Mechanics of Renting Vs Buying

Mudit Buying

With this article we will try to be as objective as possible to answer the question by discussing all arguments on buying vs renting, and weigh the options for their merits. There is no straight answer to this, however, based on the below it would make easier for you to consider your personal situation and see what works best for you. Let’s dive straight in..

Good About ‘Renting’ – thumbsup

Only one Amount – There are no repairs or maintenance costs, you have only the monthly rent to worry about.
Flexibility of Moving – If your work involves frequent relocation, renting is by far the best option. The rational behind this is that if you are not keeping a home for 2 years or more the benefits in the equity are somewhat offset by closing costs related to buying/selling.
No Financial Responsibility – You are not affected by the market downturns if they occur, you are shielded from market exposure. So you can never end up with ‘Negative Equity’.
No Upfront Costs – For getting yourself in the rental home, you don’t have to worry about closings costs associated with ownership. You just need to arrange for a deposit in the form of last month’s rent, in addition to your first month rent.

Not So Good About ‘Renting’ – thumbsdown
Dead Money – The rental amount which you pay per month is not used for building any equity or future reserves for you.
Lost Opportunity Cost – This is true in the markets trending up, the more delay in decision for owning and you end up paying higher price for the same home.
Mercy of landlord – If the owner decides to sell his/her home, you are left with no choice but to seek another rental home and arrange for moving rituals.

Good About ‘Buying’ – thumbsup

Default Savings Account – Getting a mortgage for owning a home is often compared to as opening a forced saving account, for your initial years of repayment even though the interest component is high, still a good part goes as principal payment, which essentially builds your equity in the home with every passing month. Refer example below for a detailed scenario with calculations.
Investment Returns – For other investment options (stocks, mutual funds, bonds, CD’s, precious metals etc) you get returns on your invested equity, the unique thing about Realty is that if/when you decide to sell you get to keep the appreciation on entire value of home including portion by lending institution, this makes it unique investment vehicle.
Secured Loan Opportunity – Over a period of time as you build your equity in the home with your initial down payment and as part of repayment of mortgage, the financial institutions offer you secured line of credit (HELOC).
Freedom of making Adjustments – Make any improvements or updates to the home for furnishings, wall colors, keeping pets etc.
Tax Shelter – Government provides exemption on any capital gains on your primary residence, so when you sell it you keep the entire gains.

Not So Good About ‘Buying’ – thumbsdown
Upfront Costs – For owning a home you would need to account for Closing costs (legal fees, land transfer tax, title insurance, home inspection fees, insurance cost in case of high ratio mortgages, Initial Interest Adjustments, home insurance etc).
Market Risks – With your equity involved as a homeowner you are exposed to market crashes. Not a good investment vehicle if you are looking for short term incentives, on the longer term it generally holds well.

The conclusion we can draw is that the decision of owning and renting should be taken very objectively by analyzing above parameters and how do they apply to your own family situation.

Example Scenario to Understand Renting Vs Buying:

To close it off let us take a scenario so that we can get a fair understanding. The assumptions we are taking is that house is worth $500,000 and two scenarios of renting vs owning for a term of 5 years. For buying the down payment considered is $100,000 with mortgage secured @ fixed rate of 3%, for the rent scenario the same amount of $100,000 is invested in funds/bonds assumed to give a return of 4% annually.

Scenario 1 - Renting $500K homeAmount
Rent Per Month$1800
Rent Paid in 5 Years$108,000
Utilities (Hydo, Gas, Water - assuming $250 per month)$15,000
Investment Return on $100,000 (From Bonds/Mutual Funds assuming 4% return annually in 5 years)$21,665
Net Savings$21,665
Scenario 2 - Owning $500K home Amount
EMI (with 100,000 down & mortgage of 400,000 at 3% fixed for 5 years)$1,893
Interest Paid in 5 years$55,477
Principal Paid in 5 years$58,101
Property Tax Paid in 5 years (assuming $3,500 annually)$17,500
Utilities (Hydo, Gas, Water - assuming $250 per month)$15,000
Closing Costs$6,500
Appreciation in 5 years (assuming 4% growth per year)$108,326
Net Savings (after 5 years)$166,427 - $17,500 [property tax] - $6,500 [Closing costs] = $142,427