Mary Holm: What to do about dead money

Photo / Janna Dixon

Is it just me or is there a misconception that renting is bad? A recent Herald article interviewed a couple who have just bought their first home in Onehunga. The woman stated, "We'll be 55 by the time we pay off the 30-year mortgage. But we didn't want to keep renting. That's dead money."

Surely the interest, insurance, maintenance and rates on their new home is dead money in the same way rent is? Given that decent capital gains over the next few years are looking unlikely, I think renting is financially a better option at the moment.

If instead of renting for $450 a week you bought a comparable property, it would probably cost upwards of $500,000 in Auckland. Let's assume a $100,000 deposit, leaving a $400,000 mortgage at say 6.1 per cent.

The weekly interest would be $470, plus rates and insurance of say $58 a week ($3000 a year). That's $528 per week of "dead money", excluding maintenance costs.

If you pay off principal as well as interest then gradually the weekly interest will decrease. But surely it's better to rent and put the extra $78-plus per week into savings and earn interest, and not have the stress and worry of a $400,000 debt, rising interest rates and possible depreciation?

Strangely, the concept of dead money seems to come up only in the context of renting and home ownership. I can't see that money spent on food, clothes, transport, entertainment and so on is any more alive.

It makes more sense to say that all money is dead if it's spent, and alive - in the sense that you expect to get something with it later - if it's saved.

That aside, you're quite right - much of the money spent on home ownership is dead. It's only mortgage principal repayments, as well as any money spent on improvements as opposed to regular maintenance, that benefit you in the long term - plus, of course, any gain in the value of the house.

But, as you say, big gains don't look likely in the near future, and house prices might even fall.

In another Herald story, Anne Gibson wrote: "The ideal income-to-loan ratio is around three times an annual salary. But in New Zealand it takes 5.3 times the average annual salary to pay for a house. In Tauranga it takes 6.5 times the average annual salary and in Auckland 6.4 times." At some stage the ratio must decrease.

Meantime, is it better to own a home or rent while saving the difference in costs - as you suggest? Research on this varies, depending on your assumptions about trends in rents, mortgage rates, house prices and so on. With one reasonable set of assumptions, renting and saving wins; with another, home ownerships wins.

In the end, what matters is having accommodation when your income stops, in retirement. Many people aim to have a mortgage-free home at that stage. But if, by renting and saving, you retire with a lump sum sufficient to buy a home then, that's almost as good.

I say "almost" because getting into the housing market earlier removes the risk that house prices will soar and be out of your reach at retirement. And if house prices stagnate or fall instead, it won't really matter.

Another option is to never own a home, using your retirement lump sum to cover your rent for the rest of your life. There's nothing wrong with that, except that you won't have a house to leave your family or friends. That might or might not matter to you.

There are other factors to consider, too. Read on.

Rent and have fun

My son and daughter-in-law bought a townhouse at the height of the property boom. The repayments on their 100 per cent mortgage were at the limit of what they could afford but, both having good jobs, they thought that the good times wouldn't end and that salary increases would continue.

However, come the recession my son's company went under, reducing their joint income considerably. Although he got casual work, it was nothing like what they were getting before. So belts were tightened and the mortgage made interest only.

He has now got another job on a reasonable salary, but my daughter-in-law is now on her three months of paid maternity leave. She intends to continue working from home or part time.

It seems to them that all their income is going on housing, food, transport (they have one car) and other basics, with nothing spare for anything else. But by renting instead of buying they could afford a holiday or other "luxuries".

They have asked me the pros and cons of buying a house versus renting one. Their mortgage is about $750 per week, and to rent the equivalent property in an equivalent area would be around half this.

A spare $15,000 of after-tax income would buy a fair amount of what they are not able to afford now.

The answer has always been that owning your own home is the way to go - this is a given. But why?

Yours are quite different numbers from in the letter above. For your son and daughter-in-law, renting is much cheaper than home ownership, even before adding rates, insurance and so on.

Even so, if they choose to rent, and they want to reach retirement with their accommodation taken care of, they should still save a large portion of the difference between the rent and mortgage payments. And I'm afraid that saving would considerably reduce their luxuries fund.

Having said that, retirement is a long way off for them, and it sounds as if they will have good earnings capacity for many years. So there's probably no need for them to lead too Spartan a lifestyle now.

I suggest they do one of the following:

* Sell and rent, and have a bit of fun - but set aside some savings and plan to get back into home ownership in, say, 10 years.

* Trade down to a cheaper townhouse, perhaps of equal size but in a cheaper suburb. If they do this, they should sell first, or buy only on condition that they can sell at a given price. We're in an unpredictable housing market. If this move doesn't cut mortgage payments enough, perhaps they could get a longer-term mortgage - and shorten it when times get better.

In choosing between the two options, they might want to consider some other issues, as listed in the box on the top right of the page. One point is that if you rent you need to be disciplined about saving, whereas mortgage repayments are more or less forced on you. For some people this is no big deal; for others it's a clincher.

Beyond that, for many people non-financial issues make all the difference. For instance, with a baby in the home, the security of home ownership tends to matter more.

Simple solution

Would it not have been simpler for the person in last week's column, who asked the bank to match a competitor bank's percentage terms, to have just had the maturing term deposit simply put into the current account, walked down to Bank X, and written out a cheque for the new term deposit? No looking over one's shoulder for any suspected bogey man.

Am I missing something here? Maybe my suggestion is too simple.

I don't think there's such a thing as "too simple". But our reader probably wouldn't have enjoyed the process quite as much.

A few years back I was unhappy at a long delay at my bank. On reaching the teller I asked to close the account (about $15,000). After a few minutes a lady asked me to her office and asked why I wanted to close. My reply was, "slow service", and I wanted to withdraw to make a term deposit at another bank with higher interest.

Her reply was "we will match that" and I was told that service would improve soon. They got the term deposit, and their service did improve, but it took a few months. You can bully them too.

Indeed. Clearly it pays to keep an eye on what the competitors are offering, and not to be shy about telling your bank about it.

Guerrilla tactics by mail

I was bemused to see you suggest last week that your readers send "sticky, stinky or otherwise horrid" things through the mail to offers for shares at well below the market price. This is most likely illegal and they should first consult the Postal Users Guide or the Postal Services Act 1998 Part 2, on the internet.

Your "sand" suggestion is even worse, because if it gets mistaken for anthrax it will waste a lot of police time. Anyway, there's no need. I have always found that sending a formal letter telling the organisation or individual to cease and desist sending me unsolicited mail works a treat. (Probably because no one wants to fall foul of the Harassment Act).

This is a good tip to remember in election years, because you can stop the various political parties, MPs and wannabes from bugging you. But it works on all manner of unsolicited mail.

The guide and the act say threatening things about posting "perishable items" or "any noxious substance or thing or any dead animal". So you make a good point.

As for anthrax, apparently it looks like a fine white, light tan or dark tan powder - which doesn't sound all that sand-like. But still, I guess you're right. Guerrilla tactics by mail may not be such a clever idea.

Thanks for your alternative.

For more about below-market share offers see next week's column.

Renting v owning

Renting pros
* May get higher return on invested money
* Greater flexibility with savings
* Better savings diversification
* Less responsibility
* Can move easily and cheaply
* May be easier to live close to downtown
* No worries about maintenance

Renting cons
* Can be kicked out
* Not your choice of decoration etc.
* Need savings discipline
* Exposed to rent increases
* Home ownership pros
* Accumulate equity in house
* Retirement accommodation taken care of
* Easier to borrow for business etc
* You decide when you'll leave
* Decorate and garden as you please
* Pride of ownership
* Security

Home ownership cons
* Need good credit rating to get mortgage
* Home maintenance
* More difficult and expensive to move
* Inflexible savings

* Source: Get Rich Slow by Mary Holm

Mary Holm is a freelance journalist, part-time university lecturer, consumer representative on the board of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her website is www.maryholm.com. Her advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.

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