Rent or Mortgage: Which Is Better?

Yesterday I took part in a roundtable on real estate. Many media outlets have published some of the points made at the meeting.

I have been reading the comments on my arguments on a few websites, and I am deeply disappointed. I am not disappointed that people reach for colorful epithets in defense of mortgages and accuse me of unprofessionalism. What disappoints me is that, by and large, people lack financial literacy. For the most part they go by gut feeling and cannot count or analyze information.

The main sticking point is which is more advantageous: a mortgage or renting.

1. No one is saying that you should rent all your life and never buy a home. The question is when it makes sense to buy with a mortgage, and when it is unprofitable or at least better to wait. Right now the situation is such that it is better to wait if you are applying for a mortgage on standard terms.

2. I will try to explain why waiting is more advantageous now.

The average effective mortgage rate at second-tier banks is currently 16% per year.

The goal is to buy an apartment for KZT 20 million. The buyer has savings of KZT 5 million and borrows KZT 15 million. The loan term is 20 years. In addition, the buyer has KZT 5 million for renovating the apartment.

Let's calculate how much the buyer will pay in interest and how much in principal.

Naturally, people will choose annuity payments.

The monthly payment will then be KZT 208,688, of which in the first year you will pay on average KZT 200,000 in interest on the loan.

Renovating the apartment and furnishing it will cost another KZT 5 million for the whole apartment.

In total, the outlay will be KZT 25 million, of which KZT 10 million is your own money and KZT 15 million is borrowed.

The current real estate trend is that prices are falling, and in the short term you will not be able to sell the apartment for more.

Over the entire period, your loan payments will total KZT 50,085,000, of which KZT 35 million is interest. Add your own KZT 10 million invested in the apartment. The total cost of the apartment will come to KZT 60,085,000.

Now let's assume that the apartment appreciates every year by the rate of inflation, 8% per year.

How much will the apartment be worth in 20 years? In 20 years it will be worth around KZT 93 million. Your profit will be KZT 33 million.

Now let's consider the alternative: you decide to rent for 20 years, put all the money you would have spent on the loan into a deposit at 14% per year, and live in a rented apartment. An apartment of this class, with furniture and renovation, would cost KZT 100,000 per month to rent today. Let's assume rent rises by 8% per year.

Your starting deposit is KZT 10 million. Right away you will earn KZT 120,000 a month in interest on the deposit. On top of that, each month you will add KZT 108,000 to the deposit (the money you would have used to repay the loan, net of rent), so the deposit and the interest on it will keep growing. In the first months, then, your deposit will grow by KZT 228,000 a month.

Even after paying rent, at this pace your deposit will grow to KZT 213 million in 20 years.

In 20 years, if you want to spend your last years in your own apartment or leave real estate as an inheritance, you will be able to buy your apartment for KZT 93 million and still leave your heirs an additional KZT 120 million in profit in the form of a deposit.

So we see that the difference under the current situation (and this holds only as long as current conditions do not change) is KZT 87 million. You should run this test before deciding to buy an apartment or any other property, and repeat it every year. As soon as the profit from a mortgage exceeds the return on a deposit, you can safely decide to buy.

What are the advantages of renting? It is a short-term contract, and there is no need to rent an apartment for 20 or 10 years. A mortgage rate, by contrast, is fixed for the entire term. If you took out a loan at 16%, you will still be paying 16% five years later. To change the rate, you would have to refinance with another bank or sell the apartment, which entails additional costs.

Once the economic situation changes, you can decide to buy an apartment. That could happen in a year, in two years or in five.

The following factors affect the decision to buy and could strengthen the case for buying:

1. A decline in mortgage rates. My calculation shows that, in the current situation, the rate should be around 10.75% per year. If the rate is lower, take a mortgage.

2. A change in deposit rates for individuals. There are many possible scenarios here, and in general deposit rates also affect mortgage rates. As soon as your deposit term expires and you are offered a lower rate, run the test.

3. Rent growing faster than inflation.

4. Real estate prices growing faster than inflation.

The government is now trying to bring mortgage rates down so that they appeal to the public, and we have seen the Kazakhstan Mortgage Company (KMC) launch a 10% mortgage program. So far not many banks have joined it. Incidentally, Bank CenterCredit (BCC), where I currently work, was one of the first to join the program and is one of its main participants.