Millionaire Mommy Next Door recently posted a series on renting vs buying which was quite interesting. She takes the view that renting can be much more financially rewarding than home ownership and gives her own situation as the example. While I don’t disagree that she has improved her lifestyle by renting, she makes it sound like home owners can’t participate in equity markets which is a bit ridiculous. On the other hand some of the commenters take the opposite tack and say that the only way to win at real estate (or to save) is to own a house.
There is no difference between renting and buying
I would argue that theoretically there doesn’t have to be any economic difference between renting and buying. Ideally both renters and home owners should be invested in equities and real estate and will benefit if either investment class does well.
Renters could include more REITs (such as VNQ) or investment properties in their asset allocation so they have some real estate exposure to make up for the fact that they don’t own a house. Another strategy that a renter can follow if they want to keep up with their house-owning friends is to use leverage to buy equities so that they can have a large monthly payment as well. If your best friend buys a house and has a $250k mortgage then you (a renter) can go out and borrow $150k and buy equities. The renter can expect a higher rate of return from equities and therefore doesn’t need to borrow as much as the home owner. This way you can still remain best friends and commiserate together about not having enough money.
Don’t overspend on the house
The reality is that when we rent, we tend be fairly moderate in our demands since we know that all of the rent payment is a cost and nothing is going towards our equity. When buying a house, a lot of us buy as big as possible and ignore the huge interest costs, focusing instead on the small (in the beginning at least) amount of equity we are building. A comment such as “At least I’m building equity instead of throwing my money away on rent” would only be true if the amount of interest on the mortgage plus maintenance and property tax was equal to the amount of rent being paid which it usually isn’t.
What to do if you are a homeowner?
- Only buy as much house as you can afford and still be able to save money so you can invest in equity markets.
- Pay down your mortgage at a reasonable rate – 20 years maximum. In case your house value goes down the more equity you have (had) the better off you will be. If your house value goes up then you are still better off with less mortgage.
What to do if you are a renter?
- Save as much as you can (more than the home owner) and increase your asset allocation in real estate investments such as REITs. You could also buy rental properties although that’s another ball game altogether.
- If you really want to emulate the home owner experience without actually buying a home then consider using leverage to buy equities since that’s the reason home owners have done so well in the rising real estate market. Extreme caution should be used with leverage.
- Don’t feel like you are being left behind. I honestly believe that a renter has more financial options than a home owner. The trick is to make sure you take advantage of those opportunities.
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This great debate is of particular interest since I have a 20% downpayment sitting in a high interest savings account right now trying to decide what’s best.
I’m curious as to whether banks really are willing to fork over 150K with what would be perceived as a higher risk investment in equities vs. a mortgage on a house.
Hi MM. That’s a good question about about getting lending from a bank. I was thinking more in theoretical terms with that statement (in other words I made it up).
What someone could do is use unsecured line of credits combined with margin and borrow a fair bit. As they build their equity (hopefully) they could eventually work their way up to $150k. I wouldn’t personally recommend using margin for more than about 30% of your equity (to reduce the odds of a margin call).
Don’t forget as well that the renter will be able to save at a pretty good rate so even if they are only leveraging 2:1 to begin – it would only take a few years of savings to get to the point where the leveraged amount is $100k or more.
Mike
I’d like to clarify that the purpose of this post is not to encourage renters to use leverage. In fact I think that if houses go up at their historical rate (inflation + 1) then a renter doesn’t need any leverage to keep up.
I was just trying to illustrate how a renter could “replicate” the home owner’s experience with a large mortgage.
I saw something in the Metro this morning about a Toronto couple who set a $450k budget for a house purchase and ended up spending $700,000 …. there’s a lot to be said for having the restraint to buy what you can afford and not getting too starry-eyed. With only one-and-a-bit incomes in my household at the moment I’m delighted we used our heads when we bought our place a year ago.
It seems to me that several factors still weigh in favor of buying vs. renting. One is risk. Renting necessarily assumes that you will be subject to unknown future rent increases. While one could suggest that rents will approximate inflation, the suggestion assumes much given that most people don’t have the flexibility to up and move to duplicate the overall market. They are tied to a neighborhood, a job location, a school district, etc. So beyond the fact that rents will increase, the unpredictability of rent expenses should also carry a premium that favors ownership.
So, to moneymusing, I suggest 100% ARM mortgage interest-only home purchase coupled with margin buys on Canadian banks. OK, maybe not
Guinness – that sounds like me when I go car shopping! I wish we had exercised a lot more restraint on our house purchase but there’s not much I can do about it now
Mike-TWA – good point but I would argue that there is uncertainty in the mortgage payments as well because of interest rate changes. Other uncertainties could include property tax increases. Lack of diversification is another risk for a home owner vs a renter.
Personally I don’t think buying or renting is necessarily riskier than the other – it’s how you manage your overall finances that determine your overall risk level.
I just think there are far too many factors and far too many variables to make a debate on which is better for your finances, to buy or to rent. I think it mostly comes down to personal preference.
There are some good points for buying a home, like inflation protection, forced savings, and cheapness.
See, when people compare renting to buying, they usually compare renting a fishing shanty to buying a 500K home. Of course you can save a pile of money by living in a hut. I would argue that for the exact same accommodations the cost will always be higher renting. All of the other costs would remain equal, plus a profit to an owner. The same argument could be claimed just buying less house than you need and living there and saving.
The real argument is can you be frugal in your living arrangements to save money. Not if you can save more by renting or buying.
Tim – I agree. I will say however that there are some markets ie Vancouver where it’s not cheaper to buy. From what I understand you can rent the same house/condo for far less than you can buy it for in terms of monthly payments.
Mike
I appreciate your discussion about my rent vs buy series and your input. I agree: one can invest in both equities and real estate, whether as a renter OR a homeowner. In fact, I have.
But as a renter, since my equity isn’t tied up in one home, I can diversify my investments much easier. Yes, a homeowner could leverage their equity by borrowing through a home equity loan to invest in stocks. For those with a higher risk tolerance, this could work, but it’s way too risky for me.
Alternatively, may I suggest that you NOT pay down your mortgage quickly. Use your extra money to invest in equities instead.
Traciatim, you wrote, “I would argue that for the exact same accommodations the cost will always be higher renting. ”
I have addressed this thought a couple of times already and contrary to popular belief, buying is apt to be more costly than renting – yes, FOR THE SAME ACCOMMODATIONS:
I Get Richer As A Renter @
http://millionairemommynextdoor.blogspot.com/2007/10/i-get-richer-as-renter.html
Renting beats owning, even in retirement; even if your mortgage is paid off. Here’s why. @
http://millionairemommynextdoor.blogspot.com/2007/11/renting-beats-owning-even-in-retirement.html
I encourage you to compare your own options, in your own real estate market.
I always like when this debate flars up again. Since I’m both a owner (income property) and a renter (I live in a basement apartment) I often think I’m in a good position to see both sides.
I think if someone rented, and actually did put all the extra money they would have spent on housing into investments that they’d probably come out ahead, HOWEVER very few people are that disciplined (and without the thread of foreclosure, it’ll be easier for them to increase their lifestyle and spend the money rather than save it).
“Another strategy that a renter can follow if they want to keep up with their house-owning friends is to use leverage to buy equities so that they can have a large monthly payment as well…This way you can still remain best friends and commiserate together about not having enough money.”
Mike, I find this idea interesting. I’ve been pondering a slight variation to this, which is why my interest in the SM has peaked lately.
My husband and I currently mortgage a home that is worth less than 1x our household income. I often wonder if we might increase our returns by leveraging a bit more. Though we do a fairly good job of saving, I don’t think we’re nearly as diligent as our friends with large mortgages are. It’s much easier to make a required mortgage or debt payment than it is to deposit money regularly into an investment account after maxing out the RRSP / 401k.
There is something to be said for “forced savings”.
Telly, it’s hard to argue with forced savings but unless you have a long amortization for your smaller mortgage, there’s a good chance you are saving (reducing the mortgage principal) a comparable amount to your friends including your rrsp/401k. Your friends might not be paying much principal each month.
If you wanted to increase your forced savings without buying a bigger house then leveraged investments might be the way to do it.
Mike,
When we bought the house, almost 4 yrs ago we went with a standard 25-yr amort. We’ve increased the payments every year by 20% but the payments are still relatively small compared to what we can afford.
We’re really trying to hold off on buying a bigger house because we know, realistically, we don’t need it.
Yes, I’m sure we “save” more than our friends with larger mortgages do, but often times I feel like we don’t do as well as we can.
I want to join in on the commiserating!
Ah, the never-ending debate…
One advantage of buying is that once the mortgage is paid off, you are only on hook for property taxes, maintenance and insurance as your housing expenses. These expenses are likely to be lower than half that of renting. Which means, you need less of an income to support you. Also, don’t ignore the effect of taxes on this equation. You first have to earn some money and pay income tax on it before you pay your rent.
CC – if you are comparing a home owner to a renter who doesn’t save much then that’s a very valid point. However in the case of a renter who saves and invests – it shouldn’t matter that the home owner costs will eventually be lower than the renters since the equity savings should make up for it (in theory at least).
Telly – if it will make you happy then I can transfer part of my mortgage over to you…
Ah the classic debate…
As a renter I’ve run the numbers several times in several different ways and at the end of the day it simply becomes a lifestyle decision.
My #1 problem with home ownership (for most people) is that of the “default decision”. Owning a home seems to be one of life’s “I’ll do it b/c that’s what everyone else is doing…” style of decisions. I know lots of new homeowners who spew the “throwing money away” mantra or some other variety of “logical reasoning” and then complain about the fact that they don’t have any money…
My problem with “default decisions” is not that people make them, it’s that people make them without thinking. It’s not the decision that’s questionable, it’s the supporting thought process.
It’s often the same way with cars… if you hear people truly annoyed at things like:
1. I don’t have any money b/c XXX broke and I have to pay for it
2. I don’t have any money this month b/c I have to pay [insurance fees] | [increased property taxes] | [deductible on accident that wasn't mine]
3. My boss is angry b/c I was late when my car broke down for the 2nd time this month (usually followed by “He’s such an insensitive jerk”).
4. I can’t take this great new job b/c I have to [make payments on big thing] | [can't sell my house] | [can't afford the up-front pay-cut]
You see, I hear this stuff all of the time, and it seems to stem from some kind of “bad decision anger”. If you consciously made the decision to live a car-driven lifestyle or operate your own home, then you can’t really complain about the “stuff that crops up”, right? You knew what you were getting into, right?!?
Lots of people simply don’t know what they’re getting into, which I why I’m happy that we have these forums for discussion. I don’t have a home or a car, but I don’t begrudge those who do, I just don’t want to hear you complain about it
Telly is right about the “forced savings” concept, but that’s not really thinking very highly of oneself. It would seem to me that making a big monthly “auto-payment” is no different from making mortgage payments.
Heck, if anything, the “auto-payments” into something liquid are quite empowering. Having money in the bank and some measure of financial freedom gives you something that almost no one has. Plus it’s easier to cut the tether on savings than it is on mortgages.
But hey YMMV
Thanks Mike!
Maintenance costs can vary widely. In an older home, they can add up to substantially more than the costs associated with renting, especially if you throw in a renovation or two, something you would be unlikely to do if you were renting.
Gates, the thing about auto-payments is that, when “unexpected” things come due [insurance fees] / [increased property taxes] / etc., it’s very easy to stop making them. You can’t stop making your mortgage payments, at least most people won’t.
As far as your idea that people knew what they were getting into, that’s not necessarily true, especially when it comes to home ownership, despite doing your own DD prior to purchasing (and getting an inspection).
For example, we didn’t know:
1) that our basement would flood within two weeks of purchase
2) that our heating bills would be much higher than we anticipated because our beautiful 80+ year old house with so much character didn’t have a sliver of insulation in the walls
3) that our water heater would fail on us after about 2 months
4) that our furnace would fail after 1.5 years and the A/C soon after…
I could continue. The thing is, some things are truly “unexpected” regardless of how much homework you’ve done.
So basically, people have a right to complain or commiserate if they want to.
Mike: Fair point. But in real life though, renters spend the extra money they should be investing, investors don’t get the returns the market gods give them, etc.
CC – I’ll agree that the general public won’t save much after their rent payment however the general public doesn’t read this blog (or not many of them at least). I think for people like us and our readers, it’s not a big reach to assume that we would save a lot if we were renting.
And yes they have to be good investors as well (ie get around the market return).
Gates – so we should quit our b****ing?
Mike
Hey Telly,
As far as your idea that people knew what they were getting into, that’s not necessarily true
And that was the point of my comment (though maybe I missed a bit of sarcasm there). Make whatever decision you want, just make an informed one. Make a decision that matches the way that you want to live your life, whether that follows the crowd or not.
Complaining about the cost of operating a car is like complaining about your life decisions. I mean, why is there anger when gas prices crack a loonie? We knew it was going to happen, right? The A/C on your car went? The tires blew? The car was vandalized? All really annoying, but hey, it’s part and parcel with owning a car.
That’s why you have money for insurance socked away, that’s why you make regular deposits into a bank account to cover future maintenance and to ensure that you can cover the deductible. It’s the same deal with the house. It’s not a surprise when the water heater “dies”, it’s an eventuality. You knew it had to happen sometime, you just weren’t quite sure when. If the heater came with a warranty, then every day after the warranty is one more borrowed day. Just assume it’s toast and start saving for a new one (though you already should be).
If someone makes the “car-driven” or the “home-owner” lifestyle decision, they have to live with all of these consequences. You can complain or commiserate if you want to, but the act of complaining seems like a put-down to your own lifestyle decisions. “It may be shitty, but those are the risks I accepted” never seems to come out of these conversations.
Thanks for the comment Mommy (hah!).
I just pulled your comment out of moderation which is why it only appeared now (it’s number 9)
Mike
Telly wrote, “As far as your idea that people knew what they were getting into, that’s not necessarily true”
and
Gates VP wrote, “Make whatever decision you want, just make an informed one. Make a decision that matches the way that you want to live your life, whether that follows the crowd or not.”
Yes! This is precisely why I’m posting the series on rent vs. buy on my blog. The crowd has always touted homeownership as the key to personal wealth… and we sit back and accept it as truth. Do your own math and you might be very surprised. I sure was.
CC & FP: No need to look further. Our dividend portfolio is officially paying all of our rents. This is even better than owning a home, because we pay no condo fees, no property tax, no maintenance and no home insurance (though we pay for content insurance only).
Not only that, our yield increases at a much faster click than rents. That means we’ll realize net positive cash flow pretty soon.
FJ – thanks for the info. I guess we can close this case!
Seriously, what kind of apartment do you rent? Is it something comparable to what you might buy?
Mike
Millionaire Mom wrote:
“The crowd has always touted homeownership as the key to personal wealth… and we sit back and accept it as truth. Do your own math and you might be very surprised. I sure was.”
I’m in total agreement. That’s the point I’m trying to make as well. You can do all the math you want upfront but no one does the math after the fact, instead they tout home ownership to be the key to wealth and forget about all the costs incurred over the years when they say, “I bought my house for $X and now it’s worth $X+Y!!”
FYI, I’m both a homeowner and a rental property owner.
Gates, it’s unrealistic to think someone would sock away 8-10% of their home purchase price in the 1st two years to pay for ‘unexpected’ repairs (which is what ours worked out to be). Do you save 3% in an account specifically for potential rent increases? Thankfully, we were able to use a couple months worth of cash flow to cover the costs.
FJ, those are some great numbers. I recall (from previous posts on CB forums) that you sold your home to rent instead. In a place like Vancouver, that makes a lot of sense right now. However, many home owners do not weigh their options in true dollars.
FJ – I can believe it in our ridiculous Vancouver market.
Gates makes some excellent points. I hear complaints from people all over about how much gas costs… driving their giant SUV(!!), or more locally, moving to Surrey and complaining about the traffic over the Port Mann Bridge. That’s nothing new, do a little research!
Risk was mentioned, I think the risk on a detached house is greater than any rental risk. The potential for very expensive issues (new roof, furnace, etc) can come up at any time. The bank expecting a mortgage payment doesn’t care that your house turned out to be a bit of a lemon.
I’d like to own my residence at some point in the future, but right now like Mr. Cheap I own a rental property and rent my residence. So far its working out great. I’ve been here 4 years with zero rent increase, and all utilities are included.
Thanks for the comment Warren – I read your story on FJ’s blog and found it quite interesting.
Mike
>>”Seriously, what kind of apartment do you rent? Is it something comparable to what you might buy?”
Just to give you a little background, we’re paying a bit of a premium because of our pet situation. For the same rent and without a pet, we could be renting our desired suite right now. What can we say? He’s part of the family.
The current unit is 580 sf, which is normal in Downtown Vancouver, but it has water view.
FJ – gotta keep the pet! One of the reasons I bought a house instead of a condo was because of my cat since he likes to go outside.
Water views are awesome.
Mike
Do you have any websites to back this up?
Aurum: What is it you want backed up? A comment or the original post? Which part of it? There are a lot of different ideas in the original post and the comments…
Mr. Cheap,
Perferably the orginal post. There seams to be a lot of speculation but nothing to back it up besides personal experience, which isn’t always realiable because A. Please can lie (not saying that this person is) and B. What works for one person may not work for the rest of the world.
Aurum – I have no idea what you are asking – I only posted on some ideas I had about renters being able to replicate the financial scenario of owning a house. What specifically are you questioning?
Mike