Another View On Buy vs Rent

By Neil Faulkner (TMFVertigo)
May 11, 2006

I don't own my own home. As many of you have pointed out on the discussion boards recently, it's just not cost-effective to buy right now. But is this true for all of us? When should we buy? And why must we buy? Why is it that we feel we have to own our own homes? They're not obsessed like this on the continent, are they?

These aren't rhetorical questions, will someone please answer me? No? Fine! I'll work it out for myself...

Why we want to buy

When we buy a property we feel more safe and secure. We can 'put down roots' and we feel that it improves our social status. What's more we can do what we like with our property. The main upsides to buying are:

• The property is yours.
• You can use it to supplement your pension by downsizing or equity release.
• You won't keep paying for your home when you retire (presuming you pay off your mortgage!).

The main upside to buying now is that the property is likely to go up in value, so you can try to take advantage of early gains. Before we consider this further I want to compare costs between renting and buying.

Compare the costs of renting to buying

Homeowners pay for repairs and maintenance costs (including wear and tear), buildings insurance, furniture and dozens of other things. As a renter, all or most of these are taken care of by the landlord.

The next question is: "But surely this is taken into account in the monthly rent?" This isn't necessarily so. This article explains that landlords are usually in it for the profits they make when they finally sell their properties. It also shows that they often don't make profits on rental income for at least five years. So the costs of renting can be about the same as owning, or even somewhat less.

Consider the huge amount of interest you pay at the start of a mortgage

The longer your mortgage is, the more interest you pay, particularly in the early stages. In the first years of a 25-year repayment mortgage, you pay far more interest than capital!

In the first month of a £100,000, 25-year repayment mortgage, at a rate of 6.5% you can expect to pay £542 in interest. However, the capital you pay (i.e. the small part of the house that you buy that month) is only £133. So of the £675 paid to your building society, less than 20% of this actually goes into buying the house!

The capital and interest repaid on a £100,000 repayment mortgage at 6.5%

Of course when you rent it's all dead money so, on the face of it, buying is the right thing to do. But, with the figures above, you need a ten-year mortgage before you start paying off more in capital than interest. If you can save more as a renter than you make in capital payments as a buyer, you're probably better off renting, at least initially.

Many of you will say: "What difference does it make if I find the amount I pay each month is about the same either way? Surely I may as well buy?" Good questions! Provided you have enough savings, I can see no reason why you can't just go ahead and buy.

My concern is that, without enough savings or a large deposit, if you're forced to sell in the first year or two you're more likely to make no gain from the sale, or even a loss! As a recent Fool School article said: "It's best to see housing as a place to live first and foremost and secondly as a long-term investment." A long-term investment it says. In the short-term the housing market, like any other, can be volatile.

Are there any options?

If your rent is low enough, rather than trading up and incurring lots of interest on a 25-year mortgage, you might prefer to save and invest for, say, ten years, then get a 15-year mortgage. If you invest well, you might be able to get an even shorter mortgage. Plus, the housing market is like any other: it goes up and down. You can wait for a drop in prices and time your entry. You'll be able to hit the market with a higher deposit on a cheaper property.

The upsides to buying are irrefutable. But you don't have to buy now. Save, invest, wait for the right time and get a shorter mortgage.

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