There is ample evidence that buying a house leads to greater wealth, especially in Germany 1. Those that own their own home in Germany are far better off. But would that apply to you as well, if you would buy a home? You can use the simple rent or buy calculator that Hypofriend has designed to evaluate your case.
Let's calculate whether you should rent or buy.
Outcome: Buying a property 340.000 € today would increase your wealth by 183.753 € over 10 years compared to renting. The graph below shows how long it will take to recover the purchase fees of 51.476 € given the property appreciation, interest rate fees, maintenance costs and rental savings.
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Let's see if buying makes sense to build wealth for you
You can see that buying can massively improve your net worth or wealth. Why is that? First the intuition of the main factors. If interest rates you pay on your mortgage are 1-1,5% and your property appreciates by 3,0%, you immediately know that you are very likely to be far better off (over time) buying, as your value increase is already more than your main cost.
On top of that you save rent, although you have to consider the maintenance costs as well (or more general Wohngeld). Maintenance for an old building can amount to 1% per year.
Taking these numbers together, your net worth increases some 5,50 % of your house price per year. If house prices increase only with inflation, your net worth increase would still be about 2%. If these prices increase at 10%, it is safe to say that your net worth balloons.
How to factor in up front purchase costs?
Buying a house involves quite a few up front costs. In Germany these up front costs are high. Real estate agent fees can be as high as 7,14 %, notary fees 2% and taxes on the purchase can be up to 6,5%.
If you would decide to sell the day after buying you would not be able to recoup these costs. It is money gone. It thus follows that if you decide to stay for a short period, it is not worth it to buy a house, unless you plan to rent out your house after you leave. Above, we refer to the period you need to recoup your upfront costs, as the break even period. This is the minimum stay needed to make it worth your while financially to buy.
TIP: It also follows that if you do not want to stay for a long period you are better off with properties with no real-estate agent fees, such as newly built properties.
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Does buying make sense from a monthly payment perspective?
Even if it makes sense from a wealth building perspective, you also have to be able to live a decent life and actually afford the house on a monthly basis.
For most people this is not an issue as interest rates are so low that some people can actually afford a larger house from a cash flow perspective then the house they can rent. This was not historically the case. In most periods in history, the biggest obstacle to purchasing a house was the high monthly payments in the beginning periods. Only over time the payments, relative to their income, would come down as their salaries increased and mortgage payments stayed the same, so people could take a breather.
Comparison of payments
|Net worth rent||Net worth buy|
|1||1.200 €||928 €||0 €||-32.518 €|
|2||1.236 €||928 €||0 €||-12.640 €|
|3||1.273 €||928 €||0 €||8.192 €|
|4||1.311 €||928 €||0 €||30.011 €|
|5||1.351 €||928 €||0 €||52.853 €|
|6||1.391 €||928 €||0 €||76.756 €|
|7||1.433 €||928 €||0 €||101.757 €|
|8||1.476 €||928 €||0 €||127.896 €|
|9||1.520 €||928 €||0 €||155.214 €|
|10||1.566 €||928 €||0 €||183.753 €|
A deeper dive into two of the key financial factors and associated risks
1. The expected house price increase
One of the main benefits of buying a house is the expected long-term appreciation. The wonderful thing is that it compounds. This means that the appreciation in the second year, also applies to the house price gain you had in the first year. In the third year it applies to the appreciation of the second and the first year, and so on. Over time this really adds up, and it shows in the house value the net worth graph curving up in the outer years (see above).
There is a lot of evidence that house prices appreciate over the long term, but that the appreciation is just 1,0 % - 2,0 % percent over inflation, ie 3,0 %- 4,0 % percent in nominal terms given the current ECB (European Central Bank) inflation target of keeping inflation under 2,0 %. Indeed there is no guarantee that house prices always increase. After a period of excessive increases they may go down, but this is rare and occurs mainly in a deep and prolonged recession when people lose their jobs and are forced to sell. But there are also periods that house prices increase much quicker. When the population and jobs expand for example, and low interest rates make houses affordable. This has been the case in many cities in Germany in recent years like Berlin.
Two very practical indicators can help guide you to make price expectations:
1. House price trends tend to be sticky. That means if prices go up, they tend to go up further. If the increase is decelerating and prices are well above the long term trend, this may be an indication of that prices may start stalling.
2. For prices to decline this usually requires forced house sales notably because people lose their jobs and can not find a new one. This can occur in an economic depression, ie a deep and prolonged recession.
2. The interest rate on the mortgage
Interest expenses are the main expenses for owning a home. They tend to be much, and much larger than maintenance expenditure, even on older homes.
Fortunately, interest rates are extraordinarily low in this day and age. Interest rates that apply do vary, and indeed you need to check which interest rate would apply to you: you can do that in Hypofriend’s intelligent mortgage recommendation.
Importantly your interest expenditure on your house declines over time, in contrast to your payments if you rent. Your interest payments go down as you pay-off more and more of your mortgage. With a repayment rate of 3 % (which corresponds to repaying your mortgage in about 30 years), your interests are down about 30% after 10 years. In contrast your rental payments might be up 30% - 40% over that period. This is also one of the main factors why homeowners in Germany (and many other countries) are much better off.
It is important though to take into account so called interest rate risk, the risk that interest move higher and you are confronted with much higher rates at a later date when you need to refinance your mortgage. The good thing is that Hypofriend advises you on the optimal period to fix your interest rate, so as to make sure that the risk is manageable and optimal from your perspective. We actually designed tools specifically for that purpose.
The emotional factors
There is much more than financial considerations that drives us. Houses and their ownership brings with it many emotional considerations. Some people don't like the responsibility of owning a house, including for repairs, others like the freedom ownership gives: more choice of house, and the much greater ability to adapt the house to your wishes. Some people are worried about the financial risks that home ownership brings with it. Yet other people focus on the fact that owning a house is like making a relatively save leveraged bet, that typically leads to much greater financial freedom over time. In the end you own your home, and live rent free, and thus far more secure.
The evidence for Germany is that most renters put their money in bank accounts that earn next to nothing. As a result there is quite a divide in wealth between homeowners and renters in Germany <sup><a href="#note2">2</a></sup> Renters don't benefit from appreciating house prices, nor from high returns on investment on their money. If you choose to rent, we do advise you strongly to consider better investments than bank accounts. There are investment vehicles that allow you to invest in real estate, and stocks in a very balanced manner, and over time should earn you significantly more than bank accounts.
Finally if your job requires you to be mobile and move from town to town, make sure that you are adequately compensated for the extra cost renting brings with it in the long run.