The decision: Buying vs. renting a home, part 2

How do you know whether purchasing a home or renting is better for you? Here are some financial and non-financial factors to consider when making the decision.

In Part 1, we covered the costs and benefits of becoming a homeowner. Now we will look at some of the benefits and costs involved in renting, as well as two key financial metrics to consider when choosing to buy or rent.

BENEFITS OF RENTING

  • it is usually less expensive than owning (see “Price-to-Rent” ratio below)
  • you have much more flexibility and mobility as a renter – an important consideration if you plan on extended travel or work abroad
  • good alternative if you don’t have much (or any) of a down payment for a home, or cannot qualify under the current mortgage stress test for the type of home you want

Disadvantages of renting

  • you do not have the same rights as a renter
  • landlord could choose to sell
  • you will have to pay legal rent increases
  • potential lack of suitable rental properties in the area

THE TWO KEY FINANCIAL METRICS TO CONSIDER

Financial metric #1: The “Price-to-Rent” ratio. 

This ratio is a handy benchmark to use that determines whether it is generally better to rent or buy, based on the housing costs in your city. (Purchase and rental costs vary dramatically across the country.) The formula is as follows:

Price-to-Rent ratio = Average list price / (Average Rent x 12)

For example, assume you are considering buying a home valued at $250,000. A comparable property in the same city costs $1,200/month to rent. The Price-to-Rent ratio on this home would be 17.36: $250,000 / ($1,200 x 12).   

Once you calculate the number you can see where it lands in the following ranges:

  • if the ratio is 15 or under, it is often better to buy than to rent
  • if the ratio is between 16 and 20, it is typically better to rent than buy
  • if the ratio is over 20, you are likely much better off renting.

This is a good metric to determine the affordability of owning vs. renting in your area. 

Financial metric #2: Housing costs as a percentage of your income

In Part 1, we touched on the importance of not buying more home than you need. Don’t accept the bank’s pre-approved mortgage amount as a guideline for how much you should spend on a house. Instead, look at what you can reasonably afford.

A common rule of thumb is to keep your housing costs at less than 30 per cent of your gross household income. Ideally, you should aim for less than that and target an amount that still allows you to save at least 10 per cent of your gross income. For a household with an annual gross income of $60,000, this works out to a target of $1,500/month for maximum base monthly housing costs.   

Your base monthly housing costs should factor in the following items:

Monthly mortgage/rent payment + Property Taxes + Insurance + Utilities + Condo Fees

To conclude, when making your decision, take the time to calculate your total housing costs before you commit to anything.

TAKEAWAYS

  • do not consider your home an investment – a home is not a retirement plan
  • consider the total costs of home ownership before buying
  • condo buyers should be aware of possible condo fee increases and special assessments on the property
  • consider the Price-to-Rent ratio in the area in which you are looking
  • keep total housing costs to less than 30 per cent of your gross income
  • if you rent, set up a monthly automatic transfer to save/invest the difference in housing own/rent costs that you realize
  • consider both the financial and non-financial reasons for purchasing/renting

KEEP THE CONVERSATION GOING

What else should Canadians do to help make a more informed decision when deciding on their housing situation? Post a comment below.

 

Disclaimer

The views and opinions expressed in this article are those of the author and do not necessarily reflect that of CPA Canada.

About the Author

Davin Stachoski, CPA, CA

Davin is a tax accountant and CPA Canada Financial Literacy volunteer.