When should you stop renting and buy?
We give you a short cut to figure out whether it's time to stop renting your home and buy.
A few weeks ago I wrote about finding the “right” price of a property and how sellers can get the best price when selling. Read What's the 'right' price of your house?
Now I'm looking at something completely different: is buying a specific property at a particular price going to make you financially better off than renting? (In the long run.)
Price increases are not the main thing
I've touched upon this subject in articles before, trying to get the typical British citizen to realise that how much your property price grows is not the most important thing; for example, the difference in costs you face over the long run compared to renting has more of an impact.
Let's look at the differences in costs:
|
Cost or asset |
Home buyer |
Renter |
|
Taxes |
Many home buyers must pay stamp duty. |
A renter could potentially save or invest this sum for the future. |
|
Various legal and admin costs over the years |
A home buyer and owner could potentially pay lots in such costs over the years, particularly if they move up the ladder or re-mortgage a lot. |
A renter will likely pay some legal and admin costs, but far less than a home owner. They could save or invest the difference. |
|
Deposit |
A home owner will typically put down many thousands in a deposit. |
A renter will put down a much smaller rental deposit, and could save or invest the difference elsewhere. |
|
Mortgage fees |
A home owner will typically pay lots of fees over the years, particularly when they switch from deal to deal. |
A renter could save or invest the difference. |
|
Monthly payments |
A home owner pays a monthly mortgage, which – even considering strong fluctuations in interest rates – is likely to be more expensive than renting at the beginning, and less expensive towards the end. These payments will end completely after a few decades. |
A renter pays monthly rent that rises steadily over time. It's likely to be much cheaper than paying a mortgage through most of the first 15 to 20 years, and the renter could invest the difference. Thereafter, however, a mortgage will be cheaper, and a home owner catches up – particularly quickly when the owner has fully paid off the mortgage, continues to face rising rents. |
|
Maintenance and buildings insurance |
It's extremely tricky to estimate, but a home owner could easily face simply phenomenal maintenance and insurance costs over three or four decades of home ownership. |
A renter faces virtually no maintenance and buildings insurance costs, and could invest the difference. |
|
Assets |
After several decades, you have a major asset, fully paid off. |
After several decades, you have nothing to show for it. |
In addition, home owners can fit-out and furnish a property how you want, and upgrade or renovate as often as you like. I mention this separately, because many home owners claim it's not a cost but a benefit of owning that you're allowed to personalise your property. Hence, whether you include such costs is a personal decision.
Who usually wins?
Unsurprisingly, home owners are usually better off in the long run than renters. By the time you have owned for 35 years, far, far better off. And that's even though renters can save and invest more to begin with. Each year thereafter, you become dramatically richer still, in comparison to a renter.
Even using very conservative calculations, such as assuming you bought at a peak and paid immense maintenance costs, you would have to pay a monthly mortgage that is massively higher than rent in order to be worse off in the long run. Either that, or you would have to buy in a moribund town – one that is dying because the industry in it is closing down, for example.
Doing the sums isn't easy
But forget what's usual. Let's consider your specific situation.
When I started this article, I was hoping to give you a nice, easy to understand series of sums and online calculators to help you work out for yourself whether it's worth buying your desired property or to keep on renting.
After working through it with a couple of dummy examples, however, I can see why buyers don't normally do this.
I've needed to write 10,000 words of notes and created 12 tables in Excel to do my calculations. There's no way I can simplify and explain that to you in a short article. Perhaps I'll write an ebook on it one day.
Here's a short cut
In the meantime, I can at least give you a rough and very simplified short cut:
A) Open this online mortgage calculator.
B) Type the mortgage amount you require to buy your desired property.
C) Type “30” as the number of years for the loan.
D) Type “8” as the interest rate on the loan.
Note: it doesn't matter if you don't think those numbers apply to you; it's all a way of simplifying an intricately connected series of calculations that should give you an estimate with a large margin of safety.
E) Divide the monthly repayment shown in that online mortgage calculator by the rent you would otherwise pay if you decided now not to buy.
For example, if the monthly mortgage payment is £990, and the property you would choose to rent if you didn't buy costs £660 per month, you divide 990 by 660, which is equal to 1.5.
1.5 is the magic number, whereby you have an extremely high probability of being better off if you buy after you have owned for 35 years. Much better off. In most of the following years, your gains will only increase dramatically.
I said earlier that I had excluded costs for personalising and making over your home. Even if you want to include those as a cost of owning, 1.5 is still going to give you a large safety margin.
If the result is lower than 1.5, you're probably looking at real bargain territory.
If it's over 1.5, that doesn't mean you should never buy. It just means the margin of safety falls. By the time you get to 2.0 the margin of safety could have got quite small. Before buying at this price, you should probably be as certain as possible that you intend to be a home owner for 40 years or beyond.
Other issues
I haven't considered different but related issues such as affordability, personal circumstances, downsizing, super-prime properties, how to compare two potential properties to buy, buy-to-let, interest only or no mortgage, and much more.
There are a lot more issues to look at. I should really write that ebook.
More: Yorkshire BS launches Rollover Mortgage for last-time buyers | Is overcrowding to blame for high house prices?
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Comments
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I think people will only start to buy when real living wage jobs are easier to find. There has been loads of new jobs created near me in the North West but sadly those jobs are in the new Asda , Poundland or Telesales paying under £8.00 and hour.My oldest son rents in Kent and travels daily to work in London as there seem to be few jobs round here to support his wife and their 3 under 5's. They also need to be mobile so ideally if somebody wand waves and there is a job round here he can literally be on the next bus. I think most people would love to buy but this country has changed in so many ways . Moving abroad is a sweeping statement .For me I tend to feel safe here , speak the lingo , have a fairly good grasp of the law and am fairly confident there won't be many extremes of weather that I can't cope with.
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There have been quite a few comments from people who think that monthly rent for a property will always be higher than a mortgage. This is not true. Your monthly mortgage payments are likely to be far higher in the first years after you buy than if you rented the same property. Think about it like this. If you buy today, you're buying at today's house prices and mortgage prices. However, the average landlord will have bought their properties years ago, when house prices were lower. This means that their mortgage costs are far lower than yours would be if you were to buy the property off the landlord today. Hence, they can afford to charge lower rents than a new buyer today would pay in mortgage costs, and competition ensures that they do so. In addition, new landlords often have to make a loss after mortgage and maintenance costs for the first few years. It's not until rents have risen above all the costs that they start to make a profit. Neil (article author)
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Oh Dear, some people are clearly uninformed of what you can get in the rental market if you try. "Archmage said One slight flaw, renting is never cheaper than a mortgage! Unless you are going for the bottom end of the market. Scenario I buy a house to rent, do I subsidise the rent out my own pocket for 15 years? No of course not, I charge the mortgage cost plus a bit for myself. Some people might call it exploitation, others call it business." If you can explain to me how I am living in a 5 bed mansion for £1750 a month when the place is valued at around £1.4M then I would be interested to here how renting is never cheaper than a mortgage. A mortgage even at these silly rates is around £4700 minimum per month if I put down £400K as a deposit! Interest only is £2500 a month. With no bills to upkeep the property and almost no cost or restriction to move when we feel like it, it seems you are mistaken as to what renters can get if they look around and negotiate. Cheaper to own than rent.... not at all actually.
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10 November 2012