Should I Rent or Buy a House?
There are pros and cons to both renting and buying a home. It really depends on your specific situation and what you are looking for in a home. In this article, we aim to provide some clarity on when each option might be preferable. We'll touch on the different reasons you may choose one over the other as well as an in-depth analysis of the financial implications from both a cash flow and equity perspective.
Here are some things to consider when deciding whether to rent or buy:
How long do you plan to stay in the area? If you plan on moving within the next few years, it may make more sense to rent.
How much can you afford? Buying a home can be expensive, with mortgage payments, property taxes, homeowner's insurance, and other associated costs. Renting may be a more affordable option in the short term.
What is your credit score? A good credit score can help get a lower interest rate on a mortgage.
What kind of monthly cash flow can you afford?
What are your equity goals for the next 25 years?
How long do you plan to stay in the area?
If you plan on moving within the next few years, it may make more sense to rent. Buying and selling a home is no small or inexpensive task. Realtors typically take 5% of the value of your home if you are selling it. That means the average home in Toronto ($1,155,345) costs $57,767 to sell. That's almost as much as the average yearly salary in Toronto!
How much can you afford?
Buying a home can be expensive, with mortgage payments, property taxes, homeowners insurance, and other associated costs. Renting may be a more affordable option in the short term.
For the sake of this analysis, let's use Toronto as an example. The average price of a home in Toronto is $1,155,345 according to the Toronto Regional Realestate Board. The tricky part about using Toronto is that because homes are commonly over $1,000,000, it requires a minimum downpayment of 20%. For homes under $1m, the down payment is less.
Since down payments are different based on the value of the home you are buying, we'll do this analysis for three tiers: $500k, $750k, and the average Toronto home price, $1,155,345
If we assume that you would be a first-time homebuyer, we can apply the first-time homebuyer rebate which brings down the total land transfer tax owed. The total cash you would require to purchase a home would be $264,663 for the average home in Toronto. Included in that cash outlay are the expenses that you would not get back of $33,594. This is an expense you don't need to worry about if you are renting a home, with the exception of the moving and storage expense of about $600. So, if you are short on cash-in-hand, renting might be the best option for you.
What is your credit score?
A good credit score can help get a lower interest rate on a mortgage. Lower credit scores tend to raise the cost of borrowing money by increasing what institutions charge for mortgages or other forms of lending such as auto loans or personal loans.
Rent vs Buy Cash Flow Comparison
If the average home price in Toronto is $1,155,345 and the average rent for a 3 bedroom home is $1,928, we can do an easy comparison of the cash flow between these two options.
Based on an analysis of average prices in Toronto, your monthly payments towards the home are 115% more expensive if you buy your home. You may think that based on this analysis, it makes way more sense to rent your home rather than buy. However, one typical difference between the two housing options is at the end of your mortgage term, you are left with an appreciating asset. Your payments as a renter won't count towards an asset, but you can take the savings you have from renting and put that into an investment. Let's see what happens when you do this.
Rent Vs Buy Equity Comparison
The most important question to answer is not how much cash flow do you have under each option, but how much equity you're left with at the end of a 25 year period and how much that equity costs.
If we start by looking at historic numbers, renting was actually more expensive than buying, so in this case, you wouldn't have any additional income to put into stocks as an alternative to buying a house.
As a result, we decided to look at modern house prices and attempt to predict where the value of homes would go. According to CEIC, house prices have grown by an average of 1.9% since the early 1980's. By using the average housing price, increase we can predict the growth of house prices beyond 2022.
By using the chart above we can predict that the price of the average home in Toronto will be $1,857,113 by the beginning of 2046, 25 years from now.
Adversely, the money we save by renting (downpayment and lower monthly payments) can be invested in the stock market to earn a return. We can do the same calculation to determine the future value of our savings.
Assuming that we invested in the S&P 500, which has had an 8% return since 1957, we can apply the same 25-year term to our S&P investment. In addition, our monthly payment is lower if we rent, so, any savings we have would also be invested in the S&P 500. One caveat is that rent will increase with inflation, but mortgage payments generally stay the same. If we use the average GDP growth rate of 3.02% and graph it, our rental payment savings are essentially wiped out by the end of our 25 year amortization period.
Nonetheless, even though the savings from renting decrease over time, we can still account for that and include it in our calculation. As a result, the total value of our investment at the end of our 25 year period is $933,113.
When we look at all of the values together, monthly payments can be cheaper if you are renting; however, the value of your potential asset is higher at the end of a 25 year period if you buy.
Conclusion
In the long run, it is certainly more financially beneficial to buy your home. But you also need to consider what is right for you. Moving from one home to another is very expensive, and if you are expecting to move around a lot, you may inadvertently wipe out the equity in your home. Everyone has their own unique situation and hopefully this analysis helps you make the right decision for you.
