Comparing renting to buying like apples-to-apples isn’t the answer.
It’s a common conundrum heard among many Australians: should I rent or buy a property? With housing costs continuously rising over the last 25-years, the ‘Australian dream’ of home ownership is out of reach for many people, forcing them to rent. Many people will argue that renting is money down the drain, as it works to pay off someone else’s mortgage. But is that really true?
Many people often think if a mortgage repayment is equal to or less than what you would otherwise pay in rent, then purchasing a property is the way to go. Although it’s easy to come up with some numbers, this method is more of an apples-oranges comparison than apples-to-apples.
So, how do you know which option is right for you? Here, we’ll take a look at some of the pros and cons of renting and buying property, and the idea of 'unrecoverable costs'.
Pros of buying a property
There are a number of reasons why buying a house could be the right option for you.
Equity is the difference in the value of your property and the amount owing on your loan. By paying off your home loan, your loan decreases and you're effectively building equity in your home. This could benefit you in a growing property market — you can use equity as a guarantee when applying for a loan for any other properties you may want to buy.
Buying a property as an investment has some hidden tax benefits. You can deduct property expenses from your taxable income where they add up to more than what is earned from rent. Deductions can include interest payments on a loan, necessary maintenance, and depreciation on a property's value.
For example, say your salary is $100,000 annually and you pay a bit less than $25,000 in tax per year. You decide to buy an investment property which earns you $30,000 a year in rent. If your interest payments on that property are around $40,000 a year, you can deduct the difference of $10,000 from your taxable income. This means your taxable income would drop down to $90,000, which would reduce your overall yearly tax bill to roughly $21,000. While you’re not quite out in front, you do get $4,000 back in your pocket.
A sense of community
Owning your own home means you’re committing your time and money to a particular area and being part of that community. This can often be missing if you frequently change rental properties.
Cons of buying a property
There are also a number of cons which may make buying a property an unsuitable option for you.
Aside from the actual house price, there are a lot of other costs you need to take into consideration. There’s stamp duty (varies by state), legal/conveyance fees, valuation reports, building inspection and pest inspection reports, Government title transfer fees, mortgage registration fees and loan establishment fees, just to name a few. And don’t forget, as a homeowner, you’re responsible for repairs, dealing with pests or general maintenance, council rates, strata fees (if you purchase an apartment) and home and contents insurance.
Depending on your financial position and how much you’ll be able to borrow from the bank, you may have to compromise on where you choose to buy and look further afield.
Long term commitment
Having your own mortgage is a significant undertaking and will no doubt impact your current situation, your lifestyle and your plans.
Pros of renting a property
While it often gets trashed in the media, there are a number of benefits to renting property.
Renting a house can afford you the flexibility of living where you want; whether it’s by the beach or close to the city. Considering rental contracts are for a defined time, usually of 6-12 months, you’ve got the flexibility to move on when your lease ends and test out another area to live in.
When it comes down to it, rent is generally lower than a mortgage repayment. The overall costs and expenses associated with renting can be considerably lower compared to owning a property.
Renting a property also means you could avoid most maintenance costs and tasks associated with ownership. It’s the responsibility of your landlord to maintain the property and pay taxes, even though you might have to look after the general wellbeing of the property.
Cons of renting a property
While there are some great aspects of renting, there are also a number of cons.
Security and permanence
One of the downsides of renting is the uncertainty that comes with it. Even though you may like your property, your landlord may ask you for more rent, or they could sell the property while you’re still living there. If circumstances change that don’t suit you, you could be forced to look elsewhere for a place to live.
Renting means you’re living in someone else’s property and have to follow their rules, and ultimately, you have little say in your housing situation. You’ll be subjected to regular rental inspections, may not be able to decorate as you please (like hanging pictures), and may not be able to keep a pet or carry out any renovations.
Renting isn’t an asset
No matter how affordable renting is, it’s not your property and therefore isn’t your asset.
Renting or buying based on unrecoverable costs
So, what’s a good way to decide whether to rent or buy if you’ve got the money?
By definition, unrecoverable costs are any costs you pay with no associated residual value. In other words it’s money spent, never to be seen again, in exchange for having a place to live.
To inform your rent or buy decision, it’s best to compare the total unrecoverable costs of renting, to the total unrecoverable costs of owning. This perspective places both options on a much fairer playing field.
Determining the total unrecoverable costs of renting is easy: it’s the amount you’re paying in rent and any related expenses associated with the lease.
For a homeowner, calculating unrecoverable costs is slightly more complex. A homeowner has a mortgage payment, yet this isn’t an entirely unrecoverable cost. It’s a combination of interest and principal repayment.
So what are a homeowner’s actual unrecoverable costs? There are three of them:
- Any taxes and fees related to property such as stamp duty and council rates
- Maintenance costs
- Cost of capital (mortgage interest + opportunity costs)
Thinking about the unrecoverable costs of home ownership will make it easier to arrive at a meaningful set of numbers when considering the financial ramifications of whether to rent or own your home.