Reasons to rent a house instead of buying

The following guest post on the reasons to rent a house instead of buying is from Graeme Pietersz, the man behind Moneyterms.

That it’s better to buy a house rather than rent is deeply ingrained in the British psyche. But the argument as to whether it is better to rent a house or buy is far from one-sided.

The core of the argument against renting is that rent is wasted money that you could instead save and invest in a house.

The flaw in this argument is that your entire mortgage payment is not an investment.

A mortgage payment is two payments combined:

  • One is the repayment of the amount you borrowed: this is an investment.

If paying rent to your landlord is a waste, then so is paying interest.

Rent a house or buy? The true cost comparison

You need to compare the cost of rent to the cost of paying mortgage interest. You cannot just compare rental yields to mortgage interest rates. You need to look at where both are likely to go over the lifetime of the mortgage.

For future interest rates (beyond any period for which mortgage rates are fixed) you look at a yield curve and add the spread over it that you expect to pay.

The amount you need to add is obvious for tracker mortgages, but the principle is the same for any variable rate because banks approximately follow market rates.

The Bank of England provides some nice graphs for UK rates. Similar data is available in other countries.

Model behaviour

The bad news for buyers is that it looks like we can expect yields to go up. Your mortgage payments will probably be a lot higher in five years.

To forecast future rents, the safest assumption is that they will, like house prices, roughly follow income growth over the long term.

By now you may be feeling that you are being asked to do a lot of financial modeling to decide whether to rent a house or buy. Sorry, but this is an important decision that does not have an obvious answer. It demands at least as much analysis as buying a share.

And we have not finished yet! There are more costs to be taken into account – and we have not even talked about risk.

Other costs of owning a house

Mortgage interest is not the only cost of owning a house:

  • If you own a house, you have to maintain, insure, and furnish it. Doing this costs you not only money, but time as well.
  • You need to take care to ensure that you maintain valid insurance (I know people who have happily paid for policies they did not realise were not valid).
  • You have to find plumbers and builders when needed — and pay them.
  • You have to replace old furniture, even if it has only suffered ‘fair wear and tear’.

So you need to add an estimate for all this to the cost of owning a house, and compare that number to your rent. Buying a house is probably looking a lot less attractive by now.

It looks worse when you consider the risks.

The risks of buying a house

The most obvious risk is that house prices will fall. In the long term, this risk is ameliorated by economic growth, as house prices have had a fairly stable long term correlation with incomes. The question is whether you have the will and means to last through crashes.

Also, the risks of owning a property are not just the risks to the property market in general. There are risks specific to the area you buy your house in, and to the particular property itself.

House prices do not follow the same trends all over a country. There can be huge divergences between regions. In addition, there are risks attached to your local area. It may become more or less desirable as an address.

Local facilities (schools, transport, shops) may improve or deteriorate. Changes to rivers or flood defences may make your house prone to flooding. Similar risks exist in areas vulnerable to erosion.

We touched on one of the risks peculiar to a particular property: the cost of repairs. There are a whole range of risks that can leave you badly out of pocket, from dry rot to fire. Some will be covered by your insurance, some will not be covered at all, and a good many will be inadequately covered. Regardless of who pays, it still costs you time and worry.

The price risk is far worse than similar volatility in any other investment, because most people borrow to buy a house — very few borrow to buy shares. Buying a house with a mortgage is therefore a massive margin trade

Buying a house also ties you down. If you rent a house and you are offered a job in another city, or even another country, you can be there in a few weeks. It may cost you a few months rent, but it is quick and easy, and the cost is predictable.

So, rent a house or buy?

There are times when it is obvious that buying a house is a good decision, often in the wake of a crash.

When house prices are low enough that you can pay the mortgage and also other costs with the equivalent in rent, you can’t really lose. Such high rental yields are a strong sign that prices are too low.

Most of the time it is much less clear that you are likely to benefit financially.

If house prices rise rapidly it may turn out to be a mistake to rent a house – but so would buying if they fall or stagnate. So why not keep your options open and your expenses predictable?

Note: I have updated this post from the archives because the core reasons to rent a house versus buying haven’t changed, even as various parameters have arguably become more stretched. Be aware that some of the older reader comments might now be dated, however. On the other hand, that does provide interesting context to this timeless back-and-forth!

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