Is Renting A Home “Pouring Money Down The Drain”?

For most people, owning a home is the ultimate financial goal. There are various credible reasons why people like to own houses. The most compelling for me is security for my family. If I died today, my child wouldn’t have a place to live (I live in a rented house), but if I bought or built a house, then at least they’re assured of a roof over their heads. This gets even more compelling for married men who are the sole bread winners. We can’t argue against the security aspect of owning a home.

A second compelling argument is that when you pay a mortgage, you are investing in an asset, while rent is “money down the drain”. This is sometimes true, though there are times when the math doesn’t affirm the assertion, and this post will look at the math behind the renting vs buying decision.

Say you have the option of buying a house at Kshs 6 million, or renting it for Kshs 30,000 a month.

Let us assume you have Kshs 600,000 in the bank, and a salary that can either pay rent or service a mortgage. Let us also assume that you have the option of investing the 600,000 bob in a fixed deposit account or government security that will give you 10% returns per annum.

Rent Scenario

If you are renting the house, your math will look like this:

Rental expense- 30,000*12 = 360,000

Interest income (simplified) – 10%*600,000 = 60,000

Assets and liabilities

Cash / Government Security – Kshs 600,000

Liabilities – none.

If you rent, you will have spent an extra Kshs 300,000 in the first year, and you will have equity (or an asset) of Kshs 600,000 in cash or near cash because government securities are considered as good as cash.

Buy Option

If you choose to buy, you will need to make a 10% downpayment – the 600,000 bob you have in the bank.  Let us assume you take a 20 year mortgage at 16% interest and to simplify the math, let us assume you don’t pay any fees or land rates on your property. In real life, you pay a minimum of 3% of the mortgage value in fees and legal charges.

Your monthly repayments on the mortgage will be around Kshs 75,000 per month, and in the first couple of years, this amount is mostly interest, and a very small chunk goes into reducing the principal of your mortgage. There is a tax saving  in paying interest on a mortgage. Currently, you are allowed to deduct a maximum of Kshs 240,000 from your taxable income, meaning you make a tax saving of Kshs 72,000 at the maximum tax rate of 30% (30%*240,000).

The math will look like this for the first year:

You will have paid 0.86 million in interest only, which is more than double you would have paid in rent. However, the interest component in the mortgage repayment keeps reducing with, so the picture may not always be as dire as shown above.

A final note: Until you pay off your mortgage, you are not a home owner, you are a money renter. So your options are to either be a home renter, or a money renter.

In the next post, I become the devil’s advocate and defend the mortgage option. There are other factors to consider, such as appreciation in the value of the home, the fact that rents increase every other year, etc, and we will look at them, and evaluate if the math behind the arguments makes sense.

This post is part of a 4 part series on mortgages sponsored by Barclays Bank. Read the first post on this series here.