Monday, August 14, 2006

Buy or Rent?

Buying a house is a huge deal. The amount of money needed to buy a house is more than I've had in my entire life, total (well maybe not an absolute dump in the middle of nowhere, but nothing worth living in).

There are people out there who advocate that buying a house is better than renting, because if you are renting your just making someone else's mortgage payments, so why not make your own payments and have an asset at the end of the process. Plus there is the security of owning your own home, etc.

Recently I've been thinking this is not the way to go. The big reason for this is interest. The interest on an average home loan is a bit more than the actual amount borrowed. Yay compound interest. So for every dollar of house you get, you pay another dollar to the bank. This is the killer. Let's say I rent a house, and I manage to save an amount of money equal to my rent each week. This is about the same ratio of interest to principle. 1 dollar to the house provider, one dollar to savings. At the end of the process, assuming the payments are about the same size, the home owner has paid a certain amount of money and got a house worth about half that amount of money. The renter has paid the same amount, doesn't have a house, but does have cash of about the value of the house. Plus they will have all the interest on that cash. And remember, interest on the mortgage was about as much as the principle. And even if the interest rate for savings accounts is a lot less than the interest rate for mortgages, it's still going to add up. And that doesn't even consider the possibility of investing the money somewhere where it will earn you even more money.

Now this analysis ignores a few factors, like rates, inflation, increase in the value of land, insurance, etc. Without thinking about it too much, I think these other factors would tend to balance out.

So it looks like I've got a long future of renting ahead of me, and hopefully my savings will grow as I go along. Of course, to do that, I need a god damned job.

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1 comment:

Anonymous said...

I've thought about this a bit in the past, partly because of a friend who has just become a millionaire on paper (ie. has a million dollars worth of "assets", and some ridiculously large debt) through housing. I'm not sure that inflation, insurance and stuff cancel out, with my thinking something along these lines...

I think the key is that inflation is what drives the interest rate, and it's what you're paying the bank for. Basically you're using the bank's money and paying the priveledge, and betting that you can use it better than they can. And so you pass that on to whoever is renting the place, so they end up paying your mortgage. But then the increase in land value and captial gains are all your's.

As an example, in Australia, 5% rental returns aren't uncommon - so I guess if an owner spends ~$500k house, a renter might spend ~$500/week on rent, which works out to about 5% a year. I think that if this isn't between the inflation rate (4%) and the lending rate (6%), shit fucks up. I'm obviously not an economist, so I don't know exactly what happens :)

Since we have right wing lunatics in power, the property market is a seller's market, and that the prices are driven up ridiculously - averaged over the last two decades, and adjusted for inflation, Brisbane's median property value has rised by 10% a year :) So basically, if you get a mortgage that your tenants can afford to pay, you ought to be able to walk away with (10% - some margin) of the property value per year...

JP :)