Drawing Conclusions: Is renting really a waste of money?

is renting a home really a complete waste of money you've heard all the sayings why pay the landlord's mortgage when you can pay your own or if you're renting you're just throwing money away the truth is it's possible for a renter to end up with a larger net worth than someone who buys a home but practically speaking ownership has worked out better for most people over the long run to see why owning isn't the only long-term option that can make sense let's start from the very beginning when you rent you're not throwing your money away you're getting something in exchange for it a place to live you are renting space for a period of time that just has no future value after your payments stop when you buy you're actually still renting but instead of renting space you're renting money the difference is that the money you've borrowed is used to buy an asset that will hopefully appreciate they also happen to be able to live in it a mortgage payment consists of a blend of rent on the money you've borrowed more commonly referred to as interest as well as a payment against the balance you've borrowed let's begin our analysis by doing a straight comparison for 25 years with some simple assumptions and don't worry we'll change a few of these later on we have two brothers we'll call them open the owner and Roger the renter they each have $35,000 sitting in their bank accounts and have no debt for the time being and the only difference is Owen wants to buy a house today and Roger wants to rent they both live in Toronto so to begin they each have a net worth of $35,000 let's start with Owen the owner he wants to buy a $500,000 home a 5% down payment is $25,000 that means he needs to borrow four hundred and seventy five thousand dollars mortgage default insurance is 14 thousand nine hundred sixty three dollars that gets added to his mortgage so his starting mortgage balance is four hundred and eighty nine thousand nine hundred and sixty three dollars the provincial land transfer tax is six thousand four hundred seventy-five dollars in Toronto there is an additional municipal land transfer tax and this amount is five thousand seven hundred and twenty-five dollars however there are both provincial and municipal rebates available which together provide five thousand seven hundred and twenty five dollars of tax relief provincial sales tax on the mortgage default insurance is one thousand one hundred ninety seven dollars legal fees might be one thousand dollars title insurance might be five hundred dollars the home inspection fee is $500 and appraisal fees might be another three hundred dollars that's a total of thirty four thousand nine hundred and seventy two dollars that basically eats up Owen the owners thirty five thousand dollars in cash but now he has another asset the house worth five hundred thousand dollars and a liability the mortgage worth four hundred and eighty nine thousand nine hundred and sixty three dollars his new net worth is ten thousand and thirty seven dollars Roger the renter doesn't really have any upfront costs he just needs to find a place to rent and sign a lease he finds out that the house next door is identical to the five hundred thousand dollar house but is renting for two thousand one hundred dollars per month so at the beginning of year one his net worth hasn't changed it's still thirty five thousand dollars because of the large upfront costs associated with buying a home Owen the owners net worth is less than Roger the renters once they get the keys to their new homes now we have to look at the ongoing cash flows if Owen the owner can get a three percent fixed-rate mortgage for a five-year term his mortgage payment will be two thousand three hundred and eighteen dollars and 73 cents per month if we assume he budgets one point two five percent of the home's value per year for maintenance and repairs that's five hundred and twenty dollars and eighty three cents per month to start property taxes in Toronto are zero point seven to three percent currently for a monthly cost of three hundred and one dollars and twenty five cents property insurance might start at eighty dollars per month rounded to an even number that gives Owen a total monthly cost of three thousand two hundred and twenty dollars over the next 25 years the interest rate on his mortgage may go up slightly for future five-year terms Roger the renter only has to add another $20.00 per month to his total for renters insurance and he's good to go his total monthly commitment at this point is two thousand one hundred and twenty dollars per month we'll assume his rent increases every year with inflation now to make for a mathematically apples-to-apples comparison we need to factor Roger the renter committing the same cash flow per month to his overall situation so we subtract Rogers monthly obligations of two thousand one hundred and twenty dollars from three thousand two hundred and twenty dollars to get $1,100 so Roger the renter will pay two thousand one hundred and twenty dollars per month for rent and he could commit eleven hundred dollars per month to also buying an asset in this case that asset would be an investment portfolio let's fast forward 25 years and assume they are both leaving the country Owen the owner sells his house and the gain is tax-free Roger the renter has paid taxes on investment distributions all along and has a capital gain upon selling his entire portfolio on an inflation-adjusted basis what do their net worth look like now was renting really just a total waste well a lot will depend on how fast housing and the portfolio grow over time in a TD economics report from 2013 titled long-run rate of return for Canadian home prices they suggested three point five percent before inflation was the long-term growth rate for housing they also put out a report in 2012 that looked at long term returns for equity markets and suggested 7% was appropriate with some caveats using these numbers to start we find the following using rounded approximate numbers for Owen the owner his house is now worth 1 million 182 thousand dollars he has no mortgage left so his liabilities are zero to sell his house would cost $64,000 after tallying up a 5% realtor commission GST and legal fees that leaves him with 1 million one hundred and eighteen thousand dollars adjusted for inflation his net worth is 681 thousand dollars Roger the renters portfolio has grown to 1 million and $25,000 and that's after subtracting the tax drag of distributions paid along the way he had no mortgage to begin with so his liabilities remain at zero but upon sale of his portfolio he has to pay tax on the capital gain of roughly seventy seven thousand dollars leaving him with nine hundred and forty nine thousand dollars adjusting for inflation we get a final net worth of five hundred and seventy eight thousand dollars so after 25 years he's one hundred thousand dollars behind Owen the owner now we've just seen how renting doesn't necessarily mean you're throwing all your money away if you're disciplined you can increase your net worth over time too but let's take a look at how changing just a few variables can dramatically change the results what if Owen the owner moves a few times he'll have transaction costs to sell his first house and then new costs to buy his second house if he moves every ten years the costs will bring down his ending net worth to five hundred and fifty three thousand dollars which means Roger the renter would have actually had a higher net worth at the end of twenty five years now what if Roger the renter doesn't actually save as much as he should have he might think he will save the full difference each year but it's much easier to skip a voluntary contribution to a portfolio than it is to skip a mortgage payment if Roger only manages to save fifty percent of the monthly difference between owning his ending net worth drops to only three hundred and thirty four thousand dollars or what if his portfolio only grows by five percent but he manages to save diligently he still loses as he ends up with four hundred and forty five thousand dollars as you can see the variables many of which are unknowable in advance influence which strategy will ultimately work out best

Channel: The Globe and Mail

Views: 5,204,396

Rating: 4.5626349 out of 5

Keywords: Money (Quotation Subject), Renting (Industry), Mortgage, Owning a house, Real Estate (TV Genre), home ownership, Personal Finance (TV Genre)

Id: NZR_vMTLfIk

Length: 8min 33sec (513 seconds)

Published: Sun Feb 08 2015