Kyle is in the market for a first home. He wants a 3-bedroom house, but it seems all the 3 bedroom homes in his suburb are out of his price range. Kyle went to the open home of a 70 square metre 2-bedroom house that ticks several of his boxes. However, it is much smaller than he would like for his 3-person family, which is likely to expand in the near future.
All Kyle’s friends and family will say you need to get in the market now. “If houses keep increasing in price you will miss out entirely and never be able to buy a house!” “Get on the ladder now before it’s too late”. It is scaremongering. Rushing people into making very expensive decisions.
I also don’t like how we keep referring to it as the property ladder. It makes it sound like the aim is to keep climbing higher and higher. And by the fact that the average New Zealand homeowner moves to a new house every 7 years, this is exactly what we are doing.
So, should Kyle follow everyone’s advice and buy an undesirable house now, or wait until they can afford their preferred house?
Should I buy a house now or wait?
Before we run the numbers, we will make some assumptions:
2-bedroom house costs $450,000
3-bedroom house costs $600,000
20% deposit to be made on first house
30 year mortgage
Average mortgage interest rate of 5%
Inflation of 2.5%
House maintenance costs of 1% of purchase price, increasing by 2.5% per year with inflation
Insurance costs of 0.4% of house price, increasing with inflation
Rates costs of 0.4% of house price, increasing with inflation
House purchase costs of $15,000. Includes builders report, LIM report, valuation, bank, legal, transport, and furnishing costs.
House sales costs of 3%.
Rent of $450 per week (2 bedrooms for apples to apples comparison), increasing by 5% per year
House price increase of 5% per year
The renter invests the homeowners deposit and home purchase costs
The renter invests the difference between home ownership and renting costs
Investment returns of 4% in the hand
We will now look at two scenarios:
1/. Buy 2-bedroom house now and upgrade to 3-bedroom house in 7 years
2/. Continue to rent and save, and buy 3 bedroom house in 7 years.
We will compare how each would look after 7 years.
1/. The homeowner after 7 years has $106,000 after the sale of their house for $603,000.
Many people mistakenly think that a $153,000 profit has been made,since the house was bought for $450,000. But this has been reduced to $106,000 thanks to:
$18,000 sales costs
$223,000 in home ownership costs of mortgage, rates, insurance, and maintenance being more than if rented instead.
2/. The renter after 7 years has $148,000.
Better off than the homeowner by $42,000.
This is thanks to rental costs being $190,000, compared to the home ownership costs of $223,000. For a difference of $33,000. Once we add in the opportunity cost of using the house purchase costs to invest instead, then the difference jumps to $42,000.
In this example, it will be 12 years before the homeowner is better off than the renter.
This is even with house prices increasing by 5% per year.
For the homeowner to come out ahead after 7 years, then house prices would need to increase by more than 6.5% per year. Almost 3 times the inflation rate.
Final thoughts
There is much more to home ownership than the numbers. Some people feel more secure owning their own home and can’t put a price on that. Fair enough.
But climbing the ladder can be a dangerous game. While it has worked well over the last 20 years, this has been an extraordinary period of high housing returns. The chances of these levels of returns continuing are minimal.
In my opinion, houses should be bought if you are confident that you will live there long term. Of course, life happens, and plans can change, but as long as the intention is there. Because owning houses short term before upgrading or selling can be expensive. Mortgage interest is most expensive in the beginning years, and purchase and sales costs add up too, especially when spread out over only short periods.
In order for this to work though, the renter has to be disciplined with their money. Almost as if they had a mortgage. All surplus cash should go to productive use, such as investments. We only used a very conservative 4% in our example. If you aren’t disciplined with your money, then buying that beginner home may be a good idea for you.
I ran these scenarios to show that “renting is dead money” is a common misconception. It is OK to delay purchasing a house to buy a more desirable property, especially if you think you will only be upgrading in less than 7 years anyway.
Don’t get suckered into buying just because people are telling you to get in the market before you miss out completely. Future returns are far from guaranteed and if you can keep your discipline as a renter you could very easily come out ahead by delaying the purchase. There will always be a future opportunity to jump into the market.
A house purchase is a huge financial decision that should not be rushed, and since you are spending so much money, you should not settle for a house that doesn’t tick many of your boxes.
If you need help with any financial decision, then get in touch and we may be able to help.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here