When is Paying Rent Actually The Right Option?
October 13, 2022
I’ve recently seen the popularity of a social media post that goes something like this…
Your interest on your mortgage is 5.5%but interest on your rent… 100%
This is an absurd statement!
For example, If my rent is $2,000/month, but owning the equivalent home with 20% down payment costs me $2,500/month after all expenses, but only $700/month of that is principal repayment of my mortgage (money I get to keep), then I’m only ahead by $200/month in the first year ($2,000 if I rented - $2,500 if I owned + $700 money I keep) by owning vs renting. Sure, paying rent is a 100% expense, but 92% of your cash outflow in the first year of home ownership is also an expense. The important thing about the typical mortgage in Canada (an annuity mortgage with a fixed payment) is that, as more time passes, the less of an expense your mortgage payments become.
Of course if you own an asset, the net costs should be lower than renting. At the end of the day, there has to be something in it for the owner to tie up capital and take on the risk of being responsible for that asset.
This of course is not taking into account market appreciation of the asset, BUT it also does not take into account market DEPRECIATION, the very risk the asset owner expects to be compensated for by taking on the responsibility of ownership.
I’ve also recently seen a post comparing mortgage payments between peak market and today, that look something like the chart below:
ㅤ | Feb 2022 | Sep 2022 |
Purchase price | $1,000,000 | $800,000 |
Mortgage rate | 2.50% | 5.50% |
Monthly payments | $3,572 | $3,918 |
While your affordability was better at the peak of the market, your net worth certainly isn’t. If you’re underwater on your mortgage, you have now significantly reduced your options going forward.
There are 3 situations when renting is better than buying a home:
- Asset prices are declining If prices actually decline 10% over a year, your savings of $200/month ($2,400/year) will pale in comparison to the $50K you probably lost. While the conventional view is that the market will continue to decline from here, I’ve seen the conventional view be wrong more often than right. For that reason, there is just as much a chance the market will be up in 2023 than down. Ultimately, not the banks, not the media, not the government, not agents, not even your parents know what will happen next. The hardest thing about market timing is that it causes you to try to transact too often, which has a cost that the patient person doesn’t bear. That brings me to #2.
- Your living situation is unstable You might change jobs, change cities, move in with a partner, or move back with your parents. Committing to a home purchase is a longer term commitment. If you can’t plan 5 years ahead, you probably shouldn’t buy a house. If you buy a home and have to sell it in 1-2 years, even if prices increase over the year, the cost of buying and selling alone will amount to 5-10% of the value of your purchase. And no, that’s not just because of Realtor commissions (which can be negotiated), but also land transfer taxes (which can’t be).
- You don’t have stable income or a good grip of your finances Owning a home comes with a lot more bills, expected and unexpected. If you are living paycheck to paycheck, don’t have a stable stream of cashflow, don’t have emergency funds, or aren’t sure how you'll make the next mortgage payment, you probably should not buy a home until you do. Being forced to sell a home too early can be very expensive. See #2. Walking away from a rental, much less so.
Ultimately, if you pick growing markets with limited supply of an asset that has inherent demand (like real estate in Toronto), it is prudent to purchase assets in the long run.