Housing is a huge part of any Financial Independence, Retire Early strategy. That’s why if you’re retiring early, you need to account for your mortgage or rental payments to ensure a comfortable retirement.
Previously, we explored how important housing is to FIRE . This time, we really get into the weeds with the numbers to figure out if it makes more financial sense to buy a home or rent. We are looking at factors we’re familiar with – the average mortgage rates, historical data on rental yields, the costs of moving, and more.
Just so you know, we are drawing on Hayden’s home-buying experience only to show that every person will come up with different calculations. So, consider the numbers as starting point for your research (or talking points with a financial/property adviser).
In the end, though, it’s our hope that this helps you make sense of your own numbers. Maybe you’ll also spot some opportunities or pitfalls you hadn't considered before.
The problem with Rent vs Buy calculations…
Before we go further, a long caveat: we reckon you’ll find that no two people will see eye-to-eye on any Buy vs Rent calculations out there.
When you see a spreadsheet full of calculations, what you’re really looking at is a series of logical assumptions. Folks doing the calculations try to make these guesses as logical as possible based on what they know right now. For instance: economic changes, typical life changes or historical market shifts. But, there’s no way to predict everything accurately.
It's like looking at a forecast for tomorrow’s weather. The forecast is based on a lot of complex data and models. Yet, the weather could turn out differently because there are so many unpredictable elements. It’s hard to imagine that the maths for Rent vs Buy decision could get more precise than that.
If anything, the numbers have a lot more to do with the narrative. Do they believe in the story in which owning a home pays off through increased property value and stability? Or do they buy into the story in which renting offers more flexibility and less financial risk if the market dips?
Basically, everyone will disagree on what numbers to use unless it aligns with their narrative. But, there will be no “correct” answer that applies for everyone, at any time, no matter how much we look at the spreadsheet. The factors to Buy vs Rent discussions will keep changing, and you’ll find that the answer entirely depends on which factors matter to you the most.
Interest rate changes
This is one of the many factors that are most important but hardest to predict. Everyone is piecing together clues from data, news and statements from central bankers. Yet, until the decision-makers make their announcement, nobody really knows if there’s going to be rate cut or increase. We simply don’t have all the up-to-the-second information to peg where the interest rates will be until the day we’re ready to buy (or decide to just rent).
Rental yields vs mortgage payments
Like Hayden mentioned, he was thinking about the mortgage versus rent costs. If interest rates go down, which they might (again, no one can tell), owning might make more economic sense over time (it would likely disrupt your ability to save and invest in other areas). But rent? That’s less likely to drop dramatically (though you can rely on the stability to invest the money elsewhere). So, he’s trying to guess which option might fit into his broader financial goals.
It’s a bit of a gamble either way. So, you have to play the long game and think about how these costs will evolve over time. Will paying a mortgage and coping with all the extra homeowner costs be worth it? Or are you comfortable renting, where you know what you’re paying for each month? You don’t necessarily need a Rent vs Buy calculator to answer these questions for you.
Costs vary a lot by property and state
That said, owning a property also comes with extra costs, but since these are predictable, it's easier to fit them into a spreadsheet.
For example, some properties come with strata fees. These are monthly fees required for the general upkeep of the property if it's part of a complex like an apartment building. However, the cost can sometimes be substantial enough to potentially offset any financial benefits to be gained from property appreciation.
The other thing is that stamp duty isn’t the same everywhere. Each state in Australia sets its own rates, and how much you pay can depend on the price of the property. Some states offer discounts or even waivers for first-time buyers, which can make buying more appealing if you can pay less stamp duty.
Most Buy vs Rent calculators on the Internet do take this cost into account. However, the rules for stamp duty can also change. Governments might adjust rates or offer temporary relief programs to encourage people to buy homes. Hence, you need to check the current stamp duty rules in your state from time to time.
If stamp duty is high, it adds to the initial amount you need to spend, which might make renting more attractive if you don’t have a lot of savings upfront. Conversely, if your state has low stamp duty rates or offers a concession, the financial barrier to buying a home might be slightly lower.
Investment returns will fluctuate
Lastly, we only often hear this with shares, ETFs or even cryptocurrency, but it goes the same for property: past returns don’t guarantee future results . It’s entirely possible for property markets to go through a slump, and you might end up selling for less than you paid. This is true for big and small cities, anywhere in the world.
To be fair, though, property values historically haven't fluctuated as rapidly as share prices. Changes in property values tend to occur more gradually, which can provide investors with more time to react and make decisions.
Another thing worth mentioning is that it’s relatively rare for property values to experience an over-a-decade slump on a broader scale. Most large Australian cities have seen consistent long-term growth over many decades. This is because, among other things, there’s a growing population and limited urban land supply to support that demand.
Even so, "rare" doesn’t mean "zero chances of stagnation or decline in property prices". Some areas might experience a slump due to local economic issues, changes in industry, or even changes in zoning or development regulation. It makes sense to consider these risks if you include potential returns in your calculations.
So, what numbers should you consider in a Rent vs Buy scenario?
A few years back, interest rates were temptingly low because of the pandemic. This may have made purchasing property more attractive due to cash-flow management than renting (though such estimates don’t hold up for very long in this climate). The flip side was that, since so many people were seeking housing or new living opportunities, the cost of housing also rose in that time. This made housing more expensive, although the interest on loans may have been lower. That period was an exciting times for property investors – but it was an outlier. There was also a lot of uncertainty for renters during the pandemic, and in some states there were freezes on evictions and rent increases. This time in history provided very different risks, considerations, and security, and i t gave us a glimpse into how variable any Rent vs Buy scenarios can be.
Regardless, it’s our human nature to crave for certainty, not necessarily accuracy. So, people often come back to basic calculations comparing the regular payments, assuming all things being equal. Hence, we are using these numbers to discuss this scenario.
To do some simple maths, we usually start by looking at the average mortgage rate. As of July 2024, the average rate on a 15-year mortgage is 6.53% and 7.28% on a 30-year mortgage . If you prefer the historical trend from 1990 until 2024, the average sits at 6.86% , according to the Reserve Bank of Australia.
However, what often slips under the radar are the additional expenses that come with owning a home. Things like water rates, council rates, insurance, strata fees, and maintenance can really add up. Depending on the property you’ve chosen, that could hypothetically amount to around 1% of the property’s value annually. (Whether it’s worth paying to service these areas is up to another discussion).
If you then add mortgage rates, let’s assume at 6.53%, the annual cost of owning can rise to 7.53% at the least. Now, if you compare that to the average rental yield of about 3.5% to 4.5% across Australia as of June 2024, you're looking at minimum of 2% cost difference annually between owning and renting.
If it hasn’t been made clear, we’re making a lot of assumptions with our basic maths here. That means we haven't factored in the unique details that might tweak your mortgage rates or rent. However, many people base their decisions to rent or buy using this kind of simple maths.
Alternative scenario: renting and investing
Another potential scenario people make is renting and then investing the money saved if they didn’t buy a home.
For instance, if you were to invest in an exchange-traded fund that tracks a sharemarket index, historical data suggests a growth rate of about 10% per annum. However, accounting for taxes, this might realistically be around 7% to 8%. To re-emphasise the point, these historical figures don't guarantee future earnings – meaning your actual returns could be lower or higher. And assuming you cash out in a relatively stable market, the combination of capital growth and reinvested dividends could mean a larger deposit when you’re ready to buy a home.
We haven’t really unpacked rentvesting yet, but our friends at the Get Rich Slow Club have put together some guides about it. If you’re crunching numbers using the rentvesting scenario, these articles are worth your time:
- Should I invest in ETFs, or save for a home deposit?
- Should I invest to buy a home?
- Should I build a home deposit by saving or investing?
- How does rentvesting compare to ETF investing for financial independence?
Third scenario: leveraging debt to buy and profit from a home
There's another scenario to consider when deciding whether to rent or buy, but it’s steeped in speculation. As such, we advise reading with caution. Our goal here is to lay out various perspectives and ensure you're well-equipped to make an informed decision. If you're on the brink of a major financial decision, consider this a friendly nudge to chat with a financial adviser.
The idea here is that some folks think about buying the biggest house their credit will allow. Not for the extra bedrooms or the sprawling garden, but as a financial lever to potentially increase wealth.
They plan to live in it for a while, hope the property value increases, sell it for a big profit, and then downsize later. They can pocket the difference tax-free since it was their primary residence ( main residence CGT exemption ), or invest the profit elsewhere.
In investing, we always say risk is inherent regardless of the type of investment. But, here comes the second part: the key is to take only as much risk as you can manage with sound principles, long-term thinking, and a level-headed understanding of your goals and limits. Leveraging debt to potentially increase wealth sounds thrilling, but it doesn’t exactly fit the description above.
When you pour a lot of your money into just one big asset – like a house – you're really banking on things going well in the property market. If property values dip or if the economy hits a rough patch, you might find yourself with a house worth less than you paid for it.
Plus, if most of your money is tied up in your home, you might not have enough cash on hand for emergencies or other investment opportunities. It's a bit like putting all your chips on one number in a game of roulette. The rewards can be great if you win, but the loss can be financially debilitating if you’re not in the position to handle that outcome. (Unlike shares or bonds, you can't just sell off a bedroom to compensate for the loss.)
We're not saying it's a terrible strategy, but it’s something we wouldn’t recommend to the average homebuyer. Calling it 'investing' might make it sound safer than it is, so let's just call it what it often is – speculation . And with speculation comes the need for caution.
Whether this approach makes sense for you depends on a lot more than just market trends. Mainly, it’s about how much volatility and loss you can tolerate without panicking or making it worse. So, take a step back, consider your options, and maybe have a word with a financial adviser to make sure whatever choice you make is the right one for you.
Takeaways from Hayden doing the calculations based on the scenarios above
We considered writing out all the details of Hayden’s personal calculations for his first property. However, these figures were based on some specific assumptions, like zero inflation and particular mortgage rate trends. These are things that don’t match up with reality or might not hold up over time and in different circumstances. But they are, in a way, hypothetical scenarios to help you understand potential outcomes.
Hence, to avoid confusion, we thought it might be best to save the deep dive for the listeners. In this article, we've decided to focus this part of the article on the broader insights Hayden gained from the experience.
First up, under average assumptions, Hayden thought that buying an apartment was going to be better when looking purely at the potential returns over a decade. But, he knew very well how things could quickly change. All he needed was another war or inflation and interest rates going up again. Suddenly it could be better to have not bought the apartment.
Of course, Hayden thinks there are scenarios where he could be worse off. However, since he’s eligible for stamp duty relief as a first home buyer, he feels there’s no massive cost of getting it wrong. He could just go back to renting if that makes more financial sense.
Second, while specific numbers in the spreadsheet will give you different answers at different moments, Hayden suggests that having a good range of what to anticipate is better than nothing. Because, as much as we want to keep it personal finance simple, what we really want is to avoid surprises.
For instance, you could model one scenario where the mortgage rate holds steady at the historical average. In another scenario, you could assume that it finally comes down following good news from the Reserve Bank. These are pretty reasonable assumptions. Even if you’re not confident, you’re still slimming down the risk of being caught off-guard or making a bad financial decision.
On the other hand, despite our best efforts, it’s entirely possible that most of these numbers don’t actually matter. Unless we see key events that only happen once in a century, our estimates are probably not very far off.
Because, in the end, the macroeconomic factors that move the needle are out of your control anyways. Most of them happen with no warning. So, then, the best every single person could do is give you predictions that don’t help you figure out the real answer.
This shouldn't make us feel discouraged. If we start thinking nothing could be done unless we could predict the future, the we might end up never buying a home – or making any significant decision, for that matter. And really, if that’s our approach, it begs the question: why are we even investing in the first place?
It’s simple: we are all chasing a bigger picture. For many of us, that dream is a place to call our own. For others, a sprawling backyard where their dogs can zoom around. Now, the question is: what’s your big picture?
Final thoughts
We had fun putting this episode together and really hope you had as much fun listening in. Before you go, here are some takeaways:
- Hayden ended up buying, but that was after a lot of personal deliberation. He took into account things like stamp duty, the cost of moving, and his assumptions of the economics. Likewise, if you're facing this kind of decision, you need to get into the details of your financial situation. Keep your calculations updated as things in your life and the economy shift.
- It’s key to compare the right things. If you’re renting a place for a certain price, don’t go buying something way pricier just because you can. Keep the comparisons fair, and like for like, so you're not skewing your budget.
- That said, renting might seem cheaper upfront because you're not paying for all those extras like repairs and taxes. But, depending on your situation, buying isn’t a bad option. Every time you pay towards your mortgage, you’re building equity in your home. Put another way: it’s a forced savings plan, which really helps in the long run, especially if saving isn’t your strong suit.
Lastly, if you ever want to bounce ideas off someone, don’t hesitate to reach out. Shoot us a message using the link in the show notes or drop an email to hello@aussiefirepod.com . You can also find us on our socials at Strong Money Australia (Facebook) and Pearler (Instagram) .
See you in the next one, and happy investing!
Dave and Hayden
