• Written by NewsServices.com

Here is a classic question often asked by millennials. Should you rent or buy? It’s all too often that you’ll open Instagram to realise a friend has purchased their first house and you sit there wondering whether you’re throwing money down the drain by renting.

So why do some people believe homeownership is a smart financial move while some believe it’s one of the worst financial moves you can make? To address this question, it helps to see both sides of the argument. This article will give you the economic tools to enhance your decision-making process so you can decide for yourself.

Arguments for buying

  1. If you bought a house 12 months ago, well you’re in luck given property prices have risen by more than 20% over the past year. So, to state the obvious, in periods of growth, the value of houses (and one’s equity) will inevitably increase, meaning that if you sell your house at a prime time, you will gain a significant return on your investment.
  2. There are also tax benefits associated with owning your own home over the long run as you generally don’t pay capital gains tax on your primary place of residence (if it has a dwelling on it and you’ve lived in it).
  3. Buying gives you the benefit of leverage (meaning the use of borrowed money to invest). In Australia, banks often lend a high percentage of the total value of the house, meaning the leverage can be quite high.
  4. It’s also worth noting that property builds equity in an appreciative house price environment. This equity can be leveraged to increase your future borrowings, enhancing purchasing power and ultimately builds your wealth.
  5. While mortgage repayments can hold you down from pursuing other activities, such as travel in some cases, it’s important to remember that the value of interest payments decreases over time as a greater proportion of debt continues to be paid off.
  6. There are also non-financial benefits. For example, when you own your own home, there is the security of not being displaced, unlike renting, where the landlord can decide to kick you out, and you also have the ability to renovate the property how and when you like.

Arguments against buying

  1. A popular myth is, “rent money is dead money” or so the saying goes. However, one could also argue that interest repayments are dead money right? Interest rates are currently at an all-time low of 0.1% and therefore mortgage rates are also lower than usual.

However, let’s flesh out this argument with more of a typical scenario. Let’s assume the mortgage variable interest rate is 3.75%. This means to buy a $1 million house, you would pay about $30k of interest each year on a $800,000 loan. This is almost the same amount as the $27,000 you would pay to rent a similar property for the year.

While the interest rate is currently at an all-time low, the RBA intends to raise interest rates in April 2024, meaning that if you buy a house now, mortgage repayments could increase significantly in the future (unless you switch to a fixed rate mortgage of course).

  1. There is an opportunity of tying up your money in a property instead of spending it elsewhere. Instead, you could be receiving investment returns on say, bank deposits. For example, if you invested a $175k deposit in an ETF that gives a 5% real return, that’s approximately a $9k return, which by itself would be a large share of the rent you would need to pay per year.
  2. Transaction costs of buying and selling a property are quite high. The RBA estimates that the costs of buying a house, including stamp duty and other buying costs, can equate to 4.3% on average.

On the other end, when selling a house, you have advertising costs and real estate agent commissions which can add up to approximately 3%.

Therefore, one could argue that the total cost of buying and selling a house is about 7.3%, and this is exclusive of the ongoing running costs of actually owning the property which include insurance costs, council rates, repairs, and depreciation.

  1. While buying a home is a significant investment, it isn’t a liquid investment. Therefore, the house can’t be quickly converted into cash and sold right away, unlike stocks or bonds. In fact even once you have paid off your mortgage, your home is still taking money out of your pocket in the form of taxes and maintenance costs. So arguably, there is a liability component associated with owning your own home.

Arguments for renting

If you buy a house, most of your savings will be invested in the deposit and put aside for mortgage repayments. If you rent instead, your savings could be invested elsewhere meaning that you may be able to earn a higher return on your savings than would be possible in property.

  1. You mitigate risk when the economy experiences a downturn. If your rental home loses value and you’re personally affected by an economic downturn, you can always attempt to ask for a rent reduction. This was deemed an acceptable request on average throughout the height of the pandemic in 2020.

However, if the home you own loses value, well, you can’t just ask a bank to reduce your mortgage, can you? The best you can do is ask for financial hardship assistance.

  1. When you buy a house, a significant proportion of your total wealth is packed up in one single investment which can be impacted by many factors outside of your control. So, most of your eggs are in one basket. Instead, renting diversifies this risk for you across a broader range of investments.
  2. A non-financial benefit of renting is, of course, flexibility. Your choice to rent or buy really depends on what kind of person you are and where you are at in life. If you’re a young adult who intends to move from country to country or you’re not quite sure where your job will take you, renting may be the best way to go.

Arguments against renting

  1. Put simply, rent is the cost of borrowing an asset, equivalent to the interest you would pay on a mortgage and will steadily increase over time due to inflation and the rise of property prices.

So, one could argue that while you may pay a mortgage on a house, at least the asset is yours, not a borrowed one. Whereas when you rent, that money is simply put aside for you to borrow the house.

  1. Renting doesn’t encourage savings. Rather than putting aside money for compulsory mortgage payments each month, it’s likely to be spent elsewhere. This is also known as the rent trap. Whereas a percentage of each mortgage payment on a house contributes towards the principal, which can be considered savings.
  2. While there are ongoing costs of owning a house, once the mortgage is eventually paid off, you’re free of those monthly payments to live. Plus, once you retire, your income may reduce, therefore you may be less likely to be able to afford monthly rent payments and periodic rent increases. So, there are certainly psychological benefits to rent-free living as you’re less exposed to volatility in house prices.

The bottom line

In summary, the bottom line is, sometimes it’s smarter to rent, and sometimes it’s smarter to buy. It can depend on the city and suburb you’re living in as well, if the rent is particularly low, it could be better to stick to renting.

It’s more helpful to assess your lifestyle circumstances, financial situation and learn the economic dynamics of the housing market discussed above, then do what’s right for you.

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