Is Renting a Waste of Money?

Posted by admin Fri, 23 Nov 2007 14:30:00 GMT

It's often said in the media that "renting is money down the drain" or that "rent is dead money". This is true, to the extent that you never get the money back. But the same can be said of mortgage interest, which for most people makes up a significant proportion of their mortgage payments. In fact, on a 25 year repayment mortgage, nearly 80% of the mortgage payments in the first year will be interest - money down the drain.

On this basis, a fair comparison between the cost of renting and buying is to compare the monthly costs of renting versus the monthly costs of an interest-only mortgage. The graph below shows the average UK monthly rent and the average UK mortgage interest payment, based on an interest-only mortgage on the average house price, at average mortgage interest rates. The figures used are taken from the DCLG, CML and Nationwide.

As can be seen from the graph, the costs of renting versus buying have been pretty well matched over the last decade, up until a few years ago. Now, thanks to the rapid rise of house prices and a slight increase in mortgage rates, it is around 1/3rd more expensive to buy.

This comparison is a very simplistic approach and ignores many other factors which are covered below. Nonetheless it demonstrates that the current disparity between renting and buying is a big change from the recent past. In fact, compared to renting, buying is now at its most expensive for many many years. See this Monevator article for a real-life comparison based on the case of a west London flat.

There are, of course, several other advantages and disadvantages to both renting and buying that need to be considered. Firstly, rents include many things that would be extra when buying a house. For example, the cost of any maintenance will be taken care of by the landlord. There is also the associated costs of buying, such as mortgage set-up fees and stamp duty to consider. Then of course, there is the added flexibility that renting brings. If you need to move to take advantage of a new job opportunity, you do not have the delays, hassle or costs of selling your house and buying another one to worry about.

There are also numerous advantages of buying over renting. First of all (provided you keep paying the mortgage) you have security of tenure, whereas a landlord can kick you out with two months notice. You also have the opportunity to make changes and improvements to your house - you can replace that old boiler and save on heating bills, or add some extra space with an extension or loft conversion.

Then there's the big one - house prices. If house prices rise, you are definitely worse off renting. Rising house prices aren't always a great thing for homeowners - it means your next house will be even more expensive, of course - but at least you are keeping pace with the market. On the other hand, if prices fall, you run the risk of all sorts of problems when it comes to moving, or remortgaging, plus the demoralising effect of paying the mortgage every month while your house drops in value. A dead market can also make it very difficult to move, even if you have plenty of spare equity.

Buying a house has one other advantage over the long term - it shields you from inflation. Rents will usually rise at the rate of inflation, whereas once you buy a house, the cost is fixed at that point in time. On a repayment mortgage, you should own the house outright after 25 years. But in the short term, very little of the loan is actually paid off in the first few years of a 25 year mortgage, and in the case of interest-only mortgages, none of it is paid off! When examining the long term benefits of buying over renting, it is also important to consider what the long term outlook for house prices might be. See Will House Prices Always Rise in the Long Term? for more thoughts on this.

From the above points, it seems clear that renting is not always a waste of money, as some in the media would like us to believe. Certainly it is no worse than buying with an interest-only mortgage, a choice that could be described as simply "renting from the bank". If you aim to own a house eventually, and are keen to get the best house for your money, then timing your entry into the market is important. For more discussion of this, see Is Housing The Best Investment?

Given that the cost of buying is now at a historic high point when compared to renting, and that many feel there is not much risk of house prices going higher in the next couple of years, it seems to make sense to wait and see what happens. After all, renting is not as big a waste of money as it might at first seem.