Buying versus renting your home
By Raymond Letendre, CPA, CGA, CFP® 22 February 2022 7 min read
Buying a home is a common goal among many individuals and families alike. Owning a home can provide many benefits, including pride of ownership, but there can also be ongoing financial responsibilities beyond what a renter would be responsible for. Given the added expenses often associated with home ownership, are you better off renting your home instead? Or is buying a home the better financial decision to increase wealth over the long term?
In our article mortgage financing and financial planning, we explain how your finances are connected, and how financial management can affect your overall long-term wealth. Although not all planning decisions are based solely on numbers, with a few assumptions, we can examine the potential financial results of the two options to identify how each contributes to building your net worth over time.
Some people think paying rent is a waste of money because it does not go towards acquiring an asset, or building equity as with the case of buying a home. Indeed, rent payments have no direct value after the rental term ends, but you are receiving the benefit of having a home to live in, so it isn’t necessarily a waste of money. Further, when considering the fact that renting may not have the same financial obligations as owning a home, it might be possible to contribute more towards separate savings compared to someone who buys their home. This represents an opportunity cost to a homeowner that, all else equal, may incur more expenses with home ownership and does not have these same funds available for investment.
To properly assess the two choices on a financial basis, we’ll compare the costs of each. Consider the following cases of Beth who buys her home, and Rick who rents.
Beth and Rick, a case study
Let’s begin our analysis with the assumption that both Beth and Rick are looking at similar homes. Beth will buy her home and Rick will rent his. They each have the same amount of $52,500 in current savings, and we will evaluate the results over 25 years, the period it takes Beth to pay off her mortgage.
To buy her home, Beth can make a down payment equal to 10 per cent of the purchase price. This will reduce the amount she has to borrow but she will also require mortgage insurance, which will be added to the mortgage amount to be financed.
|House purchase price||$500,000|
|10 per cent down payment||($50,000)|
|CMHC mortgage loan insurance1||$13,950|
|Amount to be financed||$463,950|
|Mortgage rate||3 per cent|
|Mortgage payment (monthly)||$2,195.62|
We assume that the mortgage rate and payment remain constant over the period. Although, as we discuss in our mortgage renewal article, the mortgage interest rate and payment may vary over the life of the mortgage.
When Beth buys her home she is required to provide her $50,000 down payment, and will face additional upfront costs for legal fees, assumed at $1,500 and another $500 each for appraisal and inspection fees, for a total of $2,500 in addition to her down payment. She uses all of her savings to buy the home and pay the upfront costs but she now has her house worth $500,000 along with a mortgage liability for $463,950. Her net worth is now $36,050 (assuming no other assets or liabilities).
Rick also has $52,500 in savings but, as a renter, he doesn’t face the same initial expenses as Beth. He finds a house to rent for $2,000/month. Rick is not required to spend any of his current savings but he now has an ongoing obligation for the rent payment. This is a key quantitative element of the comparison because if Rick simply spends his current savings or the additional cash flow, the difference in his long-term net worth will be far less than Beth. Likewise, it’s also a key qualitative factor because their desired lifestyles should be considered in order to determine the best decision for each of them from a non-financial perspective.
Ongoing cash flows
Both Beth and Rick will have certain ongoing costs that need to be considered for comparison. The impact of inflation should also be considered where appropriate. Although difficult to predict, the inflation-control target adopted by the Bank of Canada aims to keep total CPI inflation at a two per cent midpoint of a target range of one to three per cent2. Using two per cent as an inflation estimate should be applied as an annual increase to ongoing costs for home repairs, improvement and maintenance. Mortgage payments for Beth would not increase with inflation. Additional costs may vary but we will make the basic assumption that Beth incurs the following:
|Item||Monthly cost estimate|
|Maintenance costs estimate (one per cent of home value)||$417 per month|
|Property taxes estimate (one per cent of home value)3||$417 per month|
|Homeowner insurance estimate||$125 per month|
|Total monthly obligation||$3,154.62|
As a renter, Rick would not be responsible for ongoing costs such as major repairs, maintenance, or property taxes. Homeowner insurance is also typically more expensive than renter’s insurance because it covers more property, while renter’s insurance is usually limited to personal property and liability of the tenant that is not the responsibility of the landlord. As such, Rick’s additional cost might include renter’s insurance for $50 per month, bringing his total monthly obligations to $2,050.
We assume that utility costs are equal for a similar property. Under these assumptions, Beth’s monthly obligations exceed Rick’s by approximately $1,100 per month. In order to be a fair comparison, Rick’s cash flows should be equal to Beth so we will assume that he invests the $1,100 difference each month into a long-term investment portfolio. For comparative purposes we assume that their comparable cash outflows over time remain consistent. Should their expenses change over time, cash flows may deviate if Rick maintains his investment savings at $1,100 per month.
Comparing the results
How do Beth and Rick compare based on these assumptions? Was renting a waste of money for Rick? Or did he fare better by investing the difference in a portfolio with a rate of return that might be expected to exceed the assumed growth on real estate? Let’s take a look at the results.
At the end of 25 years, Beth will have paid off her mortgage and will own the appreciated value of her home. There are various schools of thought on what the rate of appreciation will be for real estate over the next 25 years in Alberta. A very general rule of thumb is that real estate growth can be expected to keep pace with inflation over the long term. For purposes of our analysis, we will assume real estate grows at 2.5 per cent, or 50 basis points above our inflation assumption.
Assuming Rick was diligent in saving the difference, he will have accumulated savings along with the applicable growth on his savings. For comparative purposes, we assume he saves in a non-registered investment account with a balanced portfolio generating a six per cent rate of return compounded annually. In a balanced portfolio, his investment returns will consist of interest, dividends, and realized gains that will be taxable each year, plus deferred gains that will be taxed on final sale. The investment account is also assumed to charge a one per cent annual fee.
|In 25 years||Beth||Rick|
|Taxes on disposition||$0.00||$26,588|
|Realty/legal fees estimate5||$36,000||$0.00|
|Net future value||$890,972||$800,776|
Transaction and tax costs must also be considered in order to compare the net value of the two alternatives. Beth’s house is not subject to tax as her principal residence. Rick has paid tax on the annual investment distributions each year, and tax on the deferred growth upon selling his portfolio.
As the numbers suggest, the net future value of Beth’s home could exceed the net future value of Rick’s investment portfolio based on the assumptions used. Does this mean that buying a home is the definitive choice for building wealth? Not necessarily. Buying a home often requires a larger dedication and commitment than renting, and, generally speaking, buying a house should be considered when you have stable income, cash flow, and want to build equity through real estate. If you are ready to buy, ATB offers guidance for buying a home in Alberta.
One of the benefits of renting for Rick is that he enjoys access to liquidity in his equity. If Beth required access to the equity she has built over time, she would be required to sell her home, or secure additional financing through mortgage refinancing, reverse mortgage, or a home equity line of credit. These can all be viable options, although less readily available than Rick’s access to his investment account.
Naturally, the financial results depend largely on the assumptions, and even slight changes in a few variables can have a significant impact on the results. A significant financial benefit to Beth is the absence of taxation on the increase in value of her principal residence. In our example we assume that Rick invests in a taxable account, but if he were to invest a portion of the savings in a tax-sheltered account such as a TFSA or RRSP, the tax savings could also be significant.
As with all financial planning considerations, the qualitative variables are equally important as the quantitative. The correct approach is to consider your personal goals and values alongside your financial situation in order to determine what’s best for your situation. Buying a home requires commitment, just as regular investing and investment returns6 will depend on a strategy that aligns with your goals and objectives. While only you can determine goals that are important to you, speaking with your advisor can help evaluate the financial variables for good decision-making.
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Canada Mortgage and Housing Corporation mortgage loan insurance costs
Bank of Cananda inflation control target https://www.bankofcanada.ca/rates/indicators/key-variables/inflation-control-target
The Mill rate in Alberta is the amount of tax payable per dollar of the assessed value of a property. Mill rates are set by each taxing authority so as to meet the revenue projections in their budgets.
Assumes a marginal tax rate of 30.50 per cent
Based on estimated realty fees of 7 per cent on the first $100,000 plus 3 per cent on the remainder, plus legal fees of $2,500, plus GST on these fees.
Investment returns can vary, and will further depend on the timeframe and criteria used. FP Canada Projection Assumption Guidelines provide guidance for making realistic long-term financial projections which our analysis is based on.
This document has been prepared by ATB Wealth. ATB Investment Management Inc., ATB Securities Inc. (Member Investment Industry Regulatory Organization of Canada and Canadian Investor Protection Fund) and ATB Insurance Advisors Inc. are wholly owned subsidiaries of ATB Financial and operate under the trade name ATB Wealth. The information provided in this article is a simplified general summary and is not intended to replace or serve as a substitute for professional advice. Professional tax advice should always be obtained when dealing with taxation issues as each individual’s situation is different. This information has been obtained from sources believed to be reliable but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. This information is subject to change and ATB Securities Inc., ATB Investment Management Inc. and ATB Insurance Advisors Inc. reserves the right to change the information without prior notice, and does not undertake to provide updated information should a change occur. ATB Financial, ATB Investment Management Inc., ATB Securities Inc. and ATB Insurance Advisors Inc. do not accept any liability whatsoever for any losses arising from the use of this document or its contents.