I've split out a case study I developed on another thread.
In this specific thread I want to set out a framework for evaluating the financial decision of whether to purchase a home.
In this analysis the key factor, in terms of personal situation, is whether you need to borrow to purchase or if you have sufficient savings.
Let's assume the following (currently) realistic scenario:
A house costs €250k
Rent is €12k p.a.
Deposit Savings rate net of dirt is 2%
Mortgage interest on residential is 4.5%
For simplicity I'll initially ignore a couple of factors which probably should be taken into account in more detailed decision making e.g. costs of owning (repairs, etc), rent inflation, etc.
We'll also assume that this is a buy to hold decision rather than a short term speculative play.
1. Buy vs rent for someone with savings
If it's a straight choice between (a) using savings to buy or (b) holding onto the savings and paying rent, the key factor is how rents compare to net of tax interest on savings.
In this case buying property is the clear winner as €12k saved in rent trumps €5k interest.
2. Buy vs rent for someone needing to borrow
If it's a straight choice between (a) using borrowings to buy or (b) paying rent, the key factor is how rents compare to cost of borrowing
In this case buying property is marginal winner as €12k saved in rent trumps €11.25k in interest repayments.
Developing the scenarios
If we build in a couple of more realistic assumptions e.g. rents increase @1.5% p.a. and owner has €2500 p.a. in costs, we get the following:
Scenario 1: Buying is still the clear winner
Scenario 2: Buying is costlier initially but more cost effective in the long run (9 years+, still a marginal decision to buy overall)
Obviously there are many other factors / risks to consider, but this method provides an initial framework to make a decision.
As can be seen, it is very dependent on whether you are a borrower or saver. It is also hugely sensitive to deposit savings rates, mortgage interest rates, taxes on savings and long term expected growth in rents.
All this before even getting into the emotional value / drag of owning a home!
Simple Mathematical rule of thumb
In each circumstance above we are effectively targetting a ratio of rent to market value that is the tipping point for the decision to buy.
In the scenario I have chosen, the ratio of rent to market value is 4.8% (€12k/€250k). Allowing for the fact that renting saves on ownership expenses, the effective rate is 3.8% (€9.5k/€250k).
A return of 2% is available on savings, whilst a mortgage costs 4.5%. If there is expected rent inflation, you can simply deduct the level of inflation from the interest rates to arrive at an effective "real" interest rate. In this case 0.5% on savings and 3% on the mortgage.
The simple rule of thumb then becomes 'purchase only if the effective rental yield exceeds the real interest rate'
In this specific thread I want to set out a framework for evaluating the financial decision of whether to purchase a home.
In this analysis the key factor, in terms of personal situation, is whether you need to borrow to purchase or if you have sufficient savings.
Let's assume the following (currently) realistic scenario:
A house costs €250k
Rent is €12k p.a.
Deposit Savings rate net of dirt is 2%
Mortgage interest on residential is 4.5%
For simplicity I'll initially ignore a couple of factors which probably should be taken into account in more detailed decision making e.g. costs of owning (repairs, etc), rent inflation, etc.
We'll also assume that this is a buy to hold decision rather than a short term speculative play.
1. Buy vs rent for someone with savings
If it's a straight choice between (a) using savings to buy or (b) holding onto the savings and paying rent, the key factor is how rents compare to net of tax interest on savings.
In this case buying property is the clear winner as €12k saved in rent trumps €5k interest.
2. Buy vs rent for someone needing to borrow
If it's a straight choice between (a) using borrowings to buy or (b) paying rent, the key factor is how rents compare to cost of borrowing
In this case buying property is marginal winner as €12k saved in rent trumps €11.25k in interest repayments.
Developing the scenarios
If we build in a couple of more realistic assumptions e.g. rents increase @1.5% p.a. and owner has €2500 p.a. in costs, we get the following:
Scenario 1: Buying is still the clear winner
Scenario 2: Buying is costlier initially but more cost effective in the long run (9 years+, still a marginal decision to buy overall)
Obviously there are many other factors / risks to consider, but this method provides an initial framework to make a decision.
As can be seen, it is very dependent on whether you are a borrower or saver. It is also hugely sensitive to deposit savings rates, mortgage interest rates, taxes on savings and long term expected growth in rents.
All this before even getting into the emotional value / drag of owning a home!
Simple Mathematical rule of thumb
In each circumstance above we are effectively targetting a ratio of rent to market value that is the tipping point for the decision to buy.
In the scenario I have chosen, the ratio of rent to market value is 4.8% (€12k/€250k). Allowing for the fact that renting saves on ownership expenses, the effective rate is 3.8% (€9.5k/€250k).
A return of 2% is available on savings, whilst a mortgage costs 4.5%. If there is expected rent inflation, you can simply deduct the level of inflation from the interest rates to arrive at an effective "real" interest rate. In this case 0.5% on savings and 3% on the mortgage.
The simple rule of thumb then becomes 'purchase only if the effective rental yield exceeds the real interest rate'