Recently I’ve really enjoyed writing and coming up with stories for my book and the ‘Invisible Slime’ blogs. Whilst I enjoy writing, I also really love numbers (which is pretty much a requirement for an actuary like me). So this week I’ve had fun playing with numbers and an excel spreadsheet to help talk about the subject of Buying v Renting a home.
This is an important topic as a large part of all the money our kids will earn will go towards their home. Also, the bigger the home, the more wealthy you are, right?!
If you’ve read my blog 'How to teach your kids that your home is not an investment', you’ll know that last statement isn’t true.
For many of our kids, buying a home might not be possible until they are in their late twenties or even later, due to the increase in property prices in major cities. This may feel very disheartening both for your kids and for you as parents. In this blog, I want to show you that the key to future financial health isn’t all dependent on the ability to buy a house and that your kids can still be wealthy, even if they rent.
Before I go into some numbers, I feel it’s worth going through some of the non-financial benefits of buying v renting a home. My wife and I have personally owned and rented a home in recent years and see the benefits of both.
Non-financial reasons for buying vs renting a home
Buying a home:
There is joy from looking at your home and saying “I own this”
Ability to personalise your home, e.g., adding an extension, refitting the kitchen or knocking down a wall.
No fear of being asked to leave your home (as long as you keep up with the mortgage payments!)
Renting a home:
Provides freedom to move around both domestically and internationally. With younger adults switching jobs more often than ever, this could be a real benefit.
Don’t have to worry about maintenance as that’s the landlord’s job.
These factors can make a huge difference to the way someone feels about their home. I wanted to share these points as our kids’ views on buying vs renting may differ from our own despite the financial implications.
The Financial Considerations
To help consider the financial side of buying vs renting a home, it’s really important to think about the bigger picture in terms of long-term financial goals.
To help with this, I encourage you to think of money like seeds - our goal should be to plant (save / invest) some seeds to grow a financial forest. Having a forest which is growing and producing seeds (money), whilst you sleep, brings financial security and, once large enough, financial freedom.
This is an important starting point as neither buying or renting a home directly helps with growing a forest. This is obvious when thinking about renting as paying rent means you are giving seeds (money) away rather than planting them.
When buying your home, it isn’t producing an income (seeds). It actually costs you a lot of money each year (mortgage interest, taxes, maintenance). This means buying your home isn’t directly contributing towards your forest. There are some indirect ways in which it does help and I’ll come on to that later.
With the goal of growing a forest in mind, we can then consider the impact that buying vs renting your home has on your kids’ ability to grow their forest.
Setting the scene: “Living in a Tent Scenario”
To help illustrate the impact of buying or renting a home, let’s first imagine you can live somewhere rent and expense free, e.g. staying at home with parents or, living in a. tent.
In this scenario, all the money our grown-up kids don’t spend on general living, could be saved / invested towards growing their forest. All else being equal, this scenario should lead to the biggest forest they can grow.
This acts as a benchmark for comparing the decision about buying vs renting, i.e. how far away does buying or renting take them from this benchmark.
I’m actually going to refer to this benchmark as the ‘Living in a tent scenario’ for the remainder of this blog.
As I said at the start, I love numbers so I’ve come up with an example. Let assume we have someone, let’s call her Katy, who lives in a tent. She has £60,000 saved and each year will be able to save £14,000 (this increases each year as she earns more).
This is Katy’s expected forest over the next 30 years (assuming investments grow at 7% per year).
Before I go on to consider the impacts of buying and renting a home, I want to be clear that I’m not suggesting your kids live in a tent. The key is to make sure our kids grow up with a balanced mindset in terms of the home they want to live in and the forest they want to grow. In so many cases today, people are solely focused on their home and don’t consider their forest until they reach their 40’s and realise they might not have enough savings for retirement.
Impacts of buying and renting a home
Buying a home:
Owning a home comes with a lot of unrecoverable costs.
There are the obvious costs such as valuation and legal fees at the start, mortgage interest / renewal fees, taxes and maintenance. Each of these costs impact on your kids’ ability to grow their forest. The bigger the home, the bigger the costs, the bigger the impact.
There is also the unrecoverable cost of missing an opportunity. For example, any money used to pay to own the home (initial deposit and via capital repayment mortgage), is essentially savings which could be deployed in the stock market, i.e. used to grow their forest. History shows that the stock market, over the long-term, has a higher return than investing in property. Essentially, you are putting money in the property market rather than the stock market which impacts on how fast your forest can grow.
These unrecoverable costs will vary over time and based on the home you buy. However, it is reasonable to assume that in total the unrecoverable costs can be around 3%-5% of the home value per year (I’ve provided how I got to the 3%-5% at the end of the blog for those interested in numbers).
This means that when our kids think about buying a home, then they need to consider that 3%-5% of the value of their home is being subtracted away from the ‘Living in a Tent Scenario’ each year.
If we go back to our example. Let’s assume Katy doesn’t want to live in a tent (which is reasonable). She decides to buy a £300,000 apartment using her £60,000 to cover the deposit, taxes and legal fees. She takes out a repayment mortgage at 2% per year which means she’ll own the apartment in full after 30 years. The mortgage costs her £11,000 per year and she’s allowed for £3,000 per year for maintenance costs and taxes (which will grow over time).
This is how her forest is now growing compared to the ‘living in a Tent Scenario’.
We can see that the ongoing costs and the fact she’s got her money in property rather than the stock market, lead to a materially smaller forest over time compared to the ‘Living in a Tent Scenario’.
As mentioned in my previous blog on home ownership, even though Katy’s apartment might be worth £1,000,000 after 30 years, she’s not financially free as it’s not providing her with an income. To benefit from her forest, she needs to sell or rent her apartment and live somewhere cheaper. This is why we all shouldn’t rely too heavily on our homes when managing our money for the long-term. We need to have a good balance.
The bigger the home and the more times Katy moves home, the bigger the gap relative to her ‘Living in a Tent Scenario’. This is really important as a lot of people think of a bigger house as a sign of wealth. The above shows a bigger house is actually reducing the size of their potential forest (wealth). I love the cartoon below as it sums up why people move further away from their ‘Living in a Tent Scenario’ over time.
Now let’s move on to renting a home.
Renting a home:
In terms of unrecoverable costs of renting, this is pretty simple. The unrecoverable costs are just the amount you pay in rent. The more your kids pay in rent, the more they move away from their ‘Living in a Tent Scenario’.
Let’s go back to our example. Katy decides to rent rather than buy the £300,000 apartment. She invests the £60,000 she had saved into the stock market and invests the money that isn’t spent on rent and general living. The rent at the start is £750 per month (£9,000 per year) which is about 3% of the home value. However, in 30 years’ time that apartment could be worth £1,000,000 (assuming 4% per year increase in property prices), so the landlord could be asking Katy for £1,800 per month (£22,000 per year) at that time.
Over the long term, renting is expected to become more expensive than buying a home, assuming they want to stay in a similar home over time. This is due to the rents they have to pay going up over time as house prices increase.
Whilst the chart above shows that buying a home leads to a bigger potential forest than renting, your kids can still grow a good-sized forest whilst renting. Just because they don’t own a home, doesn’t mean they can’t become wealthy. The key is to make sure your kids are growing their forest (investing) whilst they are renting. This might be tough at the start, however, as their earnings increase the key is to make sure they start investing rather than moving to a higher rent home.
Also, there are plenty of scenarios where renting a home could lead to a bigger forest than buying a home. For example:
The stock market goes up by a lot relative to house prices
Mortgage interest rates go up
Rents don’t increase by as much as house prices over time
We should make sure our kids don’t have the mindset of ‘owning a big house is a sign of wealth’. This can be disheartening in a world where home ownership is becoming tougher.
The focus should be ‘How can I grow my forest without having to live in a tent?’. As with most money-related topics, the key is to get a good balance. In this case, finding the right balance between finding a home you love and saving for the long-term.
Apologies if this blog leads to your kids living in a tent in your garden until they are old enough to retire 😄
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Repeat of links used within the blog:
How to teach your kids that your home is not an investment (the owl and the tree competition story)
* Assumptions for my 3-5% per year unrecoverable costs of buying a home
Assumes long-term mortgage interest rates are 2-4% per year, i.e. cost for part of the home your kids don’t own.
Assumes the difference between the return on the stock market and the increase in house prices is around 2-4% per year, i.e. the opportunity cost of the part of the home they do own.
Assumes tax plus maintenance costs combined are around 1% per year (based on my own experience and what I’ve seen other commentators use).
[I've used a lot of assumptions in this blog - these are for illustration only]