As the cost of living continues to rise and housing becomes less affordable, more and more people are wondering whether it will work out better to rent for the rest of their lives, or live the Aussie dream and own their own home. I’ve decided to create an example to illustrate who is best off after 30 years of either renting or paying off a mortgage.
Bert lives in a house worth $850,000. But, he’s renting it. Now if we apply a conservative estimate that rental properties yield 5.2% gross, Bert’s rent per week would be $850 or $44,200 per annum.
Next door to Bert lives Ernie. Ernie’s house is identical in every way and worth exactly the same amount of $850,000. We know this because that is what Ernie paid for it.
Now, here are the assumptions. Both Bert and Ernie will reside in their respective “pads” for 30 years. They both started paying either rent or mortgage on the same day. To compare apples with apples as much as humanly possible, I am being really conservative with increases in rental amounts per annum, the variable interest rate as an average, capital gains per year and finally the interest earned for cash deposits of savings. I’ll also explain what could happen at the end if all things were done a little smarter by each resident.
Okay, let’s get down to it. First to Bert. Bert’s rent will increase ever so slightly per annum. In fact to be ultra conservative let’s say only 1.2%p.a. He will also decide to invest any difference made from savings, into short-term cash investment accounts which yield on average over 30 years about 5%. In his 30 years, Bert will have paid approximately $1,584,795.64 in rent.
Now Ernie on the other hand will be paying on average over 30 years 7.81% in interest on a $850,000 purchase. If he pays consistently for 30 years he will have spent $1,354,890 on interest alone and when you add to that his principal repayments he would have spent a total of $2,204,890 over 30 years.
So who’s in front so far? Based on savings, Bert would have been able to invest about $620,094 into an interest bearing account, that if yielding 5% p.a. would equate to total savings of $651,861.
However, we have to remember that at the end of the 30 years, Ernie has an asset that has increased in market value over time, and he decides to sell on his last day of repayments. If his property increases (and again this is conservative compared to historical data) in value by an average of just 4.23% p.a. his property is worth $2,933,977.60 upon sale.
This means that Ernie has spent $2,204,890 but when you minus his principal of $850,000, he has a net result of $120,912 in the red over 30 years. In other words it has cost him $121,000 approximately to live in his primary place of residence for most of his life.
On the other hand, Bert has spent $1,584,795.64 and saved $651,861, so he has a net position of $932,934.63 in the red. It has cost him nearly a million dollars to end up with nothing after all that time, other than arguably, more cash to live a “nicer” lifestyle.
So where could each resident have been smarter, and therefore finish up in a better position? If I introduced any variables at all to the above calculations the results would have been like comparing apples with oranges. However Bert may have decided to put his extra savings into the stock market and increased his savings to around 12.2% as an average. If he had been really smart, and bought an investment property on a smaller scale, he would have made even more money, and had an asset at the end, however that would really have made some variables in our calculations (as Ernie could have used equity and done the same thing.) The same could have been said for Ernie though, who with some smarter moves, such as, deciding to pour more into his home loan and paying it off earlier, saving him a substantial amount in interest being paid, thus improving his net position. And let’s face it – most of us would try to pay off more than just the minimum amount per annum. We could also have had the capital gain be more in line with historical data of around 11.6% over a few decades, however most people will agree the next 30 years should be more conservative than the last 30 years, particularly with house values being arguably above long-term average values based on comparative household income vs household debt.
So which is better? To rent or to buy? At the end of the day it comes down to what is important to you. Would you prefer to live in the “now” and have surplus cash to live a “nicer” lifestyle? Or would you rather have an asset at the end of a long life of forced savings, pay nothing in capital gains tax, and live a “nicer” lifestyle leading up to retirement? The other thing is, of course, the ability to do to your house what you want and when you want. Of course the savings there, can also be passed onto Bert, as most renters will have the majority of repairs and maintenance costs paid for by their landlord. The owner occupier will have to spend every cent themselves if they want to improve their property or even at a minimum maintain it.
Have a play with the figures to relate more to the scenario, and see where you will be in 30 years depending on which path you choose. I still feel that owning your own little piece of Australia, will always be better than living in someone else’s property forever.
(All calculations are based on my own workings and I apologise if there are any errors or variables. All persons reading this blog rely on their own calculations and financial advice as I am a licensed Real Estate Agent and not registered or licensed to offer any financial advice.)