Last week some readers took issue with the notion that it is cheaper to rent a property than to buy one in Australia. Given that for most people, there is no more important a financial decision to make than to buy a home — the question should be asked in more details: Based on current prices, rentals, inflation rate and costs, are you better off renting or buying a property?

On pure nominal cash terms, if you have the choice between renting and using a 100% financed interest-only loan, the result appears fairly straight forward. According to RP Data, the median Australian property $475,000, while recent median national rental levels are about $360 per week. Therefore, to rent the median property it would cost you $18,720 annually, while to buy the median property, the interest alone would be $33,250 — that is before establishment costs, legal costs, maintenance, rates, depreciation and insurance are considered.

But, of course, very few people use interest-only, 100% loans, so the comparison is not really appropriate. Most people put down a deposit and repay the principal over the period of 25 years. This also means that their repayments will reduce over the period of the loan. As a Crikey reader noted that week, “after 30 years the buyer will also have the capital value of the house — even if that value has decreased”.

That point is true — but it also ignores a key fact — the money that  is being used to pay down the principal could have been invested elsewhere. Therefore, there is an “opportunity cost” involved in paying down the principal rather than say, investing that money in the share market. While some people would not be disciplined or able to find an alternative investment, the simple fact remains, if you can achieve a return of 10% elsewhere, of 5% capital growth on your own home, one is better off renting than buying (in a purely financial sense).

The reader also noted:

According to the Commonwealth Bank’s mortgage calculator, [for a $180,000 loan] he’d pay $1442 per month ($332.77 per week) or a total of $517,867 over the life of the loan. Admittedly the loan rate will fluctuate over the 30 years but it will decrease as well as increase. To pay the same amount in rent over 30 years as he would pay in buying he’d have to rent a house at $265 per week with the rent increasing by an average of only 1% per year.

There are a couple of fairly serious problems with those statements. First, a property price of $200,000 was used — this is far below the current median and would also mean that there would be lower than “median” rent payments. Using the current national median price of $475,000, the CBA calculator found that the hypothetical borrower would actually need to make interest payments of $713 per week for the first five years, and then $832 per week from year five. This does not compare favourably to the current median rental of $360 per week.

Plus, while rental payments will increase through the term of the loan, the mortgage calculator fails to account for the opportunity cost of principal repayments, which could be invested elsewhere. The difference between rental and repayments could also be re-invested further enhancing the financial desirability of renting.

A better calculator can be found on the New York Times website. This calculator allows you to compare the full costs of buying (including opportunity costs) to renting, and also choose rental and house price appreciation rates. While the US has a different tax system, the calculator can be used to give a rough guide as to whether buying a home or renting a home is preferred (from a financial viewpoint).

The assumptions are critically important. In my calculations on the NYT site, I assumed council rates of $150 per month, 5% transaction costs for buying and selling, a 30-year mortgage, 1% renovation and maintenance costs annually, a $2,000,000 capital gains exclusion (to account for Australian principal residences being CGT free), a 6% ROI elsewhere (which is the current rate on a near risk-free term deposit), a 3% inflation rate and rentals and capital gains growing by 4% annually.

Plugging those assumptions into the calculator showed that based on current medians and rentals, it is never better (even after 30 years) to rent, rather than buy. The annual savings for renters are about $20,000 a year, actually increasing through the term of the house. For buying to be preferred, one requires annual capital gains of 7% and a rental increase of at least 4% annually. This may be possible — but one suspects that unless wages and economic growth rise substantially, this is highly unlikely.

Of course, this has been a pure discussion of financial benefits. There are other benefits of owning a home that should influence a decision. Renters (generally) do not have security of tenure and have far less ability to renovate or improve their home, so a price needs to be put on those non-financial benefits. Although not everyone thinks so. Mark Zukerberg, the founder of Facebook with an estimated wealth of $15 billion, recently moved into a rented house in Palo Alto.

On a financial basis, the decision is reasonably clear. As long as you are disciplined enough to invest the money that would have been used for repaying principal, based on current home prices, renting is a much smarter move than buying.