The debate about whether you should buy or rent a house has passionate proponents on both sides. When my significant other and I bought our place 4 and a half years ago, it was mostly because we were fed up with landlords. While this is a valid emotional reason, it is not exactly the type of reason that makes for good investment decisions.
Here are some financial considerations that will serve you better in your choice between buying and renting.
The Case for Buying
The most common argument for buying is that you are paying your own mortgage instead of someone else’s. You are channelling an inevitable expense, the cost of a roof over your head, into investing in an asset that will be of immediate use and that will generally not lose its value. This makes investing in a house different to investing in the stock market (no immediate tangible use) or buying a car (a depreciating asset). You also have the freedom to make your house your dream home through improvements, with the added benefit of these improvements increasing the future selling price.
A mortgage is the cheapest debt as the interest rate on a mortgage is lower than on any other form of debt. The fact that a mortgage leaves you with an asset that will not depreciate, also makes it smart debt.
While the interest rate and therefore the monthly instalments may fluctuate, you have the option to fix your interest rate so you have more certainty about the instalments. Even if you do not fix the interest rate, the long-term trend of interest rates is stable, which means your instalments will remain more or less the same.
Lastly, an important consideration for me personally: once your mortgage is paid up, your housing expense will decrease dramatically. This will be particularly valuable once you retire and have to get by on a smaller income. Additionally, you might be able to use your house to generate an income by renting out a part of it.
The Case for Renting
The rent you pay each month is usually less than the mortgage instalment on a similar place. Furthermore, there are additional costs involved in owning a house that are often forgotten: banks require mortgage insurance and it is wise to take out homeowners insurance on free-standing property.
If you own a property, you should ideally have an emergency fund to cover maintenance costs like a burst geyser. This is not necessary if you rent as maintenance is not the tenant’s responsibility. For example, in the past 4 and a half years we have had to replace our geyser, fix damp and install a new toilet flush system, none of which we would have had to do as tenants. Such maintenance costs only add value to the house if they are upgrades on the original items.
While we like to think of a house as ours when we buy it, this is not really true. You do not own the house – the bank does. You will own it in 20 years, but until then you cannot lay claim to it. If you go bankrupt, you will lose the house and be in no better position than a tenant. Should house prices fall as they did worldwide during the 2008 financial crisis, you can even be worse off as a home owner.
An often overlooked but important difference is the initial outlay required when you buy a house. While it is possible to get a 100% loan, this is not guaranteed. You will therefore need an upfront deposit in addition to the transfer costs and bond registration. According to Rawson, the transfer costs and bond registration for a R1 million house with 10% deposit is roughly R54 000. You will therefore need R154 000 upfront.
Let’s look at some additional numbers for your R1 million home. Note that these calculations are intentionally optimistic to give you the best possible cost scenario.
Let’s assume you sell your property after 5 years. These numbers are again optimistic. For example, the property value growth rate was 3.5% in August 2018.
Your profit on the house is the selling price less the agent’s commission and the outstanding mortgage, right? So a total of R371 931.
What about your upfront investment of R154 000? And the additional monthly R2 500 you had to spend over 60 months? If you take these into consideration, your profit is actually R67 931 (and this excludes expenses like cancelling your mortgage and getting the necessary certificates ahead of the sale).
Now imagine you had invested that R154 000 instead and set up a monthly debit order for the R2 500. At a conservative interest rate of 8%, you would have R304 000 at the end of year 5.
Your 5 years of home ownership will leave you with R67 931 as opposed to R304 000 if you had rented (the monthly rental for the first 5 years will be roughly equal to the mortgage instalments and can therefore be ignored in the comparison).
So which is better?
The decision to buy or rent a house is a deeply personal one that depends on your unique situation. More than anything, it depends on how long you plan on staying in your house. If you take the long view, you should definitely consider buying. But if you do not see yourself settling in one place, renting might be the better option. Here’s a nifty calculator to help you decide which option suits you best.
Get in touch if you would like to chat about whether renting or buying makes the most sense in your situation.