Rent vs. Mortgage

I saw a post the other day which was basically the old Rent Vs Buy question, or is renting and investing the difference better than paying off a mortgage?

I’ve done a lot of in depth financial modeling on this subject and the answer I’ve found is….. it depends! I’ve developed a spreadsheet that can help you to determine if it’s the right strategy for you. It basically calculates the difference between buying using a 100% loan and an installment gearing strategy with a 50% LVR.

The reason most people will be better off purchasing a house from day 1 via a mortgage is that it is forced savings, it has to be paid each month or you’re out on your a**. Savings on the other hand can be postponed, reduced or used to pay bills, buy a car etc, etc. Savings are much harder to maintain and can be very tempting to spend!

To determine if renting and investing the difference is the right strategy for you, simply plug in how much you would need to borrow to buy the house of your dreams and the other details about how much you pay in rent per week, into my spreadsheet and you’ll get an answer.

You have to fight fire with fire when investing the difference. You have to invest into a growth asset that will perform just as well as property and you have to use the power of gearing.

Generally the closer the gap between rent and mortgage repayments the better you are buying.

Please have a play around with it and see what you come up with. You can alter the fields in Green, the rest is protected (there’s no password so you can unprotect it).

Please note it won’t be 100% accurate and the assumption on growth rates can be changed to suit your view on property and shares. I don’t want to start another property vs shares thread!

 

Thanks YG- looks like it could be a useful resource for some

Mind you, you can't exactly quantify in dollar terms other benefits of renting vs buying eg: lifestyle, security, predictability. It's an emotional argument that has no wrong or right answer, really.

 

Nice little tool. I'd imagine that of late buying a home is looking like a very tempting option for a lot of renters. Especially considering the rate at which interest rates are dropping.

Interest rates: Reserve Bank to cut rates in December

 

My *personal* view on rent vs buy is much the same as shares vs property and cashflow vs capital gain. There's no right or wrong. The advantages of both are roughly equal and it really only comes down to personal preference.

Mark

 

This is true. I personally feel that renting gives you a better lifestyle as you can (nearly) always afford to rent in areas where you can't afford to buy.

 

Affordability traditionally hasn't been as big an issue as it has been over the last decade, so using the word "always" might be a bit excessive, though it has definitely been true of the last 5 years or so. Though I think this trend is quickly reversing.

 

This may be true, but in my lifetime (gen yer) "always" is not excessive

 

As interest rates decrease, the gap will naturally close to the point where tenants will begin to notice the difference and consider home ownership. The current generosity of us taxpayers funding FHB's an extra $7-10K on top of the existing $7K grant is also another large incentive (as the govt intends it to be) to move tenants into home ownership. When the difference comes down to tens of dollars per week, as opposed to hundreds I believe you'll see more of a shift. It's still early days, however, though I would anticipate a rush of activity come April-June next year as the cutoff date looms.

 

I bet they end up extending the grant, probably indefinitely, or at least until the economic turmoil is behind us. It will hurt the industry too much to take it away, especially in this environment of low confidence.

 

Renting the better option currently

Basically renting is the better option currently as house prices are so high. You are paying 9X median income of about 60,000 for the average house in Melbourne. It is one of the highest ratios in the world. It is a good time to sell your house, not buy one. Give it a few years and you might be pleasantly surprised that houses are more affordable. There is always a good excuse for a bubble but they all end the same way.

 

So you think Melbourne properties are expensive.
You could be right but the conditions are not right for big price corrections.
Give it a few years and your wages would have increased, rents and the price of other essentials would have gone up and Melbourne property prices at their current levels will look cheap

 

Maybe, but if there is one point that should be taken away from the last 3 years it's that thing can change pretty quickly, and that property isn't a liquid investment.

Wage growth has been much lower than the trend in the last couple of years and property prices has still edged higher. If wage growth rate get back to where they were or even higher you can bet you bottom dollar we will well and truly be back in a bullish market and the property speculators will be out in full force.

If the Australian house price bubble bursts, it's far more likely that real wages will depreciate with housing prices as the economy slips into a recession an unemployment rises. There are countless good examples of this around the world in the last 5 years.

 

Chris

Property doesn't need to be liquid.
I don't expect much to change in the next couple of years but what worries me is the GSC (Global Sovereign Crisis) which could worsen credit availability and the level of our interest rates.

This only concerns me because I have big loans and high exposure to interest rate movements. However, most people who only own 1 home have very little to worry about. It will be business as usual.