Renting v/s Buying – Which is better? (The Realities of Home Ownership)

“If you rent, you’re throwing away your money.”

“Owning your own home is a forced savings plan.”

“Home ownership is an excellent path to build wealth.”

You’ve probably heard statements like these a lot of times and from a lot of people. Such sentiments are common in any discussion that involves purchasing a home and personal financial planning. It’s common knowledge that buying a home is a better financial move than renting. After all, you’re building an asset instead of throwing away your money.

Well, maybe not quite…

Rather than assuming that such common knowledge is infact true, let’s take a look at some of the financial differences between renting a home and buying a home.

For the purpose of comparing renting to owning, we will be using real-world data gathered from Indiranagar, Bangalore – one of the city’s upmarket residential locations. To make sure we are comparing apples to apples, we are going to consider a 3 BHK deluxe apartment in Indiranagar which is 1700 sft in size with above average amenities.

The monthly rent on such an apartment is roughly Rs.27,000/-

The purchase price of the same apartment is approx Rs.75,00,000/-

As 9 out of 10 home buyers would fund their purchase with a home loan (and considering that banks/lenders will fund upto 80% of the property cost), for the purpose of this calculation we assume that an investor has around Rs.15,00,000/- in the bank to make the 20% down payment. To calculate the monthly loan installment, we will use a 20-year floating interest (average) rate of 11.00%.

Let’s look at how the monthly costs break down (approximately) for the above homebuyer:

Renting   Buying  
Rent/MortgageRs.27,000.00Rs.61,980.00 (EMI)
Property TaxNIL (borne by lessor)Rs.400
Tax SavingsNIL (no tax benefits)Rs.-6250 (loan related benefit)
Total:Rs.27,000.00Rs.56,130.00

Right off the bat, you see that by purchasing a house instead of renting it results in a 208% more expensive monthly bill. That’s not a small difference. With even a slight upgrade from renting to buying (which most first-time buyers are prone to do), you can easily see how the total monthly costs would be more than double.

“If you rent, you’re throwing away your money.”

Common knowledge says that despite today’s increasing prices, buying a home is a “good investment”, mainly because you’re not “throwing away” your money, which on the face of it looks to be a valid argument. Although the lessee (person taking the unit on rent) in above scenario spends Rs.27,000/- every month that they will never see again, we wouldn’t exactly say it has been “thrown away”, although its true that there is zero financial return on that money.

However, when you take a look at the breakdown of the homebuyer’s monthly expenses, a large amount is money that will never return, either. Insurance on the loan that he takes, property tax, and the interest on the loan is money that will never return. Below table shows the portion of the EMI (equated monthly instalment) that goes towards interest payments throughout the life of a 20-year loan:

Years   % toward interest
0-5~ 80%
6-10~ 70%
11-15~ 45%
16-20~ 15%

In the first five years, approximately 80% of the EMI goes toward interest. That’s an additional Rs.52500/- for a total of Rs.61,980/- being “thrown away” every single month by the homebuyer for the first five years. In fact, not until the homebuyer has been paying down the mortgage for over 15 years will the amount they are “throwing away” be less than the money being spent by the lessee –  who has taken the unit on rent.

“Owning your own home is a forced savings plan.”

As you can see above, if home buying is like a savings plan, it’s probably the worst savings plan on Earth. Would you voluntarily sign up for a savings plan where well over half of the money you deposit in the first 20 years simply vanishes, and from which you can only generate money by renting it out post completion for an annual rental yield of 3% to 4% (and considering average inflation to be 6%, you would actually end up losing between 2 to 3% of the property cost per annum)? Ofcourse not. That does not sound anything like a savings plan.

If our potential homebuyer has that Rs.15,00,000 saved up for a down payment and deposits it along with just half of the monthly savings over buying (Rs.14,565/- per month) into an account at 8% interest, the balance will be nearly Rs.59,94,069/- in just 10 years. That’s a liquid investment that can be used for whatever you want. Buying a home is not a savings plan. Actually saving money every month is a savings plan.

“Home ownership is an excellent path to build wealth.”

If your goal is to build wealth, you will be much better off investing in real estate with a clear intention to sell off the asset in a few years and book profits once prices appreciate to a reasonable extent. Buying and keeping a home is NOT A WAY of creating wealth. In order to cash in on any “wealth” you build through your home, you will need to sell that home and move. “Extracting equity” does not count as a wealth generation technique as it simply results in a larger debt, and Debt is not equal to Wealth.

Quick Tip : The average holding time in Indian real estate market is between 2 to 2.5 years for apartments/villas/row homes and 3 to 4 years incase of residential land or plots.

Conclusion

For most people buying a home will result in their largest monthly bill (by far), and because they believe that it will bring them wealth or that they are “throwing away their money” if they rent, they often take on a much larger home debt than a prudent budget would allow. It is a really unfortunate that people are driven to get into the housing market because of misplaced notions of imagined financial benefits. Of course, everyone’s circumstances are different, and for some the numbers may actually work out in favor of buying (but such chances are rare).

Don’t misunderstand us here. We are not saying that no one should buy a home, or that our example scenario is a golden standard for all. Don’t take our word for it. Run the numbers for yourself, and do what works for you.

Many people will consider all of the consequences — financial, emotional, social status, etc. — and conclude that buying a home is the best decision. But don’t trick yourself into thinking it’s a good financial decision if it’s not. Buy a house only when you want a nice, “permanent” place to live, and not because you think “it will help me get rich”.

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By Jhashank Roy Chowdary (About the Author)

G&C Global Consortium ™

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