Rent vs. buy: When is a mortgage better than rent in Canada?
Tim Bennett
This piece was first published on December 9, 2020, and was updated on January 5, 2023.
Rent vs. buy – it’s one of those eternal questions that will be asked and answered by millions of Canadians in every generation. However, it’s not a simple question, even if your parents think it is!
You may have heard the conventional wisdom that rent is “dead money” - that you’re pouring money down the drain unless you buy a place. It’s not really a fair comparison though. The truth is that even a house that you own, with or without a mortgage, has a certain level of so-called “dead money” associated with it. So from a financial perspective, the "rent or buy" debate is a lot more complex than “buy a home as soon as you can afford it” (and that’s without considering the drop in housing affordability in recent decades).
Here’s a little more guidance on the rent vs. buy debate in Canada. The short version is that it will depend on many factors, including your lifestyle, finances and the property market where you live (or where you want to live).
Renting vs. buying a home: pros and cons
The rent vs. buy issue is much more than a financial one. There can be big differences between the lifestyles of renters and homeowners that you need to consider alongside your finances. Here are some of the advantages of both renting and buying a home that take into account both lifestyle and financial issues.
Advantages of renting
- Flexibility: Renting doesn’t tie you down in any way. If you plan to move soon, or regularly throughout your life, renting lets you move out of a place as soon as your initial lease is over, typically 12 months. With a mortgage, this isn’t really possible, as there are financial penalties when you break a mortgage and taxes to pay whenever you sell a property.
- Less hassle and maintenance: Owning a home isn’t just a drain on your wallet. The daily maintenance and upkeep of a home will demand many hours of your time, as well as a few extra dollars on top. Renting transfers this responsibility to your property manager and/or landlord, freeing up your time for more productive work.
- Cheaper: Renting is generally cheaper than a mortgage, at least in the short term. If your household income isn’t high enough to afford a mortgage, then renting is typically a more affordable option. Alternatively, if homeownership simply isn’t for you, renting can give you more disposable income to spend or invest.
- Access to alternative investments: Being a renter doesn’t mean you have to forgo investing in your future. The additional cash you can save by renting can be invested in the stock market, a GIC, your own education or toward starting a business. Some of these could pay off even more than owning a home could, if you work hard and are a bit lucky!
Advantages of buying
- Stability: Owning your home means you call all the shots. If you want to paint, replace the floor, renovate or add an en-suite, you don’t need to ask a landlord or property manager*, you just do it! Owning your home also means you won’t get suddenly evicted because your landlord’s second cousin’s 19-year old daughter needs a place to live when they’re at university for 6 months each year**.
- You retain capital gains: If your home increases in value, being the homeowner means you will pocket the additional home equity, and realize the capital gains if you choose to sell (minus capital gains tax). If you were to be renting, the only one to benefit would be your landlord – if you’re really unlucky, a price rise could see your landlord sell the home, or increase your rent! Of course, the flip side of this is that if prices fall, it’s the homeowner that’s on the hook, not the renter.
- Building up equity: With a mortgage, every monthly payment is helping you build equity in your home. While some of your mortgage payment goes toward paying the interest on your loan, the rest is paying off your mortgage principal. At the start of your mortgage, interest will make up more of your payment, but it will decrease over the years.
- (Sometimes) cheaper: Buying a home will generally see you pay a higher monthly payment than you would pay in rent on the same home, at least in the beginning. However, that isn’t always the case, especially when you subtract the amount of your monthly payment that is going toward paying down your principal. You’ll need to run the numbers on your prospective home to be sure – our mortgage payment calculator can help with that.
- Simple investment: Part of the allure of homeownership is the fact that it makes investing in your future simple. Pay off your home and you’ll have a guaranteed asset that can see you through your life – no need to worry about stocks, bonds or other financial products (unless you want to). It’s generally a safe bet, as property prices tend to be fairly stable (until they’re not, but that’s another story). If you want a simple long-term investment strategy, homeownership literally has one built in.
*You may need to ask your local council if you’re renovating.
**This is oddly specific, but it’s just a hypothetical, I promise.
Rent vs. buy: The 5% rule
When people talk about renting vs buying a home, they often misunderstand and underestimate the costs of owning a home. The 5% rule is a decent rule of thumb for the rent vs. buy issue, but it will also help to clarify the real costs of renting and buying. It is a little complicated, but we’ll walk you through it step-by-step.
First of all, here’s the 5% rule itself:
The annual unrecoverable cost of owning a home is approximately 5% of the property value (whether you have a mortgage or not). If your rent is lower than that for a comparable home, you should keep renting. If rent is higher than that, you’re probably better off buying a comparable home.
Let’s unpack this a little.
Total unrecoverable cost
What is the total unrecoverable cost? The total unrecoverable cost is the amount of money you pay for a property that doesn’t result in residual value. In the case of paying off a mortgage, the residual value is the home equity that you build up over time, which is a financial asset that you can leverage in the future.
When you’re renting, the total unrecoverable cost is simply the amount of rent you pay. You don’t own the home, and your rent doesn’t go towards purchasing an asset or investment.
When you’ve bought a home, the total unrecoverable cost is more complicated. It’s made up of three different costs that cannot be recovered:
- Property taxes
- Maintenance on your home (not including renovations, which can increase the value of your home)
- The cost of credit (see below)
The first two of these are simple enough to understand, but the cost of credit is a bit more complex. The cost of credit is either the cost of borrowing money with a mortgage (i.e. interest on your mortgage) or the opportunity cost of investing your money in a home, rather than more lucrative investments. The former applies to money that you still owe, while the second applies to your home equity. In either case, they are generally around the same amount, depending on factors including your mortgage rate and how much your home increases in price.
The 5% rule
Here’s where the 5% comes from. Property taxes are around 1% of your home’s value each year, maintenance costs are also around 1%, and the cost of credit generally comes up to 3%. That means that the total unrecoverable cost from a house you own should be around 5% of the total value each year.
So, if you can rent for less than 5% of the value of a comparable home (calculated annually) you should probably keep renting, while investing the difference in an RRSP, TFSA or the stock market. If you can buy a home where 5% of the property value is less than the rent, buying is probably a good option.
Now, this is a simplification of a rule that is already somewhat simplified, and there’s a lot more to it if you want to understand it fully. Check out Ben Felix’s video about the 5% rule below – he’s a financial planner with PWL Capital in Ottawa, so his explanation is tailor-made for Canadians.
Should you rent or buy?
As with most things, there are no easy answers to whether you should rent or buy – it depends on your lifestyle choices, the market where you live and your personal finances. However, there are a few general suggestions that might get you thinking one way or another:
- When you expect to move regularly over the next few years (or most of your life) you might consider renting.
- If you want stability in your home, including the option to renovate, you will probably want to think about buying a home.
- When your yearly rent is less than 5% of the cost of a comparable home, you might consider renting and investing the difference.
- If you’re paying rent that is more than 5% of the price of a comparable home, you might consider buying a home.
The bottom line
The key thing to remember is that there is not necessarily a better or superior alternative to renting or buying. Even a fully paid-off home represents an opportunity cost and has overheads that you will need to pay in perpetuity. Renting can give you the flexibility to make other investments and be more responsive to opportunities that come up in your career, or in other areas of your life.
If you’re confused about what the best choice is for you, it’s probably a good idea to speak to a financial advisor or mortgage broker about your options.
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