We assume that the mortgage rate and payment remain constant over the period. Although, as we discuss in our mortgage renewal article, the mortgage interest rate and payment may vary over the life of the mortgage. 

When Beth buys her home she is required to provide her $50,000 down payment, and will face additional upfront costs for legal fees, assumed at $1,500 and another $500 each for appraisal and inspection fees, for a total of $2,500 in addition to her down payment. She uses all of her savings to buy the home and pay the upfront costs but she now has her house worth $500,000 along with a mortgage liability for $463,950. Her net worth is now $36,050 (assuming no other assets or liabilities).

Rick also has $52,500 in savings but, as a renter, he doesn’t face the same initial expenses as Beth. He finds a house to rent for $2,000/month. Rick is not required to spend any of his current savings but he now has an ongoing obligation for the rent payment. This is a key quantitative element of the comparison because if Rick simply spends his current savings or the additional cash flow, the difference in his long-term net worth will be far less than Beth. Likewise, it’s also a key qualitative factor because their desired lifestyles should be considered in order to determine the best decision for each of them from a non-financial perspective. 

Ongoing cash flows

Both Beth and Rick will have certain ongoing costs that need to be considered for comparison. The impact of inflation should also be considered where appropriate. Although difficult to predict, the inflation-control target adopted by the Bank of Canada aims to keep total CPI inflation at a two per cent midpoint of a target range of one to three per cent². Using two per cent as an inflation estimate should be applied as an annual increase to ongoing costs for home repairs, improvement and maintenance. Mortgage payments for Beth would not increase with inflation. Additional costs may vary but we will make the basic assumption that Beth incurs the following:

As a renter, Rick would not be responsible for ongoing costs such as major repairs,  maintenance, or property taxes. Homeowner insurance is also typically more expensive than renter’s insurance because it covers more property, while renter’s insurance is usually limited to personal property and liability of the tenant that is not the responsibility of the landlord. As such, Rick’s additional cost might include renter’s insurance for $50 per month, bringing his total monthly obligations to $2,050. 

We assume that utility costs are equal for a similar property. Under these assumptions, Beth’s monthly obligations exceed Rick’s by approximately $1,100 per month. In order to be a fair comparison, Rick’s cash flows should be equal to Beth so we will assume that he invests the $1,100 difference each month into a long-term investment portfolio. For comparative purposes we assume that their comparable cash outflows over time remain consistent. Should their expenses change over time, cash flows may deviate if Rick maintains his investment savings at $1,100 per month.

Comparing the results

How do Beth and Rick compare based on these assumptions? Was renting a waste of money for Rick? Or did he fare better by investing the difference in a portfolio with a rate of return that might be expected to exceed the assumed growth on real estate? Let’s take a look at the results. 

At the end of 25 years, Beth will have paid off her mortgage and will own the appreciated value of her home. There are various schools of thought on what the rate of appreciation will be for real estate over the next 25 years in Alberta. A very general rule of thumb is that real estate growth can be expected to keep pace with inflation over the long term. For purposes of our analysis, we will assume real estate grows at 2.5 per cent, or 50 basis points above our inflation assumption.

Assuming Rick was diligent in saving the difference, he will have accumulated savings along with the applicable growth on his savings. For comparative purposes, we assume he saves in a non-registered investment account with a balanced portfolio generating a six per cent rate of return compounded annually. In a balanced portfolio, his investment returns will consist of interest, dividends, and realized gains that will be taxable each year, plus deferred gains that will be taxed on final sale. The investment account is also assumed to charge a one per cent annual fee.