Mortgage Math? How It Can Help Flip The Owning/Renting Debate In Favour Of The Purchase

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The transition from renting to buying is an important one for many young families, but it can be a confusing time, too, since both sides of the rent-versus-own debate come equipped with facts, numbers and compelling opinions.

Conventional wisdom suggests that renting a dwelling is often cheaper than owning, but Royal LePage decided to find out for itself. It recently commissioned a report by Will Dunning, a veteran housing market expert, who used data and simulations to compare the implications of renting and ownership in select markets for various housing types.

His conclusion: the “cost of home ownership has been considerably lower than the cost of renting over time when you look at the costs on a net basis.” The reason lies in mortgage math and interest rates.

Dunning used data for Q2 of 2021 and estimated the average cost of renting was $2,795 ($2,515 in rent and $280 for monthly utilities). If the same dwelling was owned, he assumed a purchase price of $733,549, with a 20% down payment and a mortgage interest rate of 2.19% for a 25-year amortization. He calculated the monthly ownership cost as $3,499, based on a monthly mortgage payment of $2,538, plus property taxes, homeowner’s insurance, maintenance and repairs, utilities and condo fees.

The above comparison shows that renting is cheaper by $705, but it doesn’t take a little mortgage math into account. The monthly mortgage payment has two components: interest and principal repayment. At a 2.15% interest rate, the interest cost is $1,064. The principal repayment is $1,473, which is essentially returned to the owner’s pocket. Deduct the principal repayment and the cost of ownership drops to $2,026, or $769 cheaper than renting, which the report calls the homeownership advantage.

Housing markets are, of course, inherently local and distinct, so the report also estimated the comparative costs for 278 combinations of markets and housing types to determine whether the math still works in favour of owning. The result: “Out of 278 cases, the net cost of owning is lower than the cost of renting in 253 cases (91%), and renting is less costly in only 25 (nine per cent) of the cases.”

The other advantage of owning is that housing prices increase over time, making homeownership “increasingly advantageous.” For example, the average composite quality-adjusted home price in Canada increased to $738,100 in August 2021 from $483,000 in August 2016, according to data compiled by the Canadian Real Estate Association.

The 53% increase in housing prices over the past five years continues the long-term steady rise since the early 1990s. But there is a caveat: past returns are not guaranteed for the future.

The proponents of renting also come equipped with numbers. Alex Avery, executive vice-president at H&R REIT, wrote a book called The Wealthy Renter, in which he presented a hypothetical scenario for a couple deciding between buying a house for $250,000 or renting it for $1,100. Avery, unlike Dunning, included land transfer taxes (applicable in Ontario) and legal and moving costs, which might not be significant compared to the purchase price, but must be considered, nonetheless.

Avery estimated almost the same gross amount for rent and monthly mortgage payments, though implicit in the mortgage payment is the principal repayment that should be deducted before a dollar-for-dollar comparison.

If a couple were to sell after two years and assuming a 7% increase in value, Avery estimated a net return of 1.1% per year for the initial investment of $50,000 (the down payment). But he argued that had the couple left the money in an account earning just 2% interest, their investment would have earned much higher returns.

With such contrasting conclusions, it’s no wonder consumers get confused. But Avery’s hypothetical $250,000 home that rents for $1,100 does not exist anywhere in today’s urban housing markets. In addition, the lack of tenure security could require renters to relocate at a few months’ notice.

Meanwhile, home prices have been rising at over 10% per year as of late, though one cannot guarantee similar price increases in the future. And ultra-low mortgage rates imply that the bulk of the mortgage payment will comprise principal repayment even in the first month. For example, the principal repayment in the first month increases to 61% of the monthly mortgage payment at a 2% mortgage interest rate, from 37% at four per cent.

Given the many moving parts and fluid assumptions, consumers should do their due diligence before deciding what to do. But a little mortgage math would do them good, too.