Monday, November 23, 2009

Throwing Away Your Money

I used to be quite convinced that renting was just throwing your money away. Over time though, I've learned that everything is not quite so black and white.

I like what was said about it in The Wealthy Barber. It states that shelter is a necessity and there are only two ways to get it. You either rent or you own. It's no more throwing away your money than buying groceries or clothes.

If you think of owning as an investment, like most investments, you need to be in it for the long term. Prices fluctuate, there are market corrections, and in the short term the value of your home could decrease. So one obvious time where renting makes the most sense is when you don't plan to live in an area for very long. Also, sometimes the area you want to live in might not be a great investment area. So you can't count on the home increasing with value or increasing with a decent return on investment.

So like everything else you need to evaluate whether renting makes sense for you and for your situation. Regardless of owning or renting, you don't want to spread yourself too thin. So, if you can't afford to own, Don't Do it!

Now that I've said that, given the right circumstances, I still see more benefits in owning over renting for most people in most normal circumstances.

The biggest argument I've ever heard for renting, is that you can invest the money you save by renting. That is assuming that renting is cheaper of course, which it probably will be if you put less than 20% down. To make a fair comparison of rent to mortgage you need to add the maintenance costs and/or strata fees to the mortgage. So if for example you save $100/month by renting you could then invest that difference.

While I think it's theoretically possible to make more money renting and investing the difference, I haven't seen it in practice. The problem with that theory is that you need to be able to make more money than the increase in the value of a home would have been.

The magic number everyone seems to like to use for housing price increases is a 6% per year increase on average. Of course the real number will vary drastically based on a number of factors including location. But, for arguments sake, let's assume that 6% is correct for you. It almost seems logical that if you could earn more than 6% on an investment (say 8%) you'd be better off renting. The problem is that this doesn't take into consideration the 6% is on the total property value not just your personal investment.

Let's say you put $7,250 down on a $145,000 condo. The following year the value goes up by 6%. That's 6% on $145,000, not $7,250. That's $8,700 which is more than 100% increase on your investment. Before you say I ignored the interest payments to the mortgage, I haven't really. Ignoring the equivalent in rent which you'd have to pay as your alternative, you paid $7,250 plus 100 more per month. Even then, you invested $8,450 for an increase of $8,700.

In my case I put nothing down and the value of my condo has increased by about 41% in 4 years. Now that's a higher than normal growth and it was luck and not skill on my part that I got in when I did. There is no investment I could have made that would have gotten me the same growth if I had invested it elsewhere. None that I know of anyhow!

Some other benefits I find to renting over owning:

As long as you don't experience sky rocketing interest rates, your payments will generally remain unchanged. Whereas rent will continue to increase and close that $100 gap. When you do sell, you also get some if the rent equivalent money back which would never happen with renting. Or if you stay put and don't move, eventually your mortgage is paid off, all you have left to pay is the maintenance fees and taxes. That certainly leaves you with more money to invest than the renter at that point.

Even without selling you build up equity in your home. Equity is the difference between what your house is worth and what you owe. So another advantage is that you can borrow against this money. Like anything this can get you into trouble too, so you need to be careful. Using this money allowed me to get out from a debt burden I couldn't have done without selling my place.

Another example of using the equity would be if you needed to make repairs in order to sell, but couldn't afford it until after it was sold. Also, at some point in the future I'd also like to purchase a second home for and investment and this is likely the best way for me to have the down payment.

So while rent is a valid option for providing shelter and might be the best option for some people, I still see more benefits to owning in the long term. Hopefully this helps someone. If not, I still enjoyed getting my thoughts written down somewhere. Feel free to correct me on anything you think I went astray on.


  1. As an owner, I feel STUCK and can't wait to sell and get back to renting. I find owning is much more expensive, much more of a hassle and there are no laws to help you deal with N O I S Y neighbours. As a renter you can move tomorrow. When you sell it will cost about $20,000.

  2. @Anon: I feel you pain with noisy neighbours. I'm having that problem now. Would be nice to be in a detached home some day. Owning and renting both have their pros and cons and you have to do what's best for you. Keep in mind that if you probably need to account for the rent in your retirement savings this way though.

    Good arguments for renting! Thank you for the input.