Thursday, December 21, 2017

Mortgage or rent

One of the point of attraction while buying a property is that you are "freezing" the cost and if it goes up in the future, you reap all the rewards.
What is missing from the evaluation that your interest rate on the principle will go up to compensate for it.  This is particularly the case for western europe, where most of the mortgages are it either variable rate, with fixed rate mortgage are 5 year maximum.

Lets look at an example buying vs. renting a house.  

House price - $475,000, down payment is $150,000  interest rate is 2,7%, mortgage is for 20 years.

Owning (Mortgage)
Monthly payment
Annual payment
1 year interest*
- 8,700
Principal paid
House up keep
Mortgage application

*Interest paid to the bank vs. interest missed by investing mortgage down payment in the market. The assumption is that house prices will grow at inflation rate.
** Cost of a mortgage application is $1,000, so dividing the sum by 5.
       House up keep means that it is up to you to maintain it (boiler, kitchen, floor, rood and other repairs, which you do not need to be concerned with over the long period of time). This is without taking into account that people get emotional with the houses by putting a lot more money into the thing that add no value.
       Compare the value of investing downpayment at 7% in the market vs. house price rise at 2% over 20 years:
-          $150 K at 7% in the market for 20 years 150x(1.07)20=$580K
-          $475 K at 3% in the market for 20 years 475x(1.03)20=$875K
However, when you add additional $3.5K  (annual difference between owning and renting) invested at 7% this amounts to additional $150K in 20 years (compounding interest), bringing rental investment to $730K.

        There is marginal economical sense investing in buying a house, given that are conditions are met:
-          You live in it almost like a rental house (i.e. to extravagant spending), which most people unable to do.
-          You keep the house.  Every time you  buy/sell  it, you are wiping out 7-8% of any gained value, before paying any taxes on the gains (real estate commission, tax for buying the house, legal and moving cost).

This is really a delicate balancing act between owning and renting, at the cost of freedom. This gets better back in the USA, as there are tax breaks for the home owners. Owning a house is higher risk profile venture, as house could collapse, catch a fire and there is natural wear and tear. 

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