Retirement planning Housing when you’re older – buy or rent?

Compare the costs of renting and buying carefully.

by Jürg Zulliger 15 Sep 2016

The current record-low interest rates are fueling dreams of homeownership. But the running costs of owning residential property go beyond mortgage interest payments. The following factors also come into play:

  • When buying residential property, also think about the maintenance and ancillary costs of the property, as well as taxes (imputed rental value, property tax), plus renovation costs, which are often underestimated.
  • Since external financing can cover a maximum of 80 percent of the purchase price, you need relatively high levels of equity. This ties up capital that can no longer be invested. Although it is possible to make early withdrawals from pension fund assets for the partial financing of equity, this reduces your retirement capital and impacts pension payments later in life.
  • After 15 years, the mortgage must be paid back, up to a maximum of two thirds of the collateral value of the property.

Cost progression

The Miller family – two children, 45-year-old parents – wishes to purchase a new apartment in a medium-sized Swiss municipality. The parents intend to live in the apartment for the rest of their lives. The Miller family could afford to buy a home for 1 million francs, with 80 percent of the cost borrowed and financed in the medium to long term (mortgage interest of 1 to 1.5 percent). Alternatively, a comparable rental property would cost them 3,000 francs a month. Taking the above into account, the running costs of owning their own home would currently be a good 5,000 francs below those of a rental property. However, the solution that represents the best financial strategy in the long run depends on long-term interest rate trends and changes in property values.

Interest rate trends

In our example, we’re assuming that the savings made each year in relation to the rental property would be invested at a profit. In addition, the Millers would set money aside in a renewal fund, paying in 8,000 francs a year (0.8 percent of the purchase price), which also earns interest. After 20 years – just in time for retirement – the Millers spend 200,000 francs on comprehensive renovation work.

In this example, the Millers would be better off buying their own home – provided that mortgage interest rates do not climb much higher than 2.5 percent in the long term. There is enough of a margin to cover double the mortgage costs. In this scenario, there are also enough savings left over to finance a renovation after 20 years. If the mortgage interest rate rises to 3 percent, the cost of the renovation would still be covered, but overall, the costs for a rental apartment would be lower over the parents’ lifetime. However, if the mortgage interest rate rises to 4 percent or more in the long term, they might no longer be able to afford the renovation – and the cost of owning their home would exceed a third of their income after retirement. The financing would then only be possible if they substantially cut back on their expenses in other areas.

Price progression

When considering whether to rent or buy, it’s important to take changes in property values into account as well as costs. Real estate not only protects against inflation, but homeowners have also benefited from significant price increases in the past 15 years (with real rises of +60 percent since 2000). Further substantial real-price increases are unlikely, however, and a drop in prices cannot be excluded, depending on the economic situation, the attractiveness of the location, or a big rise in interest rates. At the moment, there’s a cost advantage of 5,000 francs each year over ten years by comparison with a rental apartment. This offers a financial cushion of about 5 percent if prices should drop. Should prices fall by up to 40 percent on the other hand (as has been the case in the past), the financial cushion would be insufficient. To make sure that in the event of being forced to sell their home for cost reasons, the Millers (or their children when they inherit) will not be left with debts, buying residential property in retirement is only advisable if they have enough additional assets or if the mortgage has been sufficiently amortized.