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I know this differs from country to country, from person to person (depending on how much you already have saved), but I'm curious about the simplest example.

Let's say I have little to no money.

I can:
- get a loan and buy a house, or
- I can live for the rest of my life in rent and save the extra money (investing and stuff).

Which is generally the better option (financially)?

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6 Answers 6

up vote 27 down vote accepted

The general answer is: "it depends on how long you want to live there".

Here is a good calculator to figure it out: http://www.nytimes.com/interactive/business/buy-rent-calculator.html

Basically, if you plan to move in a few years, then renting makes more sense. It is a lot easier to move from an apartment when your lease is up versus selling a house, which can be subject to fluctuations in the real-estate market. As an example, during the real estate bubble, a lot of "young professional" types bought condos and town homes instead of renting. Now these people are married with kids, need to move somewhere bigger, but they can't get rid of their old place because they can't sell it for what they still owe. If these people had rented for a few years, they would be in a better position financially. (Many people fell for the mantra "If you are renting, you are throwing your money away", without looking at the long-term implications.)

However, your question is a little unique, because you mentioned renting for the rest of your life, and putting the savings into an investment, which is a cool idea. (Thinking outside the box, I like it.)

I'm going to assume you mean "rent the same place for many years" versus "moving around the country every few years". If you are staying in one place for a long time, I am going to say that buying a house is probably a better option. Here's why:

  • With a mortgage, at some point you stop sending a check every month. With rent, the payments never stop.
  • At the end of the mortgage, you have an asset that is worth a lot of money (your house). You can sell it and travel the world, give it to your kids, etc. (EDIT: With the rent+invest approach, you would have your investment portfolio as a sizable asset. It is open to discussion which one would come out ahead.)
  • With a mortgage, your payments are a fixed amount (unless you have an ARM). Inflation drives prices up over time, but your mortgage payment stays the same. In fact, inflation helps the homeowner by making the last mortgage payment "cheaper" than the first one. Rent prices tend to keep pace with inflation. Your landlord will probably increase the rent periodically.
  • There are tax advantages to buying a house (in the US anyway). Your mortgage interest is a tax deduction. There are also tax credits for certain home improvements (e.g. installing an energy efficient A/C). You can't take advantage of these when you rent.
  • Over the long term, home prices do go up (population is increasing, but there is a finite amount of land). I am not saying the house is a good "investment", but its value normally won't evaporate over 30 years like some other assets would. In terms of inflation-adjusted dollars, your house should maintain similar "value" over the years, as long as you stay on top of the upkeep (and your neighborhood doesn't become run-down).
  • With a mortgage, you are paying interest to a bank, which some would consider to be a "black hole" just like rent. However, you can reduce the money you pay in interest by making extra mortgage payments. Making 1-2 extra payments at the start of your mortgage can save a huge sum of money over the life of the loan.

So what about investing? Let's look at some numbers:

  • Investing in the Dow Jones Industrial Average would give you ~9% per year, with a lot of volatility (source).
  • Mortgage rates are hovering at about 5% right now. (source)
  • Seems like a good idea to invest, instead of taking out a mortgage, right?
  • Now, add in an inflation rate of ~3% (source)
  • Inflation erodes the effective stock market return, but it helps your mortgage payment by effectively making it cost less over time.
  • Next think about taxes.
  • That 9% stock market return is taxable income (which eats into your effective return), whereas the mortgage interest is a tax deduction.
  • Inflation and taxes pretty much negate higher rate of return for the stock investment.
  • Additionally, you have the inflationary impacts of a rent payment that increases over time.

So, based on the above, I say that buying a house is the way to go (as long as you plan to live in the same place for several years). However, if you could find a better investment than the Dow, or if mortgage interest rates change drastically, things could tip in another direction.

Addendum: CrimsonX brought up a good point about the costs of owning a house (upkeep and property taxes), which I didn't mention above. However, I don't think they change my answer. If you rent, you are still paying those costs. They are just hidden from you. Your landlord pays the contractor or the tax man, and then you pay the landlord as part of your rent.

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+1 Great answer. –  JohnFx Jun 17 '10 at 14:36
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On average the return on investment in a house is about the same as treasury bills( e.g. 3-5%). So its not a great investment, esp with property taxes, house maintenance/upkeep, and the inflexibility of not being able to move. Your situation may highly vary, and depending on the location of your house and when you decide to sell your "investment" may be well worth it. All things being equal, assuming you're looking for a high return and Want to live in an apartment, invest heavily in index funds and rent. (BTW I own a house, but its because I want to live in a house) –  CrimsonX Jun 17 '10 at 14:41
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mortgage interest (as such) is not a tax deduction in Canada –  Tim Jun 17 '10 at 15:43
    
@CrimsonX I specifically refrained from calling the house an investment, or treating it as such. However, at the end of the mortgage, you are left with an asset that has considerable value (>$100K), but it's not really a "growth". Good point about the property taxes though. I think I need to edit my answer slightly... –  msemack Jun 17 '10 at 15:49
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@msemack: With the mortgage, the interest portion is as much a black hole as rent money would be. Money flushed down the interest rate toilet is just as flushed away as money down the rent toilet. So, I think comparing the net equity built up in each case is apropos and may be similar as @Dan indicated. –  Chris W. Rea Jun 18 '10 at 17:32

Forget, for the moment, which will pay off most over the long term. Consider risk exposure.

You've said that you (hypothetically) have "little or no money": that's the deal-breaker. From a risk-management perspective, your investment portfolio would be better off diversified than with 90% of your assets in a house.

Consider also the nature of the risk which owning a house exposes you to: Housing prices are generally tied to the state of the economy. If the local economy crashes, not only could you lose your job, but you could lose a good part of the value of your house... and still owe a lot on your loan. (You also might not be able to move as easily if you found a new job somewhere else.)

You should almost certainly rent until you're more financially stable and could afford to pay the new mortgage for a year (or more) if you suddenly lost your job. Then you can worry more about maximizing your investments' rate of return.

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+1 for bringing up the importance of a safety net. You should always have some kind of rainy day fund (at least a few months worth of expenses) in place before you start thinking about investing. –  msemack Jun 21 '10 at 20:26
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And... even beyond the basic safety net, you probably would think twice before placing half your net worth in, say, the "iShares Dow Jones U.S. Real Estate Index Fund", right? Buying a house is a lot like that... only even more so. –  fennec Jun 22 '10 at 0:13

There's probably no simple answer, but it's fair to say there are bad times to buy, and better times. If you look at a house and see the rent is more than the mortgage payment, it may be time to consider buying. Right now, the market is depressed, if you buy and plan to stay put, not caring if it drops from here because you plan to be there for the long term, you may find a great deal to be had. Over the long term, housing matches inflation. Sounds crazy, but. Even into the bubble, if you looked at housing in terms of mortgage payment at the prevailing 30yr fixed rate and converted the payment to hours needed to work to make the payment, the 2005 bubble never was. Not at the median, anyway. At today's <5% rate, the mortgage will cost you 3.75% after taxes. And assuming a 3% long term inflation rate, less than 1%. You have expenses, to be sure, property tax, maintenance, etc, but if you fix the mortgage, inflation will eat away at it, and ultimately it's over. At retirement, I'll take a paid for house over rising rents any day.

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An important factor you failed to mention is the costs associated with owning a home. For example, every 10 / 15 years, you have to replace your AC unit ($5k) and what about replacing a roof (depends on size, but could be $10k)? Not to mention, paying a couple thousand annually for property taxes. When renting, you never have to worry about any of these three.....

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If you rent, you still pay for home upkeep and repair. It is just hidden from you. Your landlord is trying to make a profit from the lease income. If your landlord is losing money on the home repairs, expect your rent to go up. –  msemack Jan 20 '12 at 15:38
    
@msemack In my experience, rent prices don't go up $5k - $15k a year suddenly because the landlord had to do some roof or AC repairs.. so the the fact that the costs are "hidden" from you means that a) the risk is reduced and b) the cost of renting is easier to predict. If the landlord decides to increase rent due to home repairs, you can move out. –  Steven T. Snyder Feb 15 '13 at 16:56

"Which is generally the better option (financially)?"

Invest. If you can return 7-8% (less than the historical return of the S&P 500) on your money over the course of 25 years this will outperform purchasing personal property. If you WANT to own a house for other reason apart from the financial benefits then buy a house. Will you earn 7-8% on your money, there is a pretty good chance this is no because investors are prone to act emotionally.

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You fail to take into account the rent with your answer. In today's market it is likely that your rent will be nearly equal to a mortgage plus escrow. So you say to invest, but you have no extra money from renting versus buying. So it doesn't matter if you get a 100% return, 100% of zero is still zero. You could argue that maintenance costs in owning are invested, which is true but really how much on average yearly is that going to save you, maybe $1000? It won't offset the equity buildup. Besides, how many people are going to be disciplined enough to invest versus spend. –  Dunk Jan 24 '12 at 22:37
    
I'm referring to markets I know such as Toronto. I would expect most major cities in the US are similar in that renting is cheaper than owning. Mortgage payment, Interest Payment, Insurance, Taxes, Maintenance Fees. The only cities I've encountered that it is cheaper to buy than rent are cities which are grossly undervalued because they are collapsing or are are full of transients - like many resource heavy areas. You are correct, most can't save which is why housing is often viewed as the holy grail of investing. –  Dan Jan 25 '12 at 3:35
    
:I think your advice is dated. It was certainly true during the bubble but not so much anymore. I just purchased a new house which is twice the size, in a better school district and neighborhood than my old house. I'm renting out the old house. The difference between my house payment + escrow is only around $250 per month. There are some great deals on houses to be had right now. Also, at some point your house payment will build up a nice chunk of equity, which will never happen when you rent. I agree with you that there are times when renting is better, but not now. Timing is everything. –  Dunk Jan 31 '12 at 21:17
    
I don't think my advice is dated, I said I was referring to markets I know; Toronto, Calgary, Vancouver etc. I speculated about the markets in big cities in America, which I should have avoided. Currently, in Calgary it is better to rent. I think we are going around in circles based on our geographic location and local market knowledge. May I ask which city you're basing your answer on? –  Dan Feb 4 '12 at 2:27

Property in general tends to go up in value. That's one advantage you won't get if you rent.

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Tell that to someone in California or Florida these days and you'd get Lynched. –  JohnFx Jun 17 '10 at 14:35
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You can invest your would-be down payment in something that tends to go up in value, too. –  fennec Jun 21 '10 at 19:43
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Owning property is a hedge against rising rents. If you want to settle down but worry that rents could go up and force you to move out of town (perhaps you're on a fixed income, in retirement or something), and you're okay with paying the current price and never expect to see that money again and don't mind if you lost 25% on paper, then home ownership is a great option. (It won't help much with other cost-of-living factors or rising property taxes, though.) –  fennec Jun 21 '10 at 23:56
    
MoneyCone probably means that population grows but landmass is fixed. And moreover, people tend to cluster in specific areas. The only way to provide the necessary supply is to convert low density housing into high density housing, e.g. developing condos. –  mehaase Sep 8 '11 at 16:47
    
@John:People buying in California/Florida during the bubble were morons. What in their mind told them that a house worth $75,000 in 2004, was now worth $300,000 in 2007? Also, note that the poster said in general, which typically wouldn't cover aberrations like the housing bubble. –  Dunk Jan 24 '12 at 22:43

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