There is no definitive answer to whether renting or buying a house is better. The answer depends on your own personal situation - your finances, lifestyle, and personal goals. You need to weigh up the pros and cons of each based on your income, savings, and how you live.
With rising house prices and rents, choosing between buying and renting can be a challenge - both have advantages and disadvantages. In this post, we look at:
• The pros and cons of renting v buying a home.
• The monthly ongoing costs of a home.
• The one-off costs of buying a home.
• Assessing the rent v buy financial decision.
• The UK housing market.
Renting a Home: Pros and Cons
Flexibility: If you change jobs or want to try living in a different area, it is easy to move quickly. If you lose your job, you can give your landlord notice, walk away and rent something smaller, or move in with family or friends temporarily.
Maintenance is not your responsibility. You don’t need to pay for repairs and renovations.
You don’t lose money if property prices go down.
You need a smaller deposit and rental payments rarely change, making it easier to budget.
You might be able to afford to live in a bigger home and nicer area than if you were buying.
Insecurity: If your landlord decides to sell or get new tenants, you have to move out.
You are paying the landlord’s mortgage rather than your own. You don’t benefit from any increases in property values.
Your rent can go up on the whim of your landlord.
You have to abide by the tenancy rules: restrictions on things such as owning pets or modifying the property.
You have to pay a deposit, and the landlord may keep some or all of it.
Buying a Home: Pros and Cons
Security: You can’t be made to move out at short notice by a landlord.
You can decorate and furnish your home exactly to your taste; make structural modifications to enhance its value, and you don’t need anyone’s permission to have pets.
It is an investment in your future. You are paying towards something that is yours, and property values are likely to go up in the long term.
With a fixed-rate mortgage (What is good debt), you can control your costs and fully own the home at the end of the mortgage term - typically 25 years.
Less flexibility: Selling up and moving is more expensive when you own a home than when you are renting. If you are living with someone and split up, deciding what to do with the property can be complicated and costly.
You need a larger deposit: a minimum 5% deposit on a £200,000 home is £10,000.
Interest rate rises can increase your monthly payments – although you can get a fixed-rate mortgage to help budget.
If you fall too far behind on your mortgage, you could have your home repossessed.
Buying a home will initially be more expensive than renting, as there are upfront costs.
Additional costs; you will need insurance to cover buildings as well as contents, term life insurance to protect your mortgage, and also cover any maintenance costs.
The property market can go down and you might end up with ‘negative equity’ where your home is worth less than your mortgage.
Monthly Ongoing Costs of Renting and Buying
Whether you are renting or buying a home, there are monthly ongoing costs you have to pay. These include:
• Rent or mortgage.
• Council tax - the cost depends on your local authority and the property banding.
• Utility bills – gas and electricity bills, and water rates.
• Entertainment - internet connection and TV license.
• Insurance – as a renter, the landlord will have buildings insurance, but you need contents insurance to protect your belongings. As an owner, you will need both - as well as mortgage life insurance.
• Service charges - these apply if you live in a home with communal areas.
• Maintenance costs – as a renter, your landlord covers these.
One-Off Costs of Buying a Home
The biggest cost of buying a home is the mortgage deposit. It is unlikely that you will be able to buy a home without at least a 5% deposit which is £10,000 on a £200,000 home (We have discussed using a LISA to help save towards this in an earlier post).
The majority of mortgages come with up-front fees and these usually range from £1-2,000. Some deals are available fee-free, but these often carry higher interest rates. If you choose a mortgage that carries a fee but you can't afford to pay it upfront, you can usually add it to your loan. This will end up costing you more in the long run as you will have to pay interest on it.
Other costs include:
• Legal fees: £1,260
• House survey: £450
• Removals: £372
• Estate agent fees: £0 first-time buyer. Moving home - £4,000 (2% of sale price)
• Energy performance certificate: £0 first-time buyer. Moving home - £55
(Source: Comparison website Reallymoving)
• Stamp Duty (England or Northern Ireland) is tiered at different rates on different portions of the property price. For first-time buyers, homes priced up to £425,000 carry no stamp duty. Homes priced between £425,000 and £625,000 carry no stamp duty on the first £425,000, and 5% on the amount over £425,000. Home mover stamp duty rates on each proportion of the property:
£0 - £250,000: 0%
£250,001 - £925,000: 5%
£925,001 - £1.5m: 10%
Over £1.5m: 12%
(Figures correct at 1/10/2022)
Assessing the Rent v Buy Financial Decision
Rent as a proportion of take-home income has been pretty stable over the last 10 years at around 45% of income, but we are now starting to see an increase in rent due to a surge in demand following the pandemic.
The same is true of mortgage rates which have increased significantly in the last 6 months. The average rates on a two-year fix mortgage have nearly doubled from 2.24% a year ago to 4.24% now (September 2022); this means that the monthly payment on a £190,000 repayment mortgage has gone from £830 to £1,030.
It’s often assumed that if you can purchase a home with a mortgage payment that is equal to or less than what you would pay in rent, then home ownership is the way to go. Unfortunately, this is a flawed way to think about it; in order to properly assess the rent versus buy decision, you need to compare the total unrecoverable costs of renting to the total unrecoverable costs of owning. That may sound complicated, but the 5% Rule of thumb can help. Ben Felix of PWLCapital.com based in Canada came up with the 5% rule to compare the cost of renting with the cost of buying to decide on whether to rent or buy.
Unrecoverable costs are any costs you pay with no associated residual value (money spent, never to be seen again, in exchange for having a place to live). Determining the total unrecoverable costs of renting is very easy: It’s the amount you are paying in rent.
For a homeowner, the unrecoverable costs of ownership are:
• One-off costs of buying (which we listed above).
• Maintenance costs.
• Costs of finance (That is the cost of mortgage interest and the opportunity costs of the mortgage deposit payment i.e. what return you would have gained if you had invested).
Instead of inaccurately comparing mortgage to rent, we need to compare these three costs to the rent. Generally, they tally up to 5%. If you can find a property to rent that costs less than 5% of the value of the house, then you will be better off renting – excluding all the psychological pros and cons of renting versus buying.
Let’s say you are considering whether to buy a £200,000 house.
Multiplying the value of the home by 5% = £10,000.
Dividing that number by 12 = £833.
£833 is the monthly breakeven point for owning that home.
If you could rent an equivalent home for less than £833, you are better off renting.
If it would cost you more than £833 to rent a comparable home, you are better off buying.
The 5% rule is an oversimplification and will not provide the exact costs. However, adopting this framework forces you to consider all the costs, including the opportunity cost of owning a home. The 5% rule will provide an obvious outcome in overpriced real estate markets i.e. you are better off renting than buying. A more complex rent v buy calculator can be found at smartmoneytools.co.uk
In summary, buying requires a bigger upfront cost, but renting is more expensive in the long term. A good rule of thumb is that buying a property becomes better value after around 10 years, compared to renting an identical property.
Nick Green, Financial Journalist (Unbiased.co.uk)
The UK Housing Market
The average UK house price increased to £292,000 in July 2022 which would suggest a big return from owning property – but, real house prices taking inflation into account have only grown at a real 2.5% per annum. In comparison, over the last 35 years, the FTSE 100 has provided a real return of 5% per annum.
The UK is now entering a period of increasing interest rates. In 2019, The Bank of England produced a white paper that suggested all of the house price growth between 1985 and 2018 can be accounted for by the decline in interest rates over that period. They go on to state that their model predicts a 1% sustained increase in interest rates could lead to a fall in real house prices of just under 20%.
In January 2020, UK interest rates stood at 0.25%. On 22nd September 2022, they stand at 2.25%. Will these rates be sustained….?