Renting A Home Makes More Financial Sense Than Buying

It is always better to buy a house; paying rent is like pouring money down the drain. For years, such advice has encouraged people to borrow heavily to get on the property ladder as soon as possible. But it is still sound advice? House prices are currently at record levels in relation to rents in many parts of the world and it now often makes more financial sense especially for first-time buyers to rent instead.

Home buyers tend to underestimate their costs. Once maintenance costs, insurance and property taxes are added to mortgage payments, total annual outgoings now easily exceed the cost of renting an equivalent property, even after taking account of tax breaks. But capital gains will more than make up for that, it is popularly argued. Over the past seven years, average house prices in America have risen by 65%, those in Britain, Spain, Australia and Ireland have more than doubled. But it is unrealistic to expect such gains to continue. Making the assumption that house prices instead rise in line with inflation, and including buying and selling costs, then over a period of seven years-the average time American owners stay in one house, the calculation show that you would generally be better off renting.

Be warned, if you make such a bold claim at a dinner party, you will immediately be set upon. Paying rent is throwing money away, it will be argued. It is much better to spend the money on mortgage, and by so doing build up equity. The snag is that the typical first -time buyer keeps a house for less then five years, and during that time most mortgage payments go on interest, not on repaying the loan. And if prices fall, it could wipe out your equity. In any case, a renter can accumulate wealth by renting the money saved each year from the lower cost of renting into shares. These have, historically, yielded a higher return than housing. Putting all your money into a house also breaks the basic rule of prudent investing: diversify. And yes, it is true that a mortgage leverages the gains on your initial deposit on a house, but it also amplifies your losses if house prices fall.

"I want to have a place to call home," is a popular retort. Renting provides less long-term security and you cannot paint all the walls orange if you want to. Home ownership is an excellent personal goal, but it may not always make financial sense. The pride of 'owning' your own home may quickly fade it if you are saddled with a mortgage that costs much more than renting. Also, renting does have some advantages. Renters find it easier to move for a job or family reasons.

"If I don't buy now, I'll never get on the property ladder" is a common cry from first-time buyers. If house prices continue to outpace wages, that is true. But it now looks unlikely. When prices get out of line with what first-time buyer can afford, as they are today, they always eventually fall in real terms. The myth that buying is always better than renting grew out of the high inflation era of the 1970s and 1980s. First-time buyers then always ended up better off than renters, because inflation eroded the real value of mortgages even while it pushed up rents. Mortgage-interest tax relief was also worth more when inflation, and hence nominal interest rates, was high. With inflation now tamed, home ownership is far less attractive.

The divergence between rents and house prices is, of course, evidence of housing bubble. Someday prices will fall relative to rents and wages. After they do, it will make sense to buy a home. Until they do, the smart money is on renting.