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Elon Musk has been in the news a lot recently. Tweeting that he thinks Tesla’s share price is too high, naming his newborn child X AE A-12, and reportedly wanting to sell all of his possessions including his real estate, so he can become a renter.
I’m a fan of Elon Musk, especially after reading his biography by Ashlee Vance. If you know anything about Elon, you know he’s really never done anything in a conventional way. And if he did, I’m guessing Elon Musk’s name wouldn’t be known around the world. He does weird things, but also brilliant things, that’s part of what makes him who he is.
When I heard about all of the news mentioned above, my initial reaction was the same as most people: why?. Why would he devalue his own company? Why would he name his newborn that? Why would he want to be gone of all his possessions? The answer to all of the above is I really don’t know. But it re-sparked a debate that I think happens more now than ever, is it better to buy or rent?
After graduating college I had an apartment for a year and a half and then bought a house. It’s a story similar to most people I bet. Go to school, get a job, move out, start the rest of your life. Living on your own for the first time is great. You learn a lot about the real world. But one thing that always bothered me about renting, was the idea of throwing my money away.
When you rent an apartment, you pay your landlord rent and you never see that money again. When you buy a house, your downpayment and a portion of your mortgage payments go to the principal, and the rest of the payments go towards the interest. As you pay down the principal you build equity in your house (value of the property – mortgage balance = equity in property). The equity you build can provide you a lot of flexibility in the future. You could borrow against it, you could consolidate high interest debts into your mortgage, or other things that could be difficult to do without having collateral.
Buying a house has more upfront costs than renting, most notably the downpayment. You should also have saved up an emergency fund or have access to money in case of an emergency (like a line of credit, or credit card). Saving up for a downpayment can seem like a huge obstacle, but it’s amazing what you can do one step at a time. Saving a little over time really adds up. Especially if you can take advantage of the Home Buyers Plan and use an RRSP to save your money (you’ll get a huge tax refund when you contribute to an RRSP).
Looking at the month to month cost, buying a house and renting are fairly similar. Here in Winnipeg, the average rent in the city for a two-bedroom apartment is $1,223/month. The average home price in Winnipeg is about $275,000 — if you put 20% down, with a 25-year amortization at 3.00%, you’d pay about $1,040/month (mortgage payment calculator). It doesn’t specify if the rent includes all utilities, so we will assume just like in real life, it doesn’t. Let’s say that after you include all bills that would go with each (gas, electricity, water, parking) and bills that are specific to owning a house (property taxes, house insurance), owning a house is $200/month more expensive than renting (even though the house is likely to be bigger, have more bedrooms, and a yard, etc.).
If you invested the difference between renting and owning of $200/month for 40 years (age 25 to 65) at an average of 6% rate of return, you’ll end up with about $398,000. Whereas, if you paid off your mortgage in the 25 years, then invested the $1,040 you would have been paying for the remaining 15 years at 6%, you’ll end up with about $231,500. This idea of investing the difference also relies 100% on you actually sticking to the plan. Paying off your mortgage is a forced investment in a sense because instead of paying your rent and also putting money towards your investments, a mortgage payment is both. It pays your obligation to stay in your house while investing in your property.
Each year, landlords can increase rent. Whereas each year properties increase in value, but once you buy a property you don’t pay that increase in value, you’re rewarded it. If we assume rent will increase on average about 2%/year, by the time you turn 65 you’re rent would have increased from $1,223 to $2,647/month (let’s check this again in the year 2060 and see how accurate it is). Your $275,000 house, on the other hand, would have increased to a value of $595,000 at a 2% inflation rate (and your mortgage payments would not be based on inflation but on your mortgage rate). So instead of renting and having $398,000 saved up, by owning a house, you would have $231,500 and a property worth $595,000, 40 years from now.
Also, if you rented over that 40 years you will pay a total of $886,500 or an average of $1,847/month, and you’ll see none of that returned to you. Over the life of the mortgage, including your downpayment, you would have paid a total of $367,000 (of principal and interest), and would have a new property value of about $595,000. You would have to spend almost an extra $13,000/year on your house, every year for 40 years, to spend as much as the equivalent of renting. Wow.
On top of the ‘working years’, owners don’t have to worry about the typical biggest expense in retirement. Imagine your life today (well maybe assuming everything was normal again), your job, full-time salary, lifestyle, and bills. Now imagine what your bank account would look like if you didn’t have to pay for your rent or mortgage. You’d be pretty comfortable right?
If our average rent at age 65 is $2,647/month and we still assume rent will increase by 2%/year, at age 85 rent will be about $3,934/month, meaning a total of $787,400 for rent over that 20 year period. Paying almost $4,000/month for rent does seem high, but looking at historical records, only 20 years ago, in the year 2000, the average rent for a 2 bedroom apartment in Winnipeg was $591/month (source here), so in the last 20 years rent has doubled (an average increase of over 3.5%/year). So in the next 60 years, you can bet $4,000/month will look pretty accurate.
Bringing the life long rent total to $1,673,900 for rent, $1,306,900 more than the cost of paying off the mortgage on the original $275,000 house. Meaning that you would have to spend an extra $22,000/year, every year for 60 years, on your house to pay the equivalent of renting. After 60 years, your $275,000 house would now be worth just $885,000 if we continue our assumption of an increase in the value of 2%/year, and if you continued to invest your $1,040/month at 6% you’d have accumulated almost $1,482,000. Again, wow.
No matter what stage of life people are in, their biggest monthly payment goes towards their living arrangements. If you were able to retire without having to: pay rent, or pay your mortgage, you’d need a lot less to retire, or you’d have a lot more fun money. Retirement can seem like an impossibility, it’s like a house downpayment x50. But if you can eliminate your debts and obligations in retirement, you’re a lot better off.
And if in retirement you decide you want to move to a senior home, instead of having to fork over most of your savings, you can sell your house and be very well set. I really believe that owning a house can give you a lot of options down the road to meet the lifestyle you envision for yourself.
Owning isn’t always the best option. If you envision yourself moving every couple of years, then owning won’t be cost-effective for you. Real estate transactions are a big deal, so a lot of people are involved to make sure things go smoothly, and that costs money.
Another thing to consider is the stability you can provide for yourself, and your family. As much as you may love a place you’re renting, it doesn’t always work out that you’ll be there forever. Things happen and situations change that might mean you have to move out or change things up. When you own a home, you can do what you like, it’s yours. The only way you move is if you decide to, or you stop paying your bills and the bank kicks you out.
Buying or renting comes down to a lot of different factors, from cost to lifestyle. I think owning a house can provide you with financial benefits, as well as lifestyle benefits. Owning a house can help you build your wealth, and provide you with the cheapest living situation when spending money wisely matters more than ever: retirement. It can be a source of stability and certainty in an ever-changing world.
Saving up a downpayment can be a challenge, and it might mean getting a roommate, a cheaper place to live, saving more, or making more. But the alternative to saving up a $20,000 downpayment could be paying hundreds of thousands or millions of dollars in rent. Remember, we looked at averages in this article, and used conservative rates of inflation when compared to the recent history of rent increases in Winnipeg. The savings, or your own experience, could be even more significant than the numbers we looked at today. That’s why it’s always best to consult a professional on your own, unique situation.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.