There’s a very well known saying that goes around a lot “Why pay someone else’s mortgage? Renting is throwing money away.” Wait a second there. It’s completely true that renting is just throwing your money out the window, but in expensive cities like Vancouver, Toronto, New York and San Francisco, renting might be the only true alternative for someone that is just starting out. Not everyone has a million dollars to buy a detached house and certainly not everyone has rich family members that can pony up for a big down payment.
So are you royally screwed just because you can’t afford a home? Will you become one of those paycheck to paycheck scum that can’t get by in life? Don’t despair, my friends, renting isn’t as bad as it may seem. Especially from a cash flow perspective.
Throwing Your Money Away
I love the phrase “you’re just throwing money away” when homeowners talk to renters. I stare blankly back and wonder what kind of hypocrite I’m talking to. The truth is owning a home is not without it’s expenses.
Property Tax – Yes, you may own your own home, but the government still taxes you. How funny is that? If you’re living in large cities like Toronto, your property tax bill could run anywhere from $3,000-$5,000 a year. If you’re one of the unlucky ones that live in the outskirts of the GTA you could be ponying up $6000-$,7,000 a year. Oh the insult! I think that’s worse than a mamma joke.
Mortgage Interest – I can’t make fun of trust fund kids or those whose parents helped dropped a wad of cash, but to the early adopters of homes who put 5-10% down payment: Did they even realize how much interest they are paying? Go buy a $700,000 townhouse in the north part of Toronto and pay 10%. I dare you. That’s $72,531.84 of interest paid after 5 years if you’re lucky to score a 2.5% mortgage. That averages out to over $,1200 a month in interest payments. You just flushed $1,200 dollars down the toilet on that townhouse a month! How’d that feel?
Maintenance – Yeah, that leaky sink and window doesn’t need fixing. Homeowners can live with a few water stains and inadequate heating, because honestly, it costs a lot of money to fix these things. Money is short and the mortgage payment is a lot. “Buy a condo” people say! Sure… and fork over $300+ a month in maintenance?! People in homes don’t realize it, but your maintenance is probably more than the $300 a month in a condo. It’s really denial that forces people not to account for maintenance, or perhaps they do but don’t realize it’s maintenance until the roof bill comes out to $5,000.
Add it all up and see how much a home owner throws away per month. As a renter you might not feel that bad if you pay $2500 to rent a house. A homeowner is throwing away just about he same amount.
Hey, homeowners have enjoyed double digit percentage gains. Some have even made $300-400k in gains in hot markets like Toronto and Vancouver. It’s true, having 20:1 leverage is great for gains because you only need $20,000 to make say $300k. All those gains come with risk though. In a rising market, things are great, especially when interest rates are low, but what happens when mortgage rates rise? Maybe we’ll figure that out in a few years…
The key to keeping up with Jones’, or I should say, homeowners is that you have to invest as a renter. The reason? Saving cash does you no good. Given that interest rates are near zero, a GIC will give you gains less than inflation. You might as well party it up now since the dollar you save now will be worth 50 cents many years later.
Given that both homes and stock markets go up over the long run, there should be no reason why you shouldn’t invest if you forgo a home purchase. Homeowner’s call it a “forever home” right? Well as a renter you have to think of it as a “forever stock”. What can you own forever? It’s called the index. Go buy the TSX or S&P ETF cause that’s not going to zero anytime soon.
A homeowner won’t get paid for owning a home, they will continue to pay their mortgage and save using their one asset. Until the house is sold, they are no less cash strapped just like a renter, maybe even more so. So why not take advantage of the fact that you can invest and save your money like a homeowner. Invest in a balanced portfolio instead and keep making regular contributions with the money you save by NOT buying a home.
How To Save
A homeowner is putting their money away towards equity in a house and it’s going up in value. How can a renter do that? First off let me slap some silliness into you. As I already mentioned, a homeowner is already throwing away just as much money as a renter, maybe even more just to own a home. So as a renter you just have to do what they are doing, save the principal payment.
If you can afford to buy a $700,000 townhouse and can afford the $2,800 monthly mortgage payments plus the other $700-1,000 in maintenance and taxes per month, then that means you too can afford to pay $3,500-$3,800 towards your savings. But wait, you have rent! So subtract that out. That still means you should still be able to save $1000-$1300 a month. There should be no excuse! If you owned a home you wouldn’t have that extra cash anyways so stop lying to yourself! You just need discipline, or perhaps something called a pre-authorized transfer from your account.
Now start building an investment portfolio. Take that 10% down payment and the money you save every month and invest it into a balanced portfolio. That $70,000 could generate $4,200 in a year at 6%. Add the extra $12,000 you might save and you’ll generate another $720. Sure it doesn’t sound like $300k gains, but your risk is lower. You aren’t using 20:1 leverage. Not that you can’t use leverage and turn your 6% into 120%, but can you really stomach the risk?
Keep saving, and if you can, save even more than a homeowner. Homeowning incurs a very high fixed cost that cannot be avoided on a monthly basis. When you rent, your cash flow is larger. There are less trips to Home Sense. Home Depot isn’t on the radar.Save on that Persian rug and throw it into your index funds. Make the $2,000 become $3,000!
If you want to know why most people fail as renters, it’s not because they are disadvantaged. It’s because they fall prey to temptation. The one major advantage a renter has over a homeowner is cash flow. A homeowner is tied down and has to pay the mortgage, the taxes and the maintenance. This drains his monthly cash flow. A renter actually has more money to spend on a monthly basis. This is where temptation comes in.
Over the course of a 5 year mortgage of $630,000 a homeowner is obligated to pay $169,331.40 in mortgage payments, over $15,000 in property taxes and over $18,000 in maintenance costs (I’m probably still missing insurance, CMHC and other closing costs). That’s $200,000 in cash flow over 5 years which equates to over $40,000 a year.
A renter paying $2500 a month, with inflationary increases in rent, will pay around $156,000 over the same period. So where is that $44,000 in cash flow going? Crazy expensive BMW’s, luxury goods, gambling and vacations. The lack of discipline is why renters fall behind. Whereas homeowners are diligently packing money away into an appreciating asset, renters spend it frivolously. That’s one of the main reasons why renting sucks. We can’t control ourselves.
If you can continue to pay yourself first and put your own savings first over any other financial obligation, then you will no doubt still come out very well as a renter.