Owning your home is the most important financial objective of everyone (Buy vs. Rent)

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MugsGame

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N.B. I've split this from the Will Irish house prices rise or fall? thread. Go to that thread to discuss the future of the Irish housing market. This thread aims to summarise financial arguments for and against home-ownership. The arguments presented are not necessarily ones I agree with.

Please post only on financial factors relevant to the buy vs. rent decision, and succint arguments why they are (or are not) relevant. This is not a thread for opinions, rambling discussion, anecdotal evidence, or speculation on house prices.

Periodically I'll prune the thread, to keep it manageable for newcomers. I will summarise any new arguments/views here before deleting them. Additional Posting Guidelines for this thread

Brendan said:
owning your own home is the most important financial objective of everyone.
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Are there articles or financial models which support or illustrate this common assertion?
Doesn't this imply that "equity-release" schemes are always a bad idea?

I'd guess the banks actually "own" most Irish homes (whether "owner"-occupied or rented).
 
Re: Owning your own home is the most important financial objective of everyone.

Suppose we want to model this assertion in various scenarios. We want to answer these sorts of questions:

  • Does it make more sense financially to buy or rent?
  • Is renting really "dead" money?
  • What is the opportunity cost of not buying, in various scenarios?

Proposed Model

A landlord offers to sell his house to his tenant. The tenant happens to have saved a lump sum that's just enough to pay the deposit, along with stamp duty and other transaction costs. Is the tenant better off buying, or finding another similar house to rent?

Assume that if the tenant continues to rent, she invests her lump sum in an index tracker fund. Each month she invests the difference between mortgage repayments and rent (which might be negative in later years!). How will she fare against someone who bought at the same time she started investing?


Financial Factors to Include

What factors should we consider?

Buy

ECB rate and Lending Margin
House Price Inflation
General Inflation
Years between house moves (sale and purchase)

Deposit
Stamp Duty
Legal fees and outlay
Survey
Estate Agent fees

Mortgage Interest
Mortgage Capital Repayments
Interest Relief
Life Assurance
Rebuild Insurance
Repair & Maintenance
Management Fees

Accumulated house/apartment equity (Proceeds of sale)


Rent

Rent Inflation
Return on Equities and Tax on equity income/growth
Years between house moves (find a new place to rent)

Rent
Rent Relief
Moving Costs
Mortgage repayment less rent (gross or net of tax relief?)

Accumulated equity fund (less exit charges)


Financial Factors to Ignore

Property Tax -- let's consider Ireland only for now (though if one were to abolish Stamp Duty...!)
Contents Insurance
Furniture / Appliances -- perhaps a controversial one as landlords usually provide some or all of these

Owners can benefit from rent-a-room. But the renter has a similar house in our model, so can sublet (further debate on this).
The rental deposit should be returned when the tenant moves on, and is not very large in the grand scheme of things.


Predicting the Outcome?

It probably depends on the values you estimate for interest rates, inflation, return on equities, etc.

You might expect buying to be better, on average, because
  • Most of the capital is borrowed, so growth is leveraged (Gearing.). You can't borrow mortgage-sized amounts to invest in equities (even if you could, the interest rate would be higher, to reflect the perceived risk).
  • Rents rise with inflation. Mortgage repayments will rise with interest rates (particularly in the early years) but repayments are based on the sum borrowed originally, not the current property value.
  • Owners own their home outright after paying off the mortgage. Rent doesn't stop until you die.
  • Landlords have to pay all the costs that renters supposedly avoid. Landlords expect to make a profit, so this is factored in to rents. If landlords can't make a profit over the medium term, they sell up (thus lowering rental supply and raising rents to a level where landlords can profit). So unless your landlord has got his sums wrong, and (even after capital appreciation) is subsidising your rent, you are better off owning.

If owning property is so great, why are the banks selling up their branch networks only to rent them back from the purchaser?
  • There are good tax reasons for a company to lease assets rather than own them outright.
  • Solvency requirements on banks are quite stringent. Any money they lend has to be backed by a certain proportion of Tier 1 Capital. Selling property is one way to raise this capital (another way is to offer more attractive rates on deposits, something most banks are now doing.).
  • More and more branch requirements are being centralised, and banks want flexibility in managing their property.

You might think therefore that taxation policy also favours renting residential property.
  • Investment mortgages attract more tax relief on interest than residential mortgages
  • Tenants get partial rent relief
  • Landlords can write off many costs against tax, such as maintenance and insurance, and wear and tear.

Tax benefits might allow the landlord to discount the true costs. However
  • Investors pay higher stamp duty on property purchases
  • Investors pay CGT on gains from property disposals
 
Re: Owning your own home is the most important financial objective of everyone.

Non-financial factors (intangibles we won't consider)

Security of tenure favours ownership.
Liquidity: Houses are a relatively Illiquid asset, whereas the renter's investment fund is Liquid equity.

Flexibility favours renters, who can move easily e.g. for work. Renting is more flexible if personal circumstances change. If my rent goes too high, I can downsize without taking a financial hit or I can upgrade without have to spend a fortune on stamp duty.
Rents may be better value as renters can rent only as much space as they need right now, rather than buying with future needs in mind.
Renting may avoid a long commute, as property near work may be easier to rent than buy.


Freedom to decorate ("Build a nest") vs. Less maintenance hassle and no unforeseen capital costs (replaced by hassle of chasing landlord to do repairs?)

Privacy of your own home. But you can always rent a house by yourself, or get a one bedroom apartment

"Roof over your head" (Psychological security) vs. Freedom from "Mortgage burden"
A mortgage forces people to "save" in a disciplined way, even in cases where renting and investing the difference might make more financial sense.

Tenants have less rights than people paying a mortgage.





Attractiveness to potential mates may be increased by home ownership!

Does the psychology of home ownership depend on things like colonial history or current rights of renters? This [broken link removed] compares attitudes to home ownership in Germany (where owner-occupier rates are around 40%) and the Netherlands (where they are 54% and climbing.).

Can you put a monetary value on non-financial factors like these? Perhaps buying vs. renting is as much about heart vs head!
 
Re: Buy vs Rent

Their analysis is far too simplistic. A better comparison would assume that renters invest the deposit and stamp duty at 5% or so a year. Similarly for any ongoing surplus of mortgage payment over rent, savings on management fees and building insurance etc. Few homeowners stay in the same house for 30 years, but renters probably move every 3 years, so moving costs also have to be factored in. I did start a spreadsheet which tried to capture all of this. I might finish it if there is interest.

Update: looking at some of the advanced settings, they may capture these nuances after all, by calculating the net future value of money at sale time. But it's not clear from the summary output exactly what they include or how. They also include some things which are only relevant in the US market.
 
Re: Buy vs Rent

I tricked around with this application for a few minutes and - using what I thought were reasonable figures - it appeared to me that even in Ireland, most people would be better off buying than renting. This seemed counterintuitive.

I don't know if the methodology is sufficiently sophisticated to give a really useful result, but it is very interesting to see how movements in the initial figures alter the curve.
 
Re: Buy vs Rent

Have they included the peace of mind that comes from owning your own little pad that no one can take away from you.
 
Re: Buy vs Rent

MugsGame said:
That's an intangible. Besides, the bank own it until the last repayment, and you have a mortgage burden each month.
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I have to say that it would mean a lot to me.
As one of the older members here I can say that I know of only a few people in my lifetime who did not purchase a house and it was a serious mistake.
 
If I'm a renter and build up a huge investment fund instead of paying a deposit and mortgage (and maintenance fees and buildings insurance and all the other costs listed above), I have as much security for my old age* as a home-owner, and probably more flexibility.

* assuming the net value of the house and the fund are similar. That's the real question. I'm not sure, as I haven't run the numbers. I think it depends on the situation. I'm not sure the calculator linked to above captures all the variables.
 
Re: Owning your home is the most important financial objective of everyone (Buy vs. R

Hi Mugs Game

I had not noticed the original posts on this until now.

You raise some very interesting issues, which I will give some thought to and respond fully later.


However, taxation policy favours renting
  • Investment mortgages more tax relief on interest than residential mortgages
  • Tenants get partial rent relief
  • Landlords can write off many costs against tax, such as maintenance and insurance, and wear and tear.
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Let's say I am about to buy a home for €500k in a new development with a 100% mortgage. I meet my next door neighbour and we agree to let our homes to each other.

This is my position:


Rental income (€12,000)
Rent paid: €12,000
Tax relief: ( 720 )( assume I am married)
mortgage interest: €25,000
total outgoings: €24,280

Note: As the mortgage interest exceeds the rental income, there is no tax implication.

If I buy my own home
Mortgage interest paid: €25,000
Mortgage int relief: € 3,200 (Assume I am still married)
Total outgoings €21,800

In addition, by buying my own home, I will save €37,500 stamp duty up front.
In further addition, if I subsequently sell my home for €1m, I will pay no CGT whereas under the rental scheme, it will cost me €100k in CGT.

So from a financial point of view, one should buy their own home before buying an investment property.

The next question is, should one invest in the stockmarket where returns are likely in to be higher in the long run instead of buying your own home. I will look at that later.

Brendan
 
The next thing to consider is whether it is better to invest in the stockmarket instead of investing in a residential investment property.

There are three possible outcomes:

1) The returns on residential property will be the same as the stockmarket.

In this case, you will have been better off buying your own home as the figures after tax will be worse than buying a residential investment property as there will be no tax relief on the interest paid on the loan. The initial lower stamp duty will compensate to some extent.

2) The returns on residential property will be greater than the stockmarket.

Again, you will be better off buying your own home.

3) The returns on the stockmarket will be greater than on residential property.

They would have to be greater by a substantial margin to compensate for
a) the loss of tax relief on the interest
b) the exemption from CGT

They may well be but I doubt if it's worth the risk for the potential first time buyer.

If stockmarket returns are substantially better than residential returns, you will be better off finanically.

But the impact of the opposite scenario could be devastating. House prices and rents rise while the stockmarket falls. You will end up with, say €400k worth of equities and loans of €500k, while your rent is rising.

Brendan
 
Brendan said:
But the impact of the opposite scenario could be devastating. House prices and rents rise while the stockmarket falls. You will end up with €400k worth of equities and loans of €500k, while your rent is rising.
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Where do these numbers (400k & 500k) come from?

What about the scenario where house prices fall while stockmarkets rise? That would be devastating for the home buyer.
 
I had assumed you buy €500k worth of equities with a loan of €500k.

I had further assumed a drop in the value of the equities to €400k.

What about the scenario where house prices fall while stockmarkets rise? That would be devastating for the home buyer.
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It would not be devastating as long as they can continue to service their loan repayments. The rise in the stockmarket would not be relevant to the home buyer.

If they buy into the stockmarket and it falls while house prices and rents rise, they might never be able to get onto the housing ladder.

If they buy a home and its value falls, at least they have a home.

Brendan
 
Brendan said:
It would not be devastating as long as they can continue to service their loan repayments.
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By the same token, it would not be devastating if having taken the equities route, stockmarkets subsequently fall for a time, as long as they continue to service their loan repayments.

Brendan said:
If they buy into the stockmarket and it falls while house prices and rents rise, they might never be able to get onto the housing ladder.
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Why do they have to get onto the housing ladder?

Brendan said:
If they buy a home and its value falls, at least they have a home.
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If they buy equities and their value falls, at least they have ownership and entitlement to the future earnings of companies held.
 
Hi Whathome

Theoretically, a person is ok if they can continue their repayments on borrowings against an equity portfolio worth less than the loan. But in practice, they would be under severe stress and pressure. Most people would cave in and sell off their portfolios to limit their losses. In practice, the banks are going to pressure them to do so anyway.

It would be little consolation knowing that I had a dividend entitlement from the underlying companies.

Why do people have to get on the housing ladder? I know that I am going to have a need for housing for the rest of my life. Therefore, I will have great security if I know what the cost of that will be for the rest of my life. If I decide to invest in the stockmarket and rent property, rental costs could double in ten years, and I might not be able to afford the rent. If I have a mortgage, the repayments will rise and fall in line with interest rates, but the balance outstanding will remain the same or will fall. By buying a home, I can get this security and so I should go for it at some stage.
 
Brendan said:
Therefore, I will have great security if I know what the cost of that will be for the rest of my life. If I decide to invest in the stockmarket and rent property, rental costs could double in ten years, and I might not be able to afford the rent.
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What if I buy a home for €500,000, it then falls to €400,000 and interest rates rise to 8%? I might not be able to afford to keep my home, a truly devastating outcome. This scenario is just as likely to occur as the stockmarket collapsing and rental costs doubling in ten years.

Another advantage of renting is that you can move without taking a financial hit should you fall out with your neighbours or you have to move for employment reasons.
 
Re: Owning your home is the most important financial objective of everyone (Buy vs. R

ClubMan said:
Of course. Inevtiably some people will get into mortgage difficulties at some stage that requires them to cut their losses. But this doesn't mean that it will be a common situation.
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Neither is the situation common where someone has borrowed €500,000 to invest in the stockmarket which subsequently collapses while their rent doubles and the bank gets on their case.
ClubMan said:
Only if you can find a place that matches your budget.
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So you would be in the same position as the recently repossessed in scenario 1 but without having to sell your house at a loss while still owing interest and possibly a compromised credit history.
 
Re: Owning your home is the most important financial objective of everyone (Buy vs. R

Back to WhatHome's general point:

What if I buy a home for €500,000, it then falls to €400,000 and interest rates rise to 8%? I might not be able to afford to keep my home, a truly devastating outcome. This scenario is just as likely to occur as the stockmarket collapsing and rental costs doubling in ten years.
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You are making a fairly simple matter very confusing by introducing issues which are irrelevant to the main argument.

Your question should simply read:

"What happens if interest rates rise to 8%? I might not be able to afford to keep my home".

Back in the early 80's when rates rose to 17%, very few people lost their homes as a result of interest rates alone. If rates rise to 8%, lots of people will fall into arrears and struggle. The lenders won't repossess them all. They will reschedule loans and rates will, in time, fall again.

You should be comparing the likelihood of an interest rate rise with the likelihood of a rent rise. Rents will rise over the next 10 or 20 years. Many tenants will find difficulty in paying their rents and they will be put out by their landlords.

A fall in the value of your home is unlikely to significantly increase your chances of losing it. You will lose it if you can't meet your repayments over a long period of time which is most likely to happen through changed personal circumstances such as redundancy, illness or splitting up with your partner.

Brendan
 
Re: Owning your home is the most important financial objective of everyone (Buy vs. R

Brendan said:
You are making a fairly simple matter very confusing by introducing issues which are irrelevant to the main argument.
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Not really, I was simply reversing one of your scenarios so you may think it's confusing but includes the same issues that you raised here:

Brendan said:
But the impact of the opposite scenario could be devastating. House prices and rents rise while the stockmarket falls. You will end up with, say €400k worth of equities and loans of €500k, while your rent is rising.
Click to expand...

Brendan said:
Your question should simply read:

"What happens if interest rates rise to 8%? I might not be able to afford to keep my home".
Click to expand...
My point was that you could end up in negative equity and lose your home so it's important to keep the other issues included to highlight how devastating that situation would be. My question should read exactly as I wrote it.

Brendan said:
Back in the early 80's when rates rose to 17%, very few people lost their homes as a result of interest rates alone. If rates rise to 8%, lots of people will fall into arrears and struggle. The lenders won't repossess them all. They will reschedule loans and rates will, in time, fall again.

You should be comparing the likelihood of an interest rate rise with the likelihood of a rent rise. Rents will rise over the next 10 or 20 years. Many tenants will find difficulty in paying their rents and they will be put out by their landlords.
Click to expand...

Agreed, that scenario is unlikely but possible, however I think we're potentially in a far more dangerous position now than in the 80's.

Brendan said:
A fall in the value of your home is unlikely to significantly increase your chances of losing it. You will lose it if you can't meet your repayments over a long period of time which is most likely to happen through changed personal circumstances such as redundancy, illness or splitting up with your partner.
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Agreed, as above unlikely. However, a fall in the value of your equity investments is not going to increase your chances of getting evicted either.
 
Re: Owning your home is the most important financial objective of everyone (Buy vs. R

Hi Whathome

It is not valid to reverse my example.

If I decide to rent a house and invest in the stockmarket, a stockmarket fall will put me under real pressure and I may not be able to afford the rent. In practice, I will be forced to sell off my shares at a loss. If I can't afford the rent, I will be put out of the house.

If I buy a home and it falls in value, I will not be forced to sell it. If interest rates rise, I will be under pressure, but I will not be forced to sell it. I will fall into arrears and in time, I will recover from those arrears.

However, a fall in the value of your equity investments is not going to increase your chances of getting evicted either.
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If you rent an expensive house and your overall wealth drops, you will be under severe pressure on all sides.

Borrowing to invest in property is so completely different from borrowing to invest in shares. A bank cannot force you to sell your home very easily. They can force you to sell shares easily, but you will have caved in much earlier yourself.

Brendan
 
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