I’m at that stage in my life where I could possibly ‘afford’ a house. So naturally, I’m completely freaking out about what to do. Should I keep renting or should I buy?
Renting versus buying is a touchy subject. People are usually in one camp or the other, with a no man’s land between. For those that are buyers renting makes no sense to them in the long term. This is definitely the larger of the two camps.
For the renters it seems buying is an idiotic mistake, these people tend to live in cities where it makes sense to rent, or sometimes would like to be buyers but they just can’t afford it (the closet buyers if you will) or are German (god damn Germans, always doing weird things. Sauerkraut I’m looking at you).
In the spirit of the 80–20 Rule, I looked to figure out what is the simplest solution, the minimum I could do to get what I wanted. Below is what I discovered.
What do I want?
The first question is, of course, what do I want? Eh, didn’t think about it really. A house. Somewhere to live I suppose. But that’s too simplistic. I’ve asked all my friends who have or are looking to buy a house and they also seem to have not delved too deep into this question. When I ask them to have a good think about it, they will say things like ‘a home to put my own stamp on’, ‘somewhere close to good amenities (schools, shops, transport)’, ‘enough space for a potential family’ etc.
OK, that’s a good start. And we could delve even deeper into each of these points too (why do you need to put your own stamp on a place? It’s possible with renting right?) but it will be a digression.
There are pro’s and con’s for each side of the rent/buy coin but the misinformation out there on the subject is baffling. Positive research on owning a home is usually sponsored by a big mortgage lender. Hmm, seems a bit dodgy to me. Those that praise renting are no different, usually backed by the big rental websites. So the next option is word of mouth. But that is inherently biased too. Someone who rents may be anti-buying just because they don’t want to see others buy and ‘get ahead’. And only in rare cases will you hear negative feedback from someone who bought a home. This isn’t evidence for the argument of owning a house. This is known as positive reinforcement. The person you spoke to probably made the biggest financial decision of their lives. So their brain will produce every evidence and reasons for it being a good idea. It keeps the person sane.
With all this confusion I decided to come at it from a different angle, by asking myself what do I actually want (and I try and remove as much of the normal societal pressures as possible). So I created a few simple rules that my situation must meet before I make a decision on owning or renting a home:
- A house I buy will be somewhere I can live happily for the rest of my life if I must. This includes thinking about any future family needs.
- A home will not be used as an investment.
- Renting or buying must be ‘affordable’. I will not over-stretch myself financially.
I’ve known people that bought crappy flats, (seriously just a shoebox with a postcode) and then sell them on 2 years later for ~100k in profit. Others own 3 homes, rent them all out and make a good salary from that alone. But I’ve also witnessed many buy a home that was too expensive for them, fall into negative equity a year later, and are now stuck there. Others still made an 80k loss over 5 years on a home. The market is fickle. No matter where you live. If you think you can predict it, you’re wrong. Some of the examples above made amazing amounts of money, but those that do are either lucky, have money to play with, or are in the top 0.01% of talent in the industry…so not you.
You’ll hear stories from friends, family and others about how much better off they are now that they bought a house. Yes, you’ll hear a lot of good stories as I have. There is a reason for this. Same reason a gambler will only tell you when they’ve won big. Nobody likes to brag about losing their bollocks. It’s not transparent that there are just as many losers (if not more) as there are winners because nobody wants to tell this story.
All I can do, I realised, is play my own game. Don’t worry about others, or be struck by ‘the fear of missing out’, just know my priorities and execute on them.
So rule number one is that if I am buying it needs to be something and somewhere I’d be happy for the rest of my life. It probably won’t be my last home but it needs to have the potential to be. This way I can beat the market regardless, I don’t really care about the market in this case (providing I follow the next three rules as well).
The bonus with renting, of course, is that I can easily move as my family grows, or circumstances change.
Using a home as an investment is not a good idea. A good investment is liquid, fits with my risk appetite and is valued correctly (or lower than its potential worth).
A house is not a liquid asset. I cannot sell it tomorrow, it’s a long process.
A house is a risky affair, likely the biggest investment in terms of cash value I’ll ever make. And the majority of people would be risk averse like myself. But owning a house is not without massive risks. Real estate is great as a part of a diverse portfolio but in most people’s cases and my own it will not be a diverse portfolio, I’ll have something like 10k of stocks and then 500k of a house.
Finally, a lot of homes are valued incorrectly, you’re paying for a lot of unknowns; location, type of neighbours, transport, competition and the economic outlook as a whole. And so it’s difficult if not impossible to correctly value a house, more likely than not I’ll pay over the odds.
So I will not use a house as an investment. If I want to invest in real estate there are portfolios I can buy into, which do this in a much better way and can fit the bill of a good investment.
If I buy or rent, my rule is to not over-stretch myself. This is difficult to gauge of course but I like to plan for a worst-case scenario. So I think it’s good to rent (or buy) something which I can pay off comfortably (which is different for different people) even if I only had a single average wage coming into the household.
Let’s imagine a couple. Both getting paid 40k per year. My view is if one lost their job and couldn’t get another, and the other had to take a lower (closer to average) salary for some reason, then I should still be able to afford to live in the house. So imagine having a single 30k wage and then work out what I could afford. Obviously, this depends on a person’s risk appetite, and I maybe overly cautious but getting a mortgage that pushes you to your financial limit is a terrible idea. If you have to do that for the area you live in…well, then you can’t afford to live in that area.
Where Do I Stand?
Let me be clear, I’m in the no man’s land between renting and buying. I can see good arguments for both. But I’ll only decide on buying when my personal rules are met, and not be pressured into anything.
None of this is to put you off buying a house, it’s just to make sure you’re not buying a house for the wrong reasons.
The One Main Argument for Buying is bullsh*t
Anyone that has made it this far is probably tearing their hair out, shouting the overused phrase ‘but you’re throwing away money with rent!!’ I feel the biggest lie in this industry is that renting is throwing away money while paying a mortgage is not. Let’s jump into to some numbers to prove this isn’t really the case (so that you can make a good decision without this foggy topic clouding your judgement).
A caveat before we dig in. I’ve assumed with the below that someone isn’t going to give me a loan for a deposit (usually a parent). I’ve also assumed that monthly rent is cheaper than a mortgage (which is the case in most big cities). My example below is for the London market but could easily be applied to any other major city.
Renting over 15 years versus Buying with a mortgage over 15 years.
Let’s assume you want to purchase a home worth £400,000.
You need at least a 10% down payment or deposit which is £40,000.
So let’s say you get a mortgage of £360,000 for 20 years at a very reasonable 3% rate.
This means that you’ll have to pay a monthly mortgage of £2,000.
That’s £480,000 over 20 years.
Let’s also assume that miraculously your house makes 3% per year in value.
This means after 20 years you’ll have a house worth £722,000.
So after 20 years you’ll have a net worth of £722,000 — £480,000 =£242,000
Now let’s assume a similar house to rent is £1,200 per month.
That means that you pay £800 per month less than a mortgage.
Over 20 years you’ll have paid £288,000.
Assuming you’re a good investor you invest this difference in a pension, a simple index tracker fund (including the original deposit).
An average return rate of 6% means that after 20 years you’ll have an investment nest egg of £501,000.
So after 20 years you’ll have a net worth of £501,000 — £288,000 =£213,000
So not much in the difference, plus a lot of assumptions have been made. In fact if you even sold and bought another home once in your lifetime the difference would vanish (fee’s and costs with moving are large).
Inflation affects your investment less than your house so again that’s not even factored in.
Not to mention all the maintenance costs, taxes, fees etc. of owning your own home.
Of course, if this is your only home there will be none to very little tax when you sell it, but your investment would certainly incur a hefty tax if you take it all out at once, but there are ways to lessen this (annuities etc.).
So, in short, I think the minimum you can do is know what you really want and why you want it. Create your list of deal breaker rules. Once they are met you can crunch the numbers and figure out if you want to buy or rent. Both decisions are valid options.
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