Buying or renting a house ?
Tuesday, 04 December 2007 10:55

Most people prefer to own a house rather than renting it. Renting a house is more flexible when you need to move often. It can also save time since you do not need to bother about any maintenance issues. Buying a house has the advantage that you can invest in it. When you move the extra investments have increased the value of the house and you don't loose any money. Of course there are more financial differences between buying and renting. When you buy a house you have to pay interest on your mortgage, which is roughly the same as the rent, at least initially. Houses usually keep their value over the years. If the inflation is high the value of your house increases as well. So effectively you pay only the net interest, that is the actual interest minus the inflation, at least in the long run.

For any particular deal the decision whether to buy or to rent depends on the price of the house, interest rate, the costs for buying, the time for repaying the mortgage, the house maintenance costs and the rent you would need to pay otherwise. These parameters can be entered into the combined investment calculator. The calculator will be used to compute the total accumulated capital for both cases, buying and renting the house. So after executing the calculator twice you can compare the two totals and choose for the biggest amount.

Buying the house. First determine the horizon: for example 10 years. Suppose the house will be repaid in 20 yearly terms of \$ 29320 per year. Furthermore suppose the price is \$ 300000, the interest rate is 7%, the initial costs are 1%, the maintenance costs are 1% each year and the rent is \$ 1200 per month. The table below shows how these numbers can be entered into the calculator.

Field nameValueRemark
Number of years10Number of years in the computation
Inflation (%)3Expecting 3% inflation
Category in useCheck only category 1 and 2.Category 1 , category 2 is for the savings account and categorie 3 is for the value of the house.
Field nameValue category 1Value category 2Remark
Annual value increase (%)73On the mortgage you pay 7% interest and the value of the house you own increases with 3% per year.
Initial amount-300300You own a loan worth \$ -300,000 and a house that is initially worth \$ +300,000.
Yearly amount29.323Use the mortgage calculator with 20 periods of one year (equal to 21 years here) to compute the yearly amount for annuity loan. The maintenance costs are 3000 per year, increasing with the inflation.
Indexation yearly amount03Maintenance costs will increase with inflation.
Yearly costs (%)01Again the maintenance costs. Specify a yearly amount alone causes the value in the second category to increase. By specifying the same amount as a yearly cost the value stays the same.
Initial costs (\$)0.01*3000When buying the house the transaction costs are 1 % of the price of the house.

Renting the house. Again the time horizon is 10 years. The rent is \$ 1200 per month = \$ 14400 per year, increasing with inflation. This is less than the \$ 29320 plus \$ 3000 you would spend each year when you would have bought the house. The difference is about \$ 18600, which decreases roughly with inflation. This amount can be used to buy for instance equity with an average value increase of 8% per year. In addition you do not have to pay the initial costs of \$ 3000. The question is then, what is more after 10 years: the value of the brokerage account or the value of the house. In this case renting a house is better than buying a house, even after only two years. In the table below you will find the numbers to enter in the third (renting) category, with the first two categories unchecked.

Field nameValueRemark
Number of years10Number of years in the computation
Inflation (%)3Expecting 3% inflation
Category in useCheck only category 3.Category 3 is for the situation when you rent a house.
Field nameValue category 3Remark
Yield (%)88% is a conservative long term average return on equities.
Initial amount3If you rent a house you don't have initial costs on a mortgage.
Yearly amount29.32 +3Yearly mortgage term plus the maintenance costs.
Indexation yearly amount3/(29.32 +3)The mortgage terms are not subject to inflation but the maintenance costs are.
Yearly costs (\$)14.4The mortgage term are not subject to inflation but the maintenance costs are.
Indexation yearly costs (%)3The rent is expected to increase by 3% each year.

The combined investment calculator has a second example: portfolio of savings, equities and a house.