Friday, November 30, 2007

Understanding Important Hidden Psychological Aspects of Rent vs. Buy Comparisons

This article, a third in a series, is about the softer side of rent vs. buy. These comparisons have become very popular and can easily be made using one of the many online calculators available. However, the psychological aspects of this comparison have yet to receive their deserved attention. (I still recommend reading this post about how to properly compare rent vs. buy financially as many calculators don’t make the correct comparison).

As you may remember a correct comparison of rent vs. buy should be made for the same property in the same time frame where the two options are:
1. Buy the property today and repay it through out the period.
2. Rent the property today and buy it at the end of the period.

The problem with the rent vs. buy comparison is, as always, the human factor. In order to compare rent vs. buy correctly some assumptions need to be made which are not at all easy to meet up with in real life.

These assumptions are:

1. We’re talking about the same property to either rent or buy
2. By choosing to rent through out the period you commit to save regularly:
a. You commit to saving your initial equity throughout the period
b. You commit to monthly savings instead of monthly mortgage payments

What are the difficulties with these assumptions then? It is a well known fact that when one rents one is able to afford a much more expansive property. This is also usually the case. Think about it. Have you considered buying the property you currently rent? Can you afford it? For a true rent vs. buy you compare for the property you’re thinking of buying.

Another problem is with the human inability to postpone pleasures or basically put: consumption. We all know available cash flows and moneys have a tendency to be consumed rather then saved. Think of the rent option where you’re not repaying regular mortgage payments but saving them instead. Doesn’t that ski trip look inviting? By committing to monthly mortgage payments you’re avoiding temptations.

Many corporations make use of debt in order to educate general managers. Think of a CEO with a huge cash surplus. This is obviously unhealthy as CEO’s will usually use those moneys to build “empires”. Shareholder use debt as a tool to discipline managers. If you lack the self discipline to save monthly instead of repaying a mortgage then taking a mortgage as a disciplining tool for saving is recommended.

There are more psychological aspects to rent vs. buy such as ownership and confidence but these have been discussed at length in many other places. Understanding the psychological assumptions of the rent vs. buy comparison is as necessary as understanding its financials.

Relevant Posts:

1. Why Taking a Mortgage Is Leveraging Your Equity: Understanding the Potential Risks and Benefits

Rent vs. Buy: Some Assumptions May Have a Significant Impact on Your Decision

Should you Rent or Buy a Home

image by mrbill


Carin said...

When it comes to your mortgage, you may be able to save money by using term life insurance in lieu of bank mortgage insurance. Term life also gives you and not the lender the power of naming the beneficiary. You also have the option of choosing a policy that converts at the end of the term into whole life insurance for ongoing coverage without having to reapply. Shop around, you'll be surprised at how much you can save!

Lord said...

Another difficulty is whether you can even rent a place you would like to buy. In many areas, rentals don't make sense for a landlord and so aren't done, or if done are only done temporarily in between owners and you may have to move several times. Also, one must consider what it is like dealing with the landlord and the limitations imposed by them. These can inflict high non-financial costs.