If a genie pops out of an IKEA floor lamp and asks about your dream house, how would you respond?
“I want a suburban McMansion, with a swimming pool, a pink flamingo in the yard, and the whole shebang!”
“One modern architectural wonder to go, please.”
“A cottage with a Bali flair would be lovely.”
Or, like an unconventional badass, you reply, “No thanks, genie. I prefer renting.”
If you frequent any personal finance forum, you’ve probably stumbled upon this age-old debate a handful of times: to buy or to rent?
The answer, of course, depends.
While giving a blanket recommendation would be as practical as asking a park bench to teleport, I’d happily offer some pointers to consider if you find yourself with this housing dilemma.
Full disclosure: I’m a happy homeowner who occasionally reminisces over my carefree and exciting life as a former renter, especially after waking up to 10 inches of snow to shovel.
I honestly see the appeals of both lifestyles, so rest assured that I’m leaving my bias at the door when writing this article.
My goal is not to sway your opinion one way or the other, but to simply analyze the pros and cons of both options, and help you make an informed decision.
(To keep the length of this article within the realm of reason, I’m only exploring the common scenarios of buying a home in the suburbs, and renting an apartment within the city core.)
The Desire to Own
Before we dive deeper, I must ask: do you even want to be a homeowner?
It might seem like a silly question, but hear me out.
We as a society often take it for granted that homeownership is universally desired, and as much a quintessential element of modern life as ordering food online, live-tweeting, and binge-watching the latest Netflix series (often at the same time).
The merits of owning your own home have been blindly tooted and perpetuated in overlapping circles of influence. We’ve been conditioned to overlook the real reasons we aspire to attain homeowner status.
So whether your answer was a resounding “yes” or a wishy-washy “hmm,” I implore you to explore your “why.”
Are your reasons compelling enough to warrant a home purchase? You would be the best judge of that.
One of the major upsides of homeownership is that you get to call the shots on (pretty much) everything on your land, and within your walls.
Who’s to stop you from painting your ceilings a suspicious shade of red, throwing Game of Thrones themed parties (reenactment of pivotal scenes is for sure a crowd pleaser), or filling your house with 1,500 clowns? Absolutely no one, except your spouse and maybe a few concerned friends (sidebar: watch out for interventions!).
The flip side of having all this freedom? You also have to do all the work to keep it pristine, or pay someone else to do it.
This might not be a problem for gardening enthusiasts, handy badasses, and the rare breed of celestial beings whose eyes sparkle at the thought of weed pulling. (Psst, if this describes you to a tee, please be my friend! I’ll spoil you with Games of Thrones themed party favors!)
But for the rest of us mortal earthlings, home maintenance chores like vacuuming, gutter cleaning, tuning up appliances and power washing sidings send us into a downward spiral of hysteria.
Danish philosopher Søren Kierkegaard was spot on – anxiety is indeed the dizziness of freedom.
To keep a home from literally falling apart requires a constant input of physical strength, mental energy, and time – time that you might rather spend reading “In Search of Lost Time” in a hammock. Are you ready for that?
A quick note: if the maintenance part of owning a home is the only drawback for you, consider buying a condo in a well-managed building instead of a detached house.
Maintenance aside, there’re a few other lifestyle factors to consider:
- What do you care more about: coming home to luxurious home fixtures and upgraded bathrooms, or being one elevator ride away from amenities like a swimming pool, fitness center, and yoga studio?
- What do you rather have: a quieter life in the ‘burbs, or easy access to all the trendiest spots in town?
- Most importantly: do you see yourself settling down, or does the words “digital nomad” make your heart go boom boom?
If you pick the former in all three questions, you’re leaning towards buying. Otherwise, renting might be a more suitable choice.
There’s no right or wrong answer here. How you want to structure your lifestyle is all that matters.
The joy and pride of homeownership are alive and well.
Having lived in my own house for three whole years, I still swoon every time the sun brightens up the living room. It makes me feel happy, whole, and above all, grateful that I have a place on Earth I can call my own.
Before I accord any more superlatives to homeownership, allow me to share the words of Frederick Peters, a wordsmith, and contributor to Forbes:
Homeownership enhances the longing for self-determination at the heart of the American Dream. First-time homeowners, young or old, radiate not only pride but also a sense of arrival, a sense of being where they belong. It cannot be duplicated by owning a 99-year lease.
Meanwhile, renters are sometimes pushed to navigate tricky situations akin to fraternity hazing:
- Asked to fix a clogged sink with sulphuric acid
- Toughing it out in a room shorter than they are
- Battling 20 to 25 roaches a day
Of course, these stories reflect the worst of the bunch and do not accurately depict the typical renting experience.
Still, the unrestrained possibility of coming home to an eviction notice or dealing with a landlord that you don’t vibe with can cloud your inner mind with low-level psychological stressors.
Most people value privacy and a sense of control over their most intimate environment – home, so the precarious nature of living on someone else’s turf can be mildly unsettling.
The Financial Picture
Buckle up. The real fun is about to begin – if you equate “fun” with “maths.”
Let’s kick things off by addressing a common but misguided argument that supports renting.
Many claim that renting is the far superior route to take because the hidden costs of homeownership are so insane that one would be financially better off renting perpetually and investing the difference in housing costs.
It is absolutely true that, besides the mortgage, homeownership comes with additional expenses:
- Higher utility costs
- Property taxes
- Home insurance
Maintenance and repair costs alone are estimated to be around 1% of home value per year (unless you live in an HCOL area where most of your home value derives from the value of the land it sits on).
Meanwhile, renters are only responsible for paying their rent, renter’s insurance, and utilities (if they’re not included in the rent).
On the surface, homeownership does seem financially daunting, which might lead folks to believe that this pro-renting argument is valid in all circumstances.
But I haven’t shown the complete financial picture yet.
Let’s have some fun and see what happens to two fictional couples who’re identical in every way except their preference when it comes to buying and renting.
Meet Couple #1: Aphrodite and Hephaestus, who just bought a charming 3-bedroom house
Here are the numbers behind their house purchase (a combination of my best estimates, and actual numbers from a house listing):
- House value and purchase price: $459,900
- Home insurance: $100 per month
- Property taxes: $3,744 per year
- Utilities: $300 per month
- Renovations: $1,000 per year (assuming a $10,000 home upgrade once every decade or so)
- Maintenance and repairs: $4,599 per year (1% of home value)
- Mortgage: $1,931 per month (10% down payment, 25-year amortization at 2.59%)
And if you’re doing the maths with me, you would realize that the total cost of living in this house comes to a whopping $2,999 per month, or $35,987 per year. Terrifying!
Now meet Couple #2: Venus and Vulcan, happy renters who got bitten by the wanderlust bug.
When they’re not hiking the Appalachian trail, visiting temples in Myanmar, or sampling foie gras sandwiches in Provence, Venus and Vulcan stay in an average 2-bedroom apartment that costs $1,800 per month in rent, utilities included.
By choosing to rent, they’re saving quite a bit compared to Couple #1, and investing all of it in the stock market.
During the first year of owning their home, Couple #1 spends $14,147 more than Couple #2. So the latter is able to add $14,147 to their investment accounts at the end of the year, which already had $45,990 in it – the equivalent of Aphrodite and Hephaestus’ house down payment.
So far, renting a modest apartment wins by a landslide.
But what happens 25 years into the future when Couple #1 finishes paying off their mortgage, and Couple #2 continues to rent the same apartment?
The tides have turned.
In the short run, renting could be cheaper than owning, but that trend might not continue forever as rent increases over time.
While Venus and Vulcan’s stock portfolio has grown to an impressive $692,901 (assuming a return of 5% per year, compounded), they are now paying $2,953 per month in rent (assuming a 2% annual growth rate).
They’re still embarking on exciting adventures around the world, and their incomes have largely kept pace with inflation, but they start to worry about the high living costs.
Meanwhile, Aphrodite and Hephaestus have completely paid off their 25-year mortgage, and own their house outright.
Their home is now worth $754,515 (using a conservative 2% annual rate of appreciation), and the costs to own it have shrunk considerably.
Let’s tally up each couple’s net worth:
The starting net worth for both couples was the same: $45,990.
After 25 years, Couple #1 has $754,515 in home equity, while Couple #2 has $692,901 in their stock portfolio.
You might say that $692,901 and $754,515 are close enough that renting can’t be ruled out as the superior option, and you’d be partially correct in that assessment.
But let’s not forget that, with a paid-off house, Couple #1’s housing outlays dropped drastically while Couple’s #2’s continues to rise.
From the year 26 and onward, renting becomes increasingly more expensive than owning.
To see my calculations and play around with the various rates I used in my assumptions, feel free to download my spreadsheet (don’t forget to make your own copy).
But before you rush to call a realtor, know that this is neither the whole story nor the end of the story.
Off the top of my head, I can think of many scenarios where renting triumphs. I’ll address them in more detail later in this article.
Without further ado, let’s dive into the financial pros and cons of owning and renting.
I strongly encourage you to read the whole thing. But if you’re pressed for time, feel free to skip to the summary at the end.
FINANCIAL BENEFITS OF OWNING
Benefit of Owning #1: Forced savings
The renters in the example above managed to amass a sizable nest egg because they have consistently saved and invested the cost difference between renting and owning for 25 years – and because they’re fictional.
In the real world where the impulsive desires to purchase commingle with easy payment options, mustering up the unwavering discipline required to stick to a strict savings plan is definitely easier said than done.
Left to our own devices, most of us justify our spending with self-indulgent rationale and put off saving money for “a later time, when I’ll [insert excuse].”
I’ve been there, and I still am – my voids are filled by colorful office supplies, and my mental aches are relieved by eating copious amounts of take-out food in paper boxes.
We’re only humans. Instant gratification is the name of the game.
Given our propensity to consume now and worry later, getting a mortgage would actually be a wonderful thing.
You see, owning a house, in essence, forces you to save.
Since each mortgage payment buys you a slightly larger share of your home, you’re constantly saving money by boosting your home equity. The more you pay down your mortgage principal, the bigger your savings (home equity).
Having a mortgage turns an optional nice-to-do (actively putting money into retirement accounts) into an obligatory must-do (making mortgage payments on time to avoid homelessness).
Having a mortgage forces you to save: it turns an optional nice-to-do (actively putting money into retirement accounts) into an obligatory must-do (making mortgage payments on time to avoid homelessness).
You’re no longer counting on your willpower or superior budgeting skills to save.
The fact that your home equity cannot be easily accessed (at least not without a HELOC) without selling the house serves as an unintended fail-safe against squandering those savings.
Benefit of Owning #2: Financial leverage
Financial leverage allows people to acquire assets that they can’t afford with their existing assets, by leveraging money from other people or institutions (ahem, banks).
Here’s the official definition from Investopedia:
Leverage is an investment strategy of using borrowed money – specifically, the use of various financial instruments or borrowed capital – to increase the potential return of an investment.
The concept is simple, but almost too good to be true if you think about it.
Forking over only 20%, 10%, 5%, and sometimes even 0% of the purchase price upfront could buy you a home – the bigger the leverage (in other words, the more you borrow), the greater the return on investment.
To fully understand and appreciate the magic that is leverage, let’s once again return to our fictional couple Aphrodite and Hephaestus:
They bought their house for $459,900, putting 10% down ($45,990). 25 years later, the property is valued at $754,515. That’s an ROI of 540.61% on their down payment (or 7.71% annualized ROI).
Not bad for an asset that doubles as a shelter!
This is why seasoned real estate investors swear by leverage. I wouldn’t even be surprised if a handful of them have secretly tattooed “leverage” on their forearms.
By the way, if you’re shopping for a tattoo design, may I propose this?
Benefit of Owning #3: Home appreciation
Residential real estate prices in Canada have climbed steadily over the past decade or so, largely unscathed by the 2008 financial crisis.
I’m certainly no clairvoyance, but I would bet money that this upward trend will persist.
Of course, not all parts of Canada have experienced the kind of Vancouver-esque real estate boom that forced wannabe homeowners to migrate to their second-choice cities in droves. If you live somewhere where the population and job opportunities are growing rather than shrinking, don’t wait for a price correction to get in the local real estate market.
Buying is a safer route to take if you live in an economically and culturally attractive part of the world. And the sooner you buy, the sooner housing booms work for you rather than against you.
Benefit of Owning #4: Capital gains tax exemption
Every time you check out at Costco, you pay GST.
Every time you sell stocks held in a taxable investment account, you pay taxes on the gains.
But when you sell your primary residence, you pay CA$0 in taxes in Canada (again, with a few caveats), thanks to “principal residence exemption.” Ca-ching!
The United States offers a similar tax exemption program, which you can read more about here.
The awesomeness of pocketing the entire proceeds from a home sale cannot be overstated.
Going back to our fictional couples:
Let’s say Couple #1 sells their house after 25 years. Their gross profit would be $294,615 ($754,515 minus $459,900), minus selling costs. They didn’t put down 100% of the money upfront to buy it but got to keep most of the profit. Sweet deal!
In contrast, unless Couple #2’s entire stock portfolio resides in tax-advantaged accounts, they would owe thousands of dollars of capital gains tax to the government when they sell, if not more. They put in 100% of the money upfront to invest in stocks, but didn’t get to keep 100% of the profit.
Benefit of Owning #5: Government benefits
My fellow Canadian homeowners and homebuyers, you’re in luck! Behold a bunch of government and tax benefits you could potentially benefit from:
Home Buyers’ Tax Credit (HBTC):
Buying a home for the first time? Great! You might be able to claim CA$5,000 in federal tax credits.
Home Accessibility Tax Credit (HATC):
Need to upgrade your home to make it safer or more accessible for the elderly or those who need mobility assistance? Claim up to CA$10,000 in expenses.
Medical Expenses Tax Credit:
Need an AC, furnace, bathroom aids, or water purifier for medical reasons? You can claim those expenses on your tax return as well.
GST/HST New Housing Rebate:
If you meet specific criteria, you may be eligible to recover some of the GST or HST paid for a new or substantially renovated primary residence.
To learn more, please read this Canada.ca article: GST/HST new housing rebate.
Home Buyer’s Plan (HBP):
The Home Buyer’s Plan allows Canadians to withdraw up to CA$25,000 from their RRSPs to fund the purchase or construction of a home. This is perfect for those who need a little bit of extra help coming up with the down payment.
Provincial Tax Credits:
Some provinces offer unique tax credits to their residents, most notably:
- New Brunswick Seniors’ Home Renovation Tax Credit
- Manitoba Education Property Tax Credit
- Quebec Home Buyers Tax Credit
Benefit of Owning #6: Access to HELOC (Home Equity Line of Credit)
A HELOC is a line of credit that’s secured by your home, often at a lower rate than its run-of-the-mill counterparts.
Being a financially responsible person, you can’t help but wonder, “Aren’t lines of credits the financial equivalent of evil reincarnation?”
To be fair, a HELOC in the hands of an irresponsible spender could spell big trouble, and I’m definitely not advocating for taking on purposeless debts.
However, if used strategically by risk-tolerant investors, HELOC becomes a smart investing tool that lets you unlock the value of your home equity without selling your home.
This strategy even has a name – the Smith Manoeuvre, and here’s how it works:
Step 1: Apply for a HELOC
Step 2: Borrow funds from HELOC
Step 3: Invest the borrowed money in income-producing investments like dividend stocks or rental properties
Step 4: During the tax season, deduct the interest you’ve paid on the HELOC
Step 5: Make extra mortgage payments with HELOC’s investment gains
Step 6: As you pay down your mortgage faster, the size of your HELOC grows
Step 7: Rinse and repeat
Let me re-emphasize that this wealth-building strategy is not for everyone, so proceed with extra caution.
Benefit of Owning #7: Benefit from low interest rates
Few things make homeowners and real estate investors’ collective hearts flutter harder than when the Bank of Canada (or the Federal Reserve Board for Americans) announces a lower overnight rate which invariably leads to lower mortgage rates.
Low mortgage rates are like Facebook invites to government-sponsored mortgage-burning parties, or Instagram filters that instantly turn every “For Sale” sign into a “Sold” sign.
Pardon my half-hearted attempt at writing social media puns that flop.
Here’s the gist: whenever mortgage rates drop, mortgage payments are reduced, housing affordability jumps, which drives property values up.
When interest rates drop, mortgage payments are reduced, housing affordability jumps, which drives property values up.
Low interest rates and the real estate market have the kind of unhealthy symbiotic relationship that Billie Eilish sings about.
Benefit of Owning #8: Benefit from inflation
Inflation is constantly on the upswing – it’s an inevitable by-product of a healthy and growing economy.
Inflation has never been kind to renters, because landlords are incentivized to maximize the return on their investments and adjust the rent to keep up with inflation, as long as they can get away with it.
But when you hold a mortgage, inflation is on your side. As inflation slowly erodes the net value of your mortgage debt one percentage at a time, the amount you owe decreases in real value, even though your nominal mortgage remains the same on paper.
Let’s say you kickstart the year 2020 with $250,000 worth of mortgage. Assuming modest inflation of 2% and disregarding mortgage payments, your mortgage would effectively be worth $245,000 on December 31st, 2020.
As the ball drops in Times Square, the value of your mortgage drops with it.
FINANCIAL DRAWBACKS OF OWNING
Despite its many upsides, owning a home is not a surefire way to profit. Here’re a few financial drawbacks that cannot be overemphasized:
Drawback of Owning #1: Lack of equity upfront
If you buy a home with the expectation of instant profit, you would be thoroughly disappointed.
Unless you live in a city that is going through a brief period of hyper-economic growth, a decade is usually how long it takes to profit from homeownership, if ever.
Part of the reason is that building up home equity is a gradual process – homes don’t appreciate overnight, and mortgages don’t get knocked down instantaneously.
Building up home equity is a gradual process – homes don’t appreciate overnight, and mortgages don’t get knocked down instantaneously.
The fact that interest makes up a huge portion of mortgage payments until you’re about two-thirds of the way towards the finish line certainly doesn’t help.
Drawback of Owning #2: High costs of buying and selling
Despite what TV commercials will have you believe, buying a home is more than slamming a $20,000 cheque on a 20-foot-long walnut dining table and exclaiming “I’m going to take it” with a finger pointing up at the “recently replaced” roof.
Similarly, selling a home requires a tad more effort than displaying a chintzy “For Sale” sign on the front lawn and waiting for potential buyers to take the bait.
Nobody likes to talk about the dreaded money drain and open-ended time suck at the core of any housing transaction. But I’m going to.
Driving to and from open houses isn’t how anyone envisions their ideal Saturday afternoon. Foregone leisure times aside, those trips to the gas stations get old and costly fast.
And let’s not forget the exorbitant land transfer taxes and legal fees that homebuyers need to budget for, on top of saving for a 6-figure down payment.
Home sellers’ wallets suffer even worse injuries. Staging costs, sales commission, and legal fees alone are estimated to be 5% to 10% of a home’s worth.
This is why turning a profit on your home takes time – you need to build up enough equity to break even first.
Drawback of Owning #3: The opportunity cost of the down payment
When you buy a home, your down payment is tied up in your home. Outside of using a HELOC, you cannot take it out, spend it, or directly invest it. Unless you’re renting parts of your home, your down payment is not generating a recurring income.
Yes, investing in a home is generally considered safe because you’re unlikely to lose money over the long term. Still, the opportunity cost of the down payment is something we cannot afford to overlook.
If, instead of buying a home, you invest the down payment in the stock market, how much would it yield annually? Then compare and contrast that to your average home appreciation rate. I bet the stock market wins in most cases.
A $50,000 down payment, if invested in the stock market and grows at 5% a year, would turn into $169,317.75 after 25 years, without any extra money added to the pile.
Evidently, it’s totally unfair to compare a home to the stock market. After all, only one of them puts a roof over your head, and it for sure isn’t a stock certificate. But you get my point.
Drawback of Owning #4: Expensive to maintain
We’ve already covered this downside to owning a home fairly extensively, but allow me to add a new dimension to it:
The older your home is, the more expensive it is to maintain. Since a house never gets younger short of a complete overhaul, it’s a constant and uphill battle to restore it to its former glory.
This is definitely a major financial drawback of owning that renters don’t need to face.
Drawback of Owning #5: Potential home depreciation or foreclosure
Do you know what happened to Detroit between the 1950s and the 1970s?
This once-proud city lost 325,000 residents because its single-industry economy was torpedoed by the exit of the Big 3 auto companies.
An irreparable blow was dealt to its economy, and the housing market suffered collateral damage.
My stomach churns at the thought of home values melting away like clocks in a Salvador Dalí painting, metaphorically speaking.
Remember The Great Recession in 2008?
Foreclosure filings spiked by more than 81% in the US that year. And unfortunately, some good folks are still rattled by its lasting effects.
I want to bury my head in the sand and dismiss the possibility of an impending recession as unfounded speculation, but the pragmatic side of me thinks that we might be on the cusp of another one.
Your home is an investment. And as with all investments, loss of capital is nearly unavoidable when an economic crisis hits.
Your home is an investment. And as with all investments, loss of capital is nearly unavoidable when an economic crisis hits.
So I caution all potential home buyers to stay vigilant and research extensively before buying.
You know your city the best. In your heart of hearts, you know if it’s the next Detroit in disguise or a mini San Francisco in the making.
As for changes in the economic cycle, while no one can credibly and accurately predict the timing and odds of a recession, the general sentiment towards the state of the economy is usually one Google search away.
FINANCIAL BENEFITS OF RENTING
Although home buying is commonly considered a wise move, renting has its own fandom too (their fanbase nickname is, I believe, “happy renters”). This article certainly wouldn’t be complete without combing through why the latter is the case.
Before I get waist-deep in my unabashed praise for renting, let me send a few heartfelt congratulations:
- To the lucky souls who live in rent-controlled apartments: You guys have the best of both worlds. Enjoy!
- To those who live in impossibly expensive cities and choose to rent to avoid stretching their dollars too thin: Well done! You’ve made a sensible choice. You’ll be glad to have that cash cushion if the proverbial shit ever hits the ill-fated fan, believe you me.
With that out of the way, now let’s revel together in ways renting could be financially beneficial:
Benefit of Renting #1: No maintenance costs, repair bills, or property taxes
Ask any renter about maintenance fees, repair bills, or property taxes, and you’d probably receive a confused stare, with a stoically delivered “what are those?” to match.
If a renter’s stove has suddenly gone kaput, they call the landlord, who gets it fixed for free.
If a colony of mold decides to inhabit their bathroom walls, the landlord comes to the rescue and foots the bill.
If a property tax bill arrives, it must be intended for someone else because property taxes are the least of their concerns.
Not being on the hook for these costs is arguably one of the best parts of renting. We’re talking about thousands of dollars worth of financial burden that renters are dodging every year.
Benefit of Renting #2: Lower insurance and utilities
While we’re on the subject of financial burden, or the lack thereof, allow me to point out that renters also pay lower utilities and insurance than homeowners.
Last time I checked, for the low, low price of $20 a month, you would become the proud owner of a decent tenant insurance policy in Ontario. Meanwhile, homeowners are paying triple, quadruple, quintuple that amount to have their homes sufficiently covered.
Putting aside the very real possibility of zero utility bills, utilities are typically much cheaper for renters because apartments tend to be smaller and feature more compact floor plans, and thus require less usage of heat, water, and electricity.
Benefit of Renting #3: No need to save for down payment
It’s not that scrimping and saving for a down payment is particularly painful or difficult. It just takes a long while. And let’s face it, the waiting-for-savings-to-reach-a-certain-dollar-figure part sucks.
A 5% down payment on a $500,000 house is $25,000, which would take the average couple at least a year or two to gather, while hitting pause on all other types of saving and investing.
Renters don’t have this problem. Sure, they might have to fork over a 4-digit security deposit before their hand-shaped chair, and vintage bookshelf can be moved in, but that’s nothing compared to a house down payment.
For that reason, people who rent are in an ideal position to ramp up investing efforts early by directing every spare penny towards investment accounts and watch their money (hopefully) grow from day one.
This is especially true in geographical areas where housing appreciation is low or non-existent. Homeowners who have too much money tied up in their homes in these areas are bound to be late to the investing party and have a much harder time playing financial catch-up.
Benefit of Renting #4: Unaffected by real estate market downturns
Sometimes the housing market bobs up and down like a harmless yo-yo.
Other times, when the housing market hits a particularly rough patch, it acts like a boomerang that surprises you with a smash in the face and knocks you down into financial ruins.
And while a real estate market downturn might keep homeowners up at night, renters can always sleep soundly, knowing that their net worths aren’t adversely affected in such an event.
While a real estate market downturn might keep homeowners up at night, renters’ net worths aren’t negatively affected by it.
Benefit of Renting #5: More disposable income
All hail to the cash flow!
As long as your rent-to-income ratio remains reasonable, and your willingness to save overshadows your penchant for spending, you would consistently have more cash at your disposal as a renter than as a homeowner.
A large cash reserve means having more options:
- You can withstand financial emergencies, and thus avoid falling into the debt spiral that usually began with a trip to the nearest payday lender
- Let’s say your favorite blue-chip stock is suddenly trading at 10% below fair market value or a once-in-a-blue-moon investment opportunity lands on your lap, you can jump on these deals quickly without having to sell assets
FINANCIAL DRAWBACKS OF RENTING
Last but not least, let’s discuss the financial downsides of renting.
Drawback of Renting #1: The opportunity cost of rent
Unlike a mortgage’s part-principal, part-interest structure, rent is 100% expenses and 0% equity.
As I’ve shown earlier, if we look at any single year in isolation, renting could be a wiser financial decision than buying. But over a long period of 25 years or more – enough to pay off a mortgage in its entirety – renting gets progressively more expensive, both in actual costs and in opportunity costs.
Considering that renting is basically shorting the local real estate market, as long as home prices aren’t plummeting, permanent renters are missing out on a lifetime of equity building.
Drawback of Renting #2: Rent increases
Unbeknownst to you, as you bust out your signature roof-raising move in the shower, a higher power could be literally raising the rent ceiling in your area.
While smart landlords strike a fair balance between keeping good tenants happy and charging a competitive rate, the vast majority of them will increase rent by the maximum allowable rate each year.
A quick Google search revealed that, in Ontario, the rent increase guideline is 2.2% next year, or a $22 increase for every $1,000 of rent.
While that might not seem outrageous, think in terms of yearly increases.
A couple that rents a $2,000-per-month condo in Toronto could be paying an extra $528 next year, or the equivalent of 3 life-sized inflatable tube guys that make excellent gifts for ex-partners to make sure they never get over you.
Paying $528 in rent vs. paying $528 for your exes’ eternal affection? I don’t have to convince you which one is better.
Drawback of Renting #3: Moving costs
When you rent, instability and freedom define your lifestyle in equal parts.
Having freedom is a blessing because you can pack up and leave whenever your landlord adjusts your rent upward, or when a tap dancer moves upstairs.
Having instability is a curse because uprooting your life and relocating even two blocks away requires a considerable sum of money, or at least a few good buddies with excellent upper body strengths. As renters are more prone to moving, they incur higher moving costs over a lifetime.
Moving expenses don’t bankrupt people, but death (debts) by a thousand cuts (moves), right?
Sorry to break the fourth wall: my only regret with this article is not coming up with a moving-related term that rhymes with “cuts.”
Depending on which angle you look at it, buying and renting have their “yay” and “meh” moments.
In a nutshell, here’re the pros and cons of buying and renting, in condensed form.
Pros of buying:
- Financial leverage your way to maximum ROI
- Benefit from capital appreciation
- Proceeds from the home sale are exempt from capital gains tax (regional laws may vary)
- Paying down a mortgage forces you to save
- Psychological benefits of having total control over where you live
- Drastically lowered housing costs once the mortgage is paid off
- Tax benefits available exclusively to homeowners and homebuyers
- Access to HELOC
- Macroeconomic forces like declining interest rates and rising inflation tend to benefit homeowners
Cons of buying:
- Expensive, time-consuming, and stressful to maintain a home
- Risk of foreclosure as a result of job loss and financial mismanagement
- Less flexibility and mobility
- Lack of equity upfront
- High costs of selling and buying, making it financially disadvantageous to sell within a couple of years of buying
- The potentially high opportunity cost of the down payment
- Home could lose value over time – appreciation is not guaranteed
Pros of renting:
- Can pack up and go at any time without incurring massive costs
- No maintenance costs, repair bills, or property taxes
- Lower insurance and utility costs
- A bigger cash flow makes it easier to take advantage of great investment opportunities
- Free access to costly amenities like in-ground pools, fitness center, conference room, etc
- Not affected by declining property values
- No need to save for a down payment
Cons of renting:
- Dealing with landlords
- Any material changes to the place must be agreed upon with the landlord ahead of time
- Unknown rent increases
- Risk of being asked to vacate at the end of a lease
- More frequent moving means higher moving costs
- Not building home equity
Putting it all together…
You should rent if:
- You value flexibility above stability
- You’re not sure you want to stay where you are for the long haul
- You can’t comfortably afford a desirable home in your area yet
- The thought of home maintenance makes you dizzy
- Your rent is incredibly cheap and capped at below-market-rate levels forever
- You want to live near all the downtown hot spots
- You’re a disciplined saver
- Your local real estate market has been slowing down for years
- Having a constant cash flow is essential to you
You should buy if:
- Homeownership is important to you
- You value stability above flexibility
- You’ve saved up a 10% down payment or more
- You plan on staying where you are for at least a decade
- You live in an economically booming city where the cost of homes are constantly on the rise (and so is rent)
- You don’t mind the work required to maintain a home
- The thought of dealing with landlords gives you the heebie-jeebies
- You enjoy being the one making the decisions regarding your home
- The average rent in your city and your expected mortgage costs are roughly the same (or even better, mortgage payments are lower than rent)
- Less than 40% of your household’s disposable income would be allocated to housing-related expenses
- You believe that saving through mortgage payments could be a good way for you to build wealth
- You’re comfortable with the concept of financial leverage
Onward and Upward
Not going to lie. Owning a home is a decent financial move in most cases. But opting out of homeownership isn’t a shabby path to financial independence either.
I’ve typed and erased and typed and erased upwards of 10,000 words to lay out the good, the bad, and the ugly of each choice, and cracked some jokes while I’m at it.
Ultimately, the decision comes down to your lifestyle preferences, stage in life, financial goal, financial aptitude, and the local real estate climate.
Have you made up your mind yet?
Sitting in my living room in this house my wife and I bought 40 years ago I can’t tell you how much the security of having a place of our own has meant. Raising three babies into grown adults while never being more than an eight minute commute from work was something special I realize most people never get to stay in one location like I did, which makes the decision to rent or buy more difficult. Being able to expand and remodel the house maybe eight times over the years to eventually give three teenagers each their own bedroom and bathroom kept family harmony maxed out. I don’t think it was a great financial investment, but it was a great lifestyle investment. You put together a truly comprehensive guide to rent vs buy! And as you pointed out, it isn’t a simple financial decision, even though it does carry financial benefits and consequences.
Thank you for your comment and insights. 🙂 I’m very happy to hear from a much more experienced homeowner about their fulfilling owning experience. Having your own bedroom AND bathroom as a teenager is wonderful and I applaud you for being able to provide that to your kids.
This post took me 2 months to put together (between the spreadsheet, the graphics, endless writing, research, and 4 rounds of editing), and receiving your wonderful comment before I even got the chance to promote this post makes me feel like it was all worth it. 🙂
I think interest rates have been the biggest factor in terms of how real estate can appreciate. If you look at the 70s and 80s where countries all around the world had to battle runaway inflation with high interest rates, real estate prices got slammed as rates went up from 5% (lol can’t even get 2% these days) to 20%. Now we face ever deflating interest rates and if this is the new world we live in it only makes sense to own a home.
Thanks for sharing your thoughtful insights, Kevin. 🙂 I appreciate the new angle you brought to the discussion.
Well, both have their own set of benefits. For instance, renting a house offers you flexibility, predictable monthly expenses, and someone to handle repairs. Comparatively owning a home offers you a range of intangible benefits such as pride of ownership, a sense of stability, equity, and tax deductions.