Is Renting a Waste of Money?

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“As long as you’re renting, you’re throwing money out of the window” – That’s the advice you will hear from many well-meaning friends, relatives and acquaintances. These wannabe experts will explain to you that having a mortgage is much better because “at least the house will be yours at the end”.

On the surface, it may look like they are right, but most likely they are wrong. They probably haven’t done the maths and are just naively repeating what the system wants us to believe.

Most people are impulsive in home purchasing – they want a place of their own – and they don’t spend enough time considering the mortgage consequences of that action. Often people buy a house as soon as they have saved enough for a minimum down payment. Others use rules of thumb like “with a 50% down payment, a mortgage is cheaper than renting”.

The problem is that there are no rules of thumb that can apply equally to all situations. And, unfortunately, few actually compare mathematically the cost of renting versus buying in order to make an informed decision. That means a lot of bad decisions are made.

Buying Versus Renting

The best way to understand the financial difference between buying and renting is to run the figures! Let’s imagine a professional Monkey couple, trying to make up their mind about what to do.

They have steady incomes and some savings ($97,500 in our scenario). The question is, will they be better off as homeowner or as tenant?

Scenario 1.

The Monkey couple has fallen in love with a 2-bedroom house in inner Sydney. It is priced at $650,000. They will make a down payment of 15% ($97,500) and borrow the remaining $552,500.

Assuming a payback schedule with constant installments over 30 years and a mortgage rate of 7%, they will already be making monthly payments of $3,676.

It is thus unlikely that our average-income Monkeys will be able to shorten the mortgage term to increase their installments.

Scenario 2.

The Monkey couple is happy living in a 2-bedroom rental apartment. They are paying $430 per week in rent and saving as much as they can (the savings rate is 5% per year). They don’t want to worry about a mortgage or home repairs.

So? Who fares better? Homeowner Monkeys or Rental Monkeys?

In order to make a realistic comparison, we’ll need to look 30 years into the future. That means using future values, and assuming a yearly inflation rate of 1.5%.

Using the formulas for compound interest, annuities, and mortgage costs from previous posts, we’ll be able to see if our couple would be better off having bought the house with a mortgage or having rented throughout.

Buying Costs

Buying a house implies many hidden costs that most people don’t tend to consider. They only focus on the market value of the house, discarding any recurring taxes, fees and other payments that come with being a homeowner.

Item
Assets
Liabilities
Comments
Total
$1,016,002
($1,279,333)
Net Worth = -$263,331
House
$1,016,002
Even though I don't believe in automatic real estate price growth, I will assume the price of this $650,000 home follows the 1.5% inflation rate.
Mortgage Cost
($770,787)
This is the total cost of the mortgage for interest paid over 30 years on a principal of $552,500, assuming constant installments and a mortgage rate of 7%.
Mortgage Insurance
($8,636)
Following market practice, we will assume its cost to be 1% of the mortgage principal, hence $5,525 compounded at the inflation rate over 30 years.
Inspection Fees
($1,563)
We assume $1,000 are spent on various building and pest control inspections prior to the purchase. This amount is the inflation adjusted future value.
Renovation Work
($31,262)
Realistically, when you buy a new home, you will perform some immediate renovation (kitchen, bathrooms, painting, flooring, etc...). We assume a reasonable spending of $20,000 up front.
Government Fees
($39,149)
This includes mortgage registration fees, transfer fees and stamp duty. This amount is the future value of $25,046, compounded at the inflation rate for 30 years. (Source: NSW Stamp Duty Calculator from RAMS)
Council Rates / Strata fees
($150,155)
We will assume $1,000 per quarter are paid towards those fees, amount which increases with inflation.
Property Tax / Land Tax
($120,120)
For 2013, the land tax in NSW for a $650,000 property amounts to $4,004. This amount will be assumed to stay constant over time as the government already readjusts the property valuation with inflation. (Source: NSW Land Tax Calculator)
Water Bills
($45,046)
This is one of the few utilities renters do not pay and is only born by owners. For this property, we will assume $300 a quarter is necessary, which we adjust with the inflation rate.
Home Maintenance
($75,077)
There are several rules of thumb to estimate yearly repair costs for regular wear and tear. There is the 1% price rule, the 1% square foot rule, etc... Let us just assume $2,000 per year is spent in repairs, adjusted with inflation.
Home Insurance
($37,539)
This insurance covers the building itself, not the contents. Given the value of the property, it would roughly cost $1000 a year to insure it, which we adjust with inflation.

Renting Costs

When renting, all maintenance costs are already included in the rental price. As a tenant, you don’t need to worry about anything apart from insuring your belongings. Everything else is the responsibility of the landlord.

Item
Assets
Liabilities
Comments
Total
$1,944,043
($839,365)
Net Worth = +$1,104,678
Downpayment
$435,605
Given that Rental Monkeys didn't put their savings towards the downpayment ($97,500), it will generate interest for the next 30 years.
Regular Savings
$1,508,438
Rental Monkeys are able to save the difference between the mortgage installment and the rent i.e. $1,812 per month. To keep calculation simple, we assume their salaries increase with inflation such that it counterbalances the inflation-adjusted rent, keeping their level of savings unchanged. Using the constant annuity formula, we get the future value of their savings account.
Rent
($839,365)
We assume a weekly rent of $430 to start with, amount which is adjusted yearly by inflation.

Summary

After 30 years, Homeowner Monkeys have a house which is now worth $1,016,002 (assuming there was no market crash…).

Factoring in purchasing and maintenance costs, they have spent a total of $1,279,333. If they would resell the property at that point in time, they would have lost $263,331 (not taking into account real estate agent commissions and fees derived from the sale).

Rental Monkeys have no property but have been busy saving instead. They now have $1,104,678 in their bank account. That means they could buy Homeowner Monkeys’ house, pay the inspection fees, renovation work, government fees and still have $16,072 left in the bank! Hence, in this case, renting was the better financial decision.

The main goal of this post is to stimulate you to think. There is no one best answer that fits all scenarios; you need to compare buying to renting based on market conditions. The critical factors to take into account are:

  1. The interest rates, both for mortgage and savings (the higher, the better to rent!)
  2. The term of the mortgage (the shorter, the better!)
  3. The amount of principal borrowed (the smaller, the better!)

The long and short of this post is that the statement “buying is always better” is wrong. It is a myth that keeps us locked into a life of salaried work to repay our debt.

However, there are also cases when buying will be a better financial decision than renting. It’s possible but a lot of parameters will have to be in your favour: lots of savings, small mortgage, high salary, short mortgage term, etc…

If you think you are in the right position, don’t just rely on your gut feeling – Make sure you can prove it mathematically!

Free Download – Buying vs Renting Spreadsheet

4.90 avg. rating (97% score) - 10 votes

Monkey Master

My wife and I are currently living in Sydney, Australia. We plan on becoming financially self-sufficient in 2015 so we can retire at 35. We are regular working people, trying to be smart about saving money and generating passive income. I want to share with you how we reached that decision and how we are planning towards financial independence. Continue Reading.
Contact: monkeymaster@monkeyism.com

13 thoughts on “Is Renting a Waste of Money?

  • 22 May, 2013 at 6:27 am
    Permalink

    Thanks for bringing this post to my attention. At present, we are renting a small apartment which costs $1,200 a month. We actually thought of just buying a condo unit because we felt we are wasting money on rent. We can’t rent the rest of our lives right? And the price keeps getting higher every year. It’s the same as owning a house.

    Reply
    • 22 May, 2013 at 7:41 am
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      Thanks for your inputs Allisa.

      The right decision to make will depend on your personal situation (interest rate, mortgage principal, etc…). There could be a tipping point when buying becomes financially beneficial. Most people just make the mistake of buying too early and not optimising their finances.

      Owning a condo could trigger regular fees (like a small rent on top of interest repayments) that are not cheap at all. This is why I try to list all common fees for home ownership to raise awareness.

      Nothing prevents you from renting for the rest of your life if you have calculated that it is more efficient. I personally think it is a social stigma, that we’ve been raised to think that owning our own house is a vital need. And if you worry about inheritance, you can always leave your kids a bunch of cash rather than a house.

      Mathematically, you could end up better off by just renting all your life. But again, it depends on a number of factors and I’m just pushing people to build their own spreadsheet and check for themselves. As long as you understand what you are getting into, that’s the most important. Good luck with your decision!

      Reply
  • 29 May, 2013 at 6:20 am
    Permalink

    While I agree with you, I feel your maths should be corrected. If Rental Monkeys buy the homeowners Monkeys’ flat they will not have $33,091 in the bank because they still need to pay government fees (stamp Duty), which will be based on your calculations $39,149; and most probably will need to renovated that 30yr old kitchen, which according to your calculations will take $31,262. That puts Rental Monkeys at -$37,320.

    If you have everything in a spreadsheet with the formulas (and it isn’t much trouble) I would like to ‘play’ with the number (change number of years, value of the house, inflation, etc…). I am having troubles to get the exact same numbers as you (most probably my formulas are wrong ☺).

    Reply
    • 29 May, 2013 at 11:08 am
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      That’s a fair point :). If I simulate the sale of the house, I would need to take into account inspection fees as well. And on the seller side, I would also need to substract agency fees. Let me review the scenario first and I’ll try to put the Excel file for download as well. I just need to format it properly before sharing it. It’ll be good to have people double-checking it as well in case I made a mistake…

      Reply
  • 8 June, 2013 at 2:51 pm
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    Interesting stuff – but a couple of items not included in the calculation is removalist costs for the renters, because it’s unlikely they will be able to rent the same place for 30 years. Possibly even having to move upto once every year! (Although, could be less frequent). Then you get a bit of ‘renter stress’, which is hard to measure/cost, but one of the benefits of being a home owner. (but of course, the home owners get stress if they can’t make their repayments!)

    And yes, the flip side of being a renter, you’re not locked into the one place, if you need to move for work, bigger place for kids, etc.

    Reply
    • 9 June, 2013 at 12:26 pm
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      I agree with you there is room for additional considerations. All I want to highlight is the big picture where one should think through as you did about every possible costs on each side before making a decision. Afterwards, you can play with the spreadsheet and run different scenarios that suit your personal case.

      Reply
  • 8 June, 2013 at 3:14 pm
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    Land Tax in NSW is calculated on the value of the LAND. An apartment will only have a very small portion of the price as land value. ie, a $650,000 apartment is not worth $650,000 for land tax. Further, a principal place of residence (your home/the apartment in the example) is EXEMPT from Land Tax (currently – who know’s in 30 years!) http://www.osr.nsw.gov.au/taxes/land/

    And on the renters side, landlords are allowed to charge the water USAGE amount to renters. This is not the full water utilities bill, so it will still be lower than homeowners, but another cost to factor in. See http://www.fairtrading.nsw.gov.au/Tenants_and_home_owners/Being_a_landlord/During_a_tenancy/Passing_on_water_charges.html

    Also, not sure if you’ve deducted tax from the renters interest income on savings/investment income? This could be a big difference.

    Reply
    • 9 June, 2013 at 12:40 pm
      Permalink

      Tax is always a tricky box to fill in… Whether it is a tax paid or tax break, I’m leaving this for everyone to fill in depending on their situation. In the example, I indeed used the land tax calculator to get a rough amount for the comparison. But I agree with you it can better be adjusted.

      Reply
  • 15 June, 2013 at 2:46 pm
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    You also have to consider that people generally buy a bigger and more expensive house as compared with a smaller rental. That compares apples and oranges, but this is often a reality. This results in differences in cost of furnishings and the cost of heating/AC and other maintenance.

    There is also the psychology of a homeowner. When you own the house, you are much more likely to spend money on “improvements” and you tend to fill up the house with stuff because you know you will not be moving soon.

    Reply
    • 16 June, 2013 at 12:41 pm
      Permalink

      I totally agree. Someone who rents a 2-bedroom flat is more likely to buy a 3-bedroom house or larger property to have a guest room, play room etc…

      Although my example deals with properties having the same number of rooms, I have roughly taken what you mention into account by playing on the rental amount. A $650,000 house for rent would probably be on the market at around $600 per week in Sydney.

      By setting the rent at $430, I am roughly comparing renting a flat worth $500,000 against buying a house worth $650,000. But that’s the reality, most people will rent a relatively cheaper property to save money in order to buy a higher value property.

      Reply
  • 9 December, 2013 at 7:11 am
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    In the city I live in, rental prices are really volatile. There are instances where landlords demand double the rent after a contract ends. Renters then have to scramble for places to live, and unfortunately have to move into much smaller spaces because of rental hikes all over the city. Other renters have been forced to move because the owner sold the flat. While it is true that buying a flat is not always a better option, at least you can be free from the hassle of having to move and hunting for flats.

    Reply
    • 9 December, 2013 at 9:31 am
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      Thanks for sharing your experience. There is no doubt that owning the property brings more convenience but it may come at a premium. We’ve bought a flat before and it was definitely a bad financial investment looking back. But we wanted our own place so I totally understand people who’d rather buy in all cases. I’m just trying to be more rational about it following our own experience.

      However, I would assume that if rental hikes are happening across the city, home prices would also be on the rise as well. If it is possible to get high rental income, it would draw more investors and push home prices up. So in the end, you would still be doing a similar comparison between renting and buying but at higher values for both rents and home prices.

      Reply
  • 30 January, 2014 at 5:17 am
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    You also forgot the realtors commission of 6% when the homeowner decides to sell

    Reply

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