Is mortgage interest just like paying rent to the banks
Over the years I have heard the statement “rent is dead money” literally hundreds of times and on almost every occasion I have tried to explain why in my opinion this is not always true. Finally a new report by the RBA confirms what I have always said – rent is no more dead than interest and other costs you have in owning a house unless capital growth is strong.
Over the past few years Sydney and Melbourne have had very high capital growth, none the less the annual rate of growth in property value since 1955 is just under 2.50%. The RBA report suggests that at 2.40% growth an owner has to hold the property for around 8 years to be in front of a renter however there are suggestions that following the recent bubble, growth may plateau at around 1.70% and at that rate it will take an owner almost 30 years to break even.
However there are times in the market such as the last few years where growth of 15% to 18% means those who missed the boat are now even further away from their dreams. Not only in terms of the additional $150,000 purchase price but the required $30,000 deposit to cover that additional contract price. However with most capitals now falling it is conceivable that Sydney prices for example could slip by $150,000 over the next year.
So what’s my angle
My argument on rent is usually more aimed at buyers who have limited savings, these are typically young couples or people who have experienced set-backs such as illness or divorce and the most important ingredients here are LMI ( lenders mortgage insurance) and stamp duty. Borrowers with the bare minimum 5% deposit who live in states with no stamp duty concessions are really struggling to get into the market. In most cases 5% is no where near sufficient – for example in NSW a house in a regional area with a deposit of $17,500 on a $350,000 house does not even begin to cover stamp duty $10,000 and LMI $12,000.
Repayments on a $345,000 ( 95% + LMI) loan at 5% interest will be $1850 per month or $426 per week, however for $426 per week you could rent a much better house worth around $550,000. Or if you look at the interest only component of $1440 per month you could still rent a house worth $430,000 and at 2.50% growth as the RBA confirm it will take 8 years for the $350,000 house to be worth $430,000. Over that 8 years you have paid exactly the same amount of interest as you would have paid rent plus rates, insurance, maintenance and all the other costs that go with home ownership.
Therefore my advice is that unless the market is taking off or about to take off – and that is not easy to pick, then you are probably financially better off save that $410 a month which after 8 years will give you $40,000 more deposit and a much stronger position and therefore a better loan. Having said all that “what price” the ability to change the curtains or hang a picture on the wall.