwelling in which one wishes to live, the rental can sometimes be more advantageous. However, it is difficult to compare the costs of renting a home, which boils down to the price of rent, to those of the acquisition of a condo, which includes various types of expenses (mortgage, insurance, taxes, repairs, renovations, heating, etc.).
The cost of the rent
Rent is a one-time, monthly payment that covers all the costs of housing – except for heating and electricity. Admittedly, this amount may seem high at first glance, but only a detailed calculation makes it possible to make a fair comparison. The fact remains that, unlike the costs of a property, the cost of rent never decreases: it is, on the contrary, called to increase constantly because of inflation that drives up the property tax bill. The owner has the right to give his tenant a portion of the increase in municipal and other taxes.
The cost of the property
For its part, the owner accumulates expenses: you must pay your mortgage and interest on your debt, municipal and other taxes, and insurance on your property. You must also pay the money for renovations and repairs when the inevitable breakages occur. These payments must be made on a regular basis, every month, six months or every year, or at an irregular frequency, during repairs.
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If the down payment is not sufficient, the homeowner must add a monthly premium to these payments to the respective authorities. If you have borrowed money from any home buyer planning and all, you also have to repay it within a stipulated time.
Buying or Renting: Some of the Myths
While starting to acquire assets for building up equity, the first venture may be to buy a house. But many people get really intimidated about the idea and even hear stories of people losing money after buying a house.
Let us resolve an old myth about buying a house and convince you that buying a home is not only easy but also really profitable in many cases. Let us focus on some of the common pros and cons of renting versus buying a house.
Some of the positive aspects of renting are:
- You can usually have a bad credit and still rent a house without any problem
- You will not get tied down to a mortgage
- You do not have to bear a maintenance cost
- You do not have to worry if neighborhood depreciates as it is still not your house
Now let us consider some of the key cons of renting a house:
- Rent is usually higher than the mortgage payments (which means you are effectively paying more per month for the same priced house, i.e. if you have bought the same house your mortgage payment will be less than the rent)
- You are usually sharing your floors, ceiling or walls with your neighbors if you live in an apartment or a duplex
- You are not building any equity and it is not an asset
- There may be restrictions on the pets you can own and other freedoms (you cannot redecorate the house the way you want to)
- The rent could rise at any time
- The owner could decide to sell the house at any point and just ask you to leave (you could have been there for 10 or 20 years, but the owner can still tell you to move as he/she wants to sell. Now, suddenly you have no place to live and have to move on from a well-acquainted neighborhood)
On the other hand, owning a home has the following pros and cons to consider about. The pros are:
- You are building up equity by paying down your mortgage
- You get the benefit if the neighborhood appreciates and not your landlord
- You have all the creative control over the house (you can renovate or redecorate it at will without having to check in with someone)
The general cons of buying a house are:
- There are more secondary costs when you own a house (maintenance, taxes, and insurance)
- If the market depreciates your equity goes down
- You have to qualify with income/credit (but there are programs for low-income people so that you can own your own home)
- You are tied down to a mortgage
So, let us evaluate in details the above-mentioned points. Buying a home is not as scary as you think and that most of the supposed negatives mentioned above might not even be that relevant in your case. Most of the negative points discussed here are simply myths. You might have heard that you should only buy a house if you will be living in it for at least 3 years. Some of these myths may be true to some extent, but there are always ways if you are smart about it to buy and sell in a short amount of time without losing money or without being afraid of being stuck. Now if we look at it, you can understand that it is easy to see why people get worried about these myths. It all comes down to simple math.
A concrete scenario: an Easy explanation of the above circumstances
It will be better for the understanding to consider a hypothetical scenario. Most houses appreciate at 3% a year. So if you buy a house right at the market value of $500,000 and it is worth $500,000, then you put $25000 as down payment and owe $475,000 on your mortgage. Therefore, in case you wait for 6 months and then decided to sell, what will happen?
Now your house is only worth $507,500 because it is appreciating at 3% a year. In order to sell, you will be paying the realtor commissions around 1% to 2% for closing costs and buyer concessions. So, you come away losing money because you only get $507,500 for the sale and have to shed 2% which is $10,150. Thus, you get only $497,350 in hand after selling your house.
How much money does that leave you with, in your pocket? So you are losing around $2650. You may be thinking that you have lost money and you would need to stay longer for a profitable deal. But in the real sense, you just bought a wrong property and you should not actually need to stay longer if you bought it the correct way.
You could be able to sell it any time if you buy it in the right way. Now in the above circumstances, if you waited for 3 years, your house would have been appreciated to over $545,000 and taking away the 2% as before for realtors and closing costs ($10,900 in this case), you will get $34,100 in your pocket due to the sale, even after deducting all the fees. This is where the 3-year rule comes into play. So, the longer you hold the better chance you have of not losing money. Singapore has seller stamp duty (SSD) sell within the first year – 12% tax second year – 8% tax third year – 4% tax Fourth year – 0%. So it makes more sense of selling the house after 3 years only.
Some key strategies to buy a home and remain cash positive
But, it is not a good idea that if you want to buy a house you have to be a slave to it and stay in it for three years even when you do not want to. What if you want to take a year off and travel and move to a different house. This could totally be an option if you buy the house strategically. You can make money every month by renting it for the time you are away. You have to be very strategic to buy a house which involves a few key factors.
Thinking like an investor may help
There are hundreds of books/articles out there for first-time homebuyers; listing all the things you need to take into account and offering you valuable suggestions. But what it comes down to is just thinking like an investor. Your house is your investment and you should not buy a house purely on emotion or your tastes. That is, whether it has a waterfront, in-ground pool, skylight, balcony, and so on should not be your primary preferences when selecting a house to buy.
It is, of course, difficult to digest such an advice and not giving a head on your preferences while buying a house. However, such things do make some sense. When an investor buys a house, it has to make sense with numbers wise and most of the time they are looking for the type of house that would attract the average buyers. They will go for houses that would appeal to a wide range of buyers.
When you buy a house, the first thing to make sure is whether you are getting it at a discount. It might be discounted because it is distressed or outdated or just needs some basic renovations. Also, the house might be fine, but the seller is distressed because they are in foreclosure or have an emergency where they need to sell the house quickly. One good rule of thumb is never to buy the nicest house in the neighborhood, but try to buy the worst house in a nice neighborhood and renovate it to be above average way.
Other ways to go about it is to buy a four-bedroom house so that you can live in one bedroom and rent out the other three. This could also apply to buy a duplex or a house with a basement you do not need to use. Usually, the rents from the other roommates will more than cover your monthly mortgage cost. So, you may now understand that how buying a house strategically can make it a lot less intimidating and really increases the benefits of owning an asset.
Buy or rent an apartment: a concrete example
Take the example of one 4 bedroom HDB apartment. For rent, this comfortable three-bedroom apartment would cost you about $2000 per month. In co-ownership, you should pay at least $500,000 to buy it. What is the best option for you?
First, you must understand that buying a HDB is a non-productive investment in turns of returns as a property. That is to say that all expenses related to this purchase will have to be paid by you. You will have to pay all taxes and interest that, unlike a revenue home, are non-tax deductible. In fact, only money spent on gaining income from a residential building is tax deductible. However, on the resale of an income property, the capital gain is taxed at 50% on the rental portions.
In order to evaluate your best choice, let us analyze what would be the monthly costs of a mortgage for 25 years, with a down payment of 5% ($25,000). This does not include the insurance you will have to take on your property.
As we have already provided some examples, it would cost you less per month to rent than to buy your apartment. In addition, you could record a loss or a profit on your investment, depending on the price at which you can resell your property in the future. However, this transaction could represent to you in a form of savings, allowing you to become owners of a property whose value could increase over time.
To avoid paying the loan premium, you could have increased your down payment by up to 20% of the price of your apartment. You could also buy your HDB in another neighborhood where the price of homes and condos is more affordable.
If instead of buying you continue to rent it, you could put the capital into some other investments that you are willing to pay for the purchase of your HDB ($25,000) and related costs to make it grow. After 25 years, this investment will probably be worth as much as the HDB you have bought. However, you will have to continue to pay a monthly rent, indexed to the cost of living.
Buying or renting: not just a question of money
Staying as a tenant or becoming a homeowner is not based solely on financial considerations. It all depends on your personality and your life plan.
Buying real estate: security and comfort
The decision to make a first real estate purchase is motivated by many psychological factors, starting with the need to take root somewhere and the sense of security of owning the roof over one’s head.
This ancestral need is more pragmatic than it seems at first sight. A tenant, in fact, is never totally at home and cannot engage in a particular work without previously referring to the owner. Even if the latter agrees, the nature of the realizable projects will be very limited in nature and will represent a pure investment from the point of view of the occupant. The tenant, moreover, never has the guarantee of being able to occupy the dwelling as long as he/she wishes it. A six-month notice is still possible from the landlord, who may wish to resell the house, for example, or retrieve it for his/her own living.
In most cases, finally, the real estate market with the purchase-sale tends to be much more increasing than that of the renting, especially if you seek a big family home. By being ready to buy, you are therefore much more likely to find the home of your dreams.
Rental: flexibility and mobility
It may be perfectly justified to continue to rent even if you have the means to buy, especially if you value your freedom of movement and to maintain some form of a carefree attitude. As a tenant, you do not need to worry about the timely completion of many jobs and that can be done at the expense of the owner: a phone call is enough!
The rental also offers many advantages, starting with the great “flexibility” offered by the status of a tenant. Thus, unlike a landlord, if you want to change housing (professional transfer, change of life, etc.), you are not forced to wait for its resale to move.
By being a tenant, you will be free to invest (business savings, PEL, the stock market, etc.) the equivalent of your unused contribution for the purchase of real estate, in order to make it profitable for a future investment.
This is an undeniable advantage compared to the owner, who will have to go through an offer for sale of his property, the signing of a promise to sell, the appointment at the notary and the acquittal of fees that go together … Five to six months of patience and stress are often a minimum, and can easily be extended in case of difficulty to find a buyer!
The Final Verdict
Rent: impossible to build anything without the owner’s approval
As a tenant, you will naturally have fewer responsibilities than an owner. For example, in case of work, you will be exempt from the many steps (search for a craftsman, requests for quotes …) which will be at the expense of your owner. When you need to repair an element of the housing (electric shutters, gutter, etc.), it is also your lessor who will take care of it.
On the other hand, the status of the tenant has drawbacks. Therefore, when you want to carry out developmental works or some renovation (painting, floor, etc.); you must obtain the authorization of your landlord. When the time comes to leave the house, your landlord may ask you to put everything back in the initial state.
Buy your home to be “at home” and secure your future
Unlike renting, becoming a homeowner will allow you to live truly” at home”. This means that you will be able to arrange it as you wish, without asking permission from anyone.
Buying your home is also a way to secure your future. In fact, when you retire, living in a house or apartment, which will belong to you and you will have paid off, will make you more financially comfortable: you will not have to spend anything every month on your housing, at a time in life when your income will probably be lower.
Buying home may be beneficial in the long run
On paper, owning your home seems more financially attractive than staying a tenant, especially because of the added value you get when you sell it. In addition, similar housing (comfort, surface, situation, etc.), the repayment of a mortgage can be equivalent or even lower than the rents offered in some cities.
Nevertheless, this logic is qualified by the fact that the expenses of the owners are much higher than those of the tenant (property tax, charges of co-ownership, and costs of the works…). Moreover, to be profitable, a real estate purchase must be thought of in the long term.
Many big people stay in rented homes instead of buying it. It is a lot cheaper for them to spend $20,000 per month and then pick up and go whenever they want and deploy their money in other businesses.
For them, it is better to be not tied down in a home with a down payment and a higher monthly payment. For the cash flow purposes, it just works out a lot cheaper to rent instead of buying a home.
But, generally for those planning to live in their home for more than seven years at a stretch, it may be buying which offers a better and cheaper route. Go and buy a property you really just like with a higher monthly cost, but without the worry of increase in rent or having a crazy landlord.
You will have total control over your property and 30 down the line you will own it completely. You will also get all the tax benefits of owning real estate and you can build up equity in an appreciating asset.
However, when you buy a house you are really tying yourself down to that property. You are tying up your money and if you need to sell in a year or two you will really at the mercy of the market where you might sell at a loss unless the home price goes up higher than your closing costs.
The long-term owning a property tends to be a lot cheaper. But you can have some smart buying techniques to make the home profitable even if you sell it within a few years of purchasing it. Getting a bigger house and renting it most parts of it or the basement can be a great idea to fund your down payment.
Whether renting or buying will be cheaper really depends on quite a few variables. If you intend to only be there a few years and you want to move on to something else, then renting is usually going to be the cheaper option.
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If you have a better use for your money and can invest in a lucrative business, or something that generates you a higher return than about 12% then also renting tends to be cheaper.
But if you intend to buy something and stay there a long time, buying tends to be a lot cheaper or if you are in a market that is rapidly appreciating or in a big city where prices are just continually going up, then also buying tends to be a lot cheaper.
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