You will hear that at least one hundred times in your life: stop wasting your money on renting and buy your own place instead. The question: is renting really throwing money by the window? I don’t think so! Let’s see it for ourselves!
I will give you an example to illustrate the situation but in another context.
John is an investor and has a big chunk of money, let’s say 50000$. A friend of John tells him that he should put money in a small business because he sees it could be really profitable in a few years. John looks at the company’s financial statement and decides to put his money in there. But wait, he will also borrow another 250000$ and put it there as well. John now has 300000$ in the same small company. Does this make any sense? Not really unless he’s a big gambler, he could in fact win big but lose big as well!
You might say that John is crazy and that it’s way too risky. Well it is but buying an house might be as well depending on how much of your assets you put in there.
Where It Doesn’t Make Much Sense
Part of the problem is, in my opinion, that people don’t see their investments as a whole, house included! Here is John’s asset mix.
Ok you’re right, this is not really a great representation of his assets, in fact, he has more liability than assets because he owes money on the house. He has not paid any principal yet, but let’s say he could sell the house any time to simplify the asset allocation a bit. We’ll make the house more “liquid”.
This seems like really poor risk management because his house is in a single country, single city and single neighborhood, making it highly tied to this market price and also, very risky. What happens if it gets flooded or if it burns down? It’s taking way too much of John’s portfolio and creates a lot of risk. Diversification please! You might say that insurance will cover a bit but that will most likely not be enough. Lose your biggest asset and you will almost lose everything.
In addition, it’s very costly as he will pay interest on his mortgage and maintenance on his house. Let’s say the repairs account for 1% of the value of the property, that means around 3000$ per year. And I’m not even counting all the other taxes and fees. Ouch! Hell of an investment isn’t it!?
I would rather put my money in all the companies of a single country rather than an house for more than 70% of my assets, that’s for sure!
What do people normally say about investing? Put money when you’re young so it can grow for when you’ll get old: Compounding. Compounding is what happens on the long run when your money starts growing exponentially if invested properly. Anyways, buying an house seems the exact opposite as we’re putting a lot of money in there when we’re young for a long period of time which ensures a lot of interest given to the bank. Banks won’t complain that’s a sure thing, but maybe you should wait and invest more when you’re young as recommended.
What About Renting?
In John’s situation, it might be more valuable to rent for a while as he will have less volatility and more time to gather money. If we try another scenario in which he invests in an TFSA instead and puts the rest in regular investments and an emergency fund.
Let’s assume he invests money in Mutual Funds/ETFs following what his adviser recommends and makes around 4.5% after inflation over 5 years. Don’t forget that all the money he doesn’t pay his mortgage with is also going there!
Here is an estimate of how much John might have in each account after five years if he puts:
- 200$ every month in RRSP
- 200$ every month in TFSA
- 500$ every month in Regular Investments
If we assume he makes 3000$ a month after income tax, 900$ seems reasonable since he will have 2100$ left to pay for everything else.
Time To Buy!
He might want to buy five years later and that’s understandable since he has been living in an apartment for quite some time. John will put the same amount as a down payment (50000$) and borrow the same amount (250000$) and we will see the difference it makes in his asset allocation.
It’s a bit better but he still has almost 65% of all his assets in the house which is again pretty risky, but less risky. My opinion is that maybe he is aiming too high and should not get something that expensive.
Instead he will go for a Condo and save a bit more than 6000$ in the emergency fund for possible higher condo fees. In the end, the condo might take around 50% of his total assets which is starting to make sense in my opinion. At least, if something bad happens he will have enough money set aside to cover the expenses. This option would be a lot less expensive monthly and would give him safer finances and less burden.
What I am trying to say is that I think it’s a good idea to consider renting and not only buying, or maybe you should look for something smaller to make sure you can keep your head out of the water.
Tools To Help Us
I’ve found a tool on the Website GetSmarterAboutMoney which I really find useful. It helps you compare between renting and buying. Here are a few test run I did just to show you with my city`s approximate pricing.
On the buy side
On the rental side
On the buy side
On the rental side
Well, it really depends on what you enter in the boxes but I invite you to try on your own!
Some Things Cannot Be Calculated
In fact, some things simply cannot be calculated. I am talking about the urge to get a place you own. Be careful as you never really own the house anyways even if you’re done paying it. Something else to consider is that an house is a huge responsibility compared to an apartment. That’s why the price must be assessed with caution: how much this backward is worth since you might be close to a park? Is it really necessary to have that much space if you only use a few rooms in your house? Maybe you will be paying for space you won’t even use. We need to remember that houses are taxed like crazy! School tax, city tax, welcome tax, insurance and so on.
It’s possible to raise a family in an apartment, maybe not the best situation but some people do. In other words, how much luxury do you need to be happy? Unless you love cleaning, fixing and so on, maybe a castle is not for you.
I would not consider housing as a step in life, I think it’s more of a choice. Someone could be renting all their life and still be very happy. Renting provides potentially less risk money wise and less responsibilities.
I think it really depends on your situation but you should definitely consider renting alongside buying. Make a budget and make sure you can afford the house you want. It might greatly reduce the risk of not liking the neighbourhood or not knowing exactly what you want when you buy for the first time, it could be a very expensive mistake. Also, I would say that your needs will probably change so if you’re not ready to settle for at least 10 years, I would consider renting!
Here is a nice post I’ve read that might make you change your opinion on buying!
This post reflects my opinion on the subject and may or may not apply to your situation.
As an opinion post, you’re more than welcome to comment and start a debate!