It is a perennial problem in the UK, and, I suppose in other countries too, as to what to do about accommodation. A house is very expensive, with typical prices in the UK at around £220,000 for a quite modest, indeed small, house or flat (apartment). Of course prices vary a lot: out in the countryside it could easily be £175,000, in London, £340,000 for the same thing. But whatever the price, is there a way of deciding whether it is better to buy or rent?

Well, the common argument is that it is better to buy, because you own an asset. However, most people don’t pay cash, they pay for a mortgage. I think that this alters the calculation a lot. In the long run it has to be a good idea to own an asset, but the cost of that asset can make a big difference. Is it better to pay rent while you save up so you can pay cash in the end, or is it better to pay for a mortgage and move in right away?

Let’s look at trying to buy a flat in London compared to renting a similar flat, also in London. Renting a small 2-bed flat in London is about £1,000 a month. The price, about £340,000. Calculations done using this mortgage calculator from the BBC, assuming the historical average interest rate of 7%, and comparing with 12% which happens from time-to-time (and worse). I will assume a repayment mortgage rather than an interest-only/endowment mortgage, because in the latter case you still have to set aside the extra money to pay off the capital in the end, even if you are hoping that some worthless insurance company can invest it for a profit for you (and as we have seen in the Credit Crunch, that is a vain hope: invest it yourself, carefully, or expect to lose some of it).

First of all, renting in London.

£1000 x 12 months x 25 years = £300,000.Ouch! Plus, you have to save something to build up the cash to buy, eventually.

Next, a mortgage for £300,000 at 7% interest (assuming £40,000 deposit and to make it equivalent to the cost of the rent).

£2145 x 12 months x 25 years = £645,500So… at 7% you are in fact buying just over two houses for the price of one.

At 12%:

£3187 x 12 months x 25 years = £956,100At 12% you are buying just over 3 houses for the price of one.

So… is renting better? Well, you could spend £300,000 on rent, and save up £300,000 to buy, and you would be no worse off than if you had taken out a *low interest* mortgage. At high interest, it would be much more expensive to buy.

On the other hand, this all assumes constant prices. We are used to seeing prices, and rents, rise. Indeed, over the last 30 years or so, it would have been nearly impossible to save fast enough to keep up with the rising house prices. With house prices typically rising at some 10% a year, where else will you get £30,000 of effective income for doing nothing? So, up until recent times, it was probably sensible to get the mortgage and pay, because over the course of a few years the increase in value of your home would have rendered the mortgage payments negligible in comparison. You could have bought a house for £60,000 and by the time you paid it off it could easily have been worth £250,000: more than the price plus interest, so a clear profit.

Now however, the calculation looks different. Prices are no longer rising, they are slowly drifting downwards, in an annoyingly hard to follow zig-zag pattern. It is, of course, impossible to be certain which way they are going to go over the next 25 years. Although we are used to prices going up, this is not the only direction and in economic depressions of the past, prices have trended downwards for longer than 25 years at a time. It could happen again. It could be happening now. We just don’t know. We do know that the politicians and economists don’t know what they’re talking about.

My bet? Rent and save, as long as interest rates are below 7% and house prices are increasing at less in cash terms each year than I can afford to save each year. If that formula changes, it will be time to look again at the figures. What do you think? Leave a comment and tell me if I’m wrong, or right!

What happens to these figures if we do this calculation in the countryside somewhere? In Bleanau Gwent in darkest Wales, the average house is only £80,000. Assuming you would need £20,000 deposit, the calculation looks like this.

Rent

£200 x 12 x 25 = £60,000Mortgage at 7%:

£429 x 12 x 25 = £128,700At 12%:

£637 x 12 x 25 = £191,100The calculation, in fact, looks the same: just over two, or three, houses for the price of one when you’re paying a mortgage. But saving is a *lot* easier here. Even on the National Minimum Wage of about £950 a month net, one person could afford the 7% mortgage, just about, and if they were really careful with their money, they could save a little too. If they were sensible and got married or rented out a spare room, they should be able to save quite rapidly.

However, looking online, the £200pcm places in Wales seem a bit… poor: flatshares and the like. The absolute minimum rental for some quality of life seems to be £300pcm (£90,000), or £644pm at 7% (£193,200), £956 at 12% (£286,800). At 12% this is beyond the minimum wage for one person, but a couple could easily rent and save some £1000 a month at those rent levels, it seems to me. A house could be purchased for cash there (or somewhere abroad with a nice climate) within 10 years.

Do you agree? What do you think about this calculation? Am I missing something? Leave a comment and let me know!

There are some online real estate rent or buy calculators that might be able to help you work out what the best options are for you, as follows.

• Here are a few different rent or buy calculators aimed at the UK market (including one from a buy-to-let perspective), although they would probably be helpful internationally too. They consist of very detailed spreadsheets into which you can input your after-tax income, general expenditure, guess at your after-tax savings interest rate, and how much prices are going to go up or down year-by-year, and come up with a general estimate of whether you will be better off financially renting or buying from year to year. If you want to purchase the house as an asset for all time, of course, it is less critical whether you make a profit in the short term: all calculations have a time-horizon, that is, are you better off buying or renting in 5, 10, 25, 50 years, or not? There are some training videos on how to use the spreadsheets, and the advanced video for the rent or buy spreadsheet is particularly worth watching: there are some very nifty tricks you can do to make sure you don’t overspend while paying off your mortgage!
• There is a rent or buy calculator from the New York Times aimed at US users. This looks simpler than the above spreadsheets, but don’t be deceived – there are a lot of parameters and sliders you can adjust, and there is an ‘Advanced’ button you can click to tinker with the settings.

I have written another article about this subject, from a slightly different perspective, and in that article, I come to the conclusion that buying is likely to be a better bet if you can do it, despite the expense. Should I Rent Or Buy A House? (On Infobarrel.com).