Mortgage or deposit: which real estate purchase method is more profitable?
When you are thinking about purchasing own house, then, there are two main alternatives - take mortgage and simultaneously buy an apartment or keep money on a deposit and then buy, when necessary amount is available. What is more profitable? There are many fans of both options, actually the choice is often based on the personal views and beliefs of the buyer. In this article we will discuss only financial side of the issue and describe in detail calculation procedure.
If you don’t want to study now into the mathematical details of the calculation and you want to immediately know what today profitable, then click here .
Mortgage Method - a person acquires an apartment by means of a mortgage, immediately into it moved in, and for some period repays the debt.
Deposit method - person saves money (and at the same time rents an apartment), usually at a bank deposit, and then acquires the property.
Arrangements and restrictions
Before moving on directly to the calculations, we’ll make some important agreements.
We do not consider whether a person has housing at current moment (i.e he acquires first or second home). If there is no house, then during the deposit period, a person will spend money on rental housing. If there is house, then he will live in it and at the same time miss the possible income from putting this housing in rent. In other words, in any case, under the deposit method, the rent cost needs to be included in the model. (Note: this is not entirely true, because there is no tax payment, if person buy first house, but here we abstract from this factor).
For fair comparison, the buying cost of the apartment must be the same for both the first and second options. Similarly, a person’s income and the amount of his expenses for current consumption (food, transport, education, treatment, housing and communal services, entertainment, etc.) are constant regardless of the method of acquiring an apartment. In addition, under the deposit method, we proceed from the cost of rent an apartment similar to the one we are going to purchase. It's no secret that in the process accumulation people prefer to live in more cramped conditions, and then move to a more comfortable apartment. However, here we are analyzing not real life situation (you can correct numbers in our calculator based on your needs), and only comparing two ways to buy a house.
The conclusion about the preference of one of the two options depends on the future economic indicators. Today we do not know what will be in the future deposit rates and how property prices will rise. Therefore, for the calculations will be based on the assumption that the external environment will not change too strongly, that is, we will lay in the model the current level of deposit rates and current average annual rate of price increase.
There are a huge number of non-financial reasons for a deposit or a mortgage. For a mortgage - the opportunity to move into an apartment here and now, fix your interest expenses (the rate is usually fixed for the entire loan term), the ability force yourself don't spend money on non-obligotary purchases, etc. Against a mortgage - the risk of job loss and the inability to predict your financial situation for a long time, a feeling of a heavy burden, etc. Often all the arguments for and against mortgages at various forums are built primarily around these arguments. We consider that these (let's call them as non-financial) arguments is purely individual, this article does not take them into account.
How will we compare two methods (analysis methodology)?
For equal competition between purchase methods, several prerequisites should be set:
- The cost of the apartment and the amount of equity available at the time of purchase are the same
- A person allocates a certain amount to solve his housing problem, which is equal to a fixed percentage of his income. This amount is the same for both methods: under a mortgage, this money is sent to repay the loan, under the deposit method - accumulated on bank account
- We will rent (under deposit method) the same apartment we want to buy (so that living conditions are identical)
- Interest on a mortgage is usually higher than interest on a deposit
Before the calculations, we will try to briefly suggest why one of the two method to purchase housing can “win”:
|Mortgage arguments||Deposit arguments|
|Mortgage allows you to purchase an apartment now, at the current market price (at deposit method of purchase is made at the end of the term when the price of the apartment most likely to increase due to inflation)||There are no need to pay interest on a mortgage. Percentage load may be significant at especially high loan amounts.|
|Mortgage allows you to abandon the need for rental housing, or brings additional passive income from renting an apartment.||We don't need pay interest on the mortgage, moreover we also get additional passive interest income on deposit.|
|Tax deduction on mortgage interest. Under russian tax law, you will be able to return income tax rate of the funds spent on a mortgage, with the deposit method you do not have such an opportunity will be.|
How to determine which of the above will outweigh in a particular case? Comparison can be entered in the following categories:
- Cost - compares the total cost of the mortgage loan (cost of the apartment + mortgage interest) and the total cost of housing for cumulative method (cost of the apartment at the time of purchase plus expenses for rental housing minus income on deposit)
- Time - preferably the way in which the housing problem can be solve faster. The housing problem is resolved when you either paid the mortgage or have accumulated the required amount on the deposit.
The result may be different due to the tax deduction for the purchase. The deduction amount will be the same for both the mortgage and the deposit method (time value of money is not taken into account). However, under the mortgage method you will receive this deduction earlier (the deduction is paid immediately after buying the apartment) and you can use this money to repay loan and decrease future interest. Under the deposit method, you get this deduction after the housing problem is solved.
Some people thinks - since the mortgage rate is usually higher than deposit rate, the acquisition of housing through the accumulation of funds on the default deposit is more profitable. This reasoning is not entirely correct, since the growth of apartment prices is missed from consideration (since mortgage housing is bought immediately, and with a deposit - only at the end of the term).
Mortgage method of buying an apartment (calculation methodology)
With a mortgage, the housing problem is resolved when a mortgage loan is paid:
A loan is granted for an amount equal to the difference between the cost of the apartment and the funds that the borrower has at the time of purchase. The share of equity is usually 30% or more.
The monthly loan payment is calculated according to the annuity scheme - according to the classical formula - each month the borrower pays the same amount, which includes the repayment of interest and principal.
The amount of the annuity payment is equal to the amount of the person’s income allocated to solve the housing problem p>
Mortgage rate is fixed and is not subject to revision during the entire loan term (this is common practice)
Early repayments are possible at least once a month. At current moment, Russian legislation does not allow banks to prevent this (this rule is applicable only when individuals buy an apartment not for entrepreneurial purposes).
The amount of growth in our income is allocated to early repayment of the loan (as a result of this adjustment, the share of funds allocated to solve the housing problem in our monthly budget remains fixed).
Similarly, the amount of the received tax deduction (both for the apartment itself and for interest) will be immediately directed by the borrower to repay the main debt. In this case, the deduction is calculated based on the total income of the borrower, and not on the basis of income aimed at the decision housing problems.
We assume that the taxpayer will receive his first deduction in April of the year following the year of purchase (he will file a declaration in January + 3 months for a tax audit). We also assume that buyers will obtain a deduction at work (it is more profitable and it allows to receive additional cash immediately) in subsequent years.
We neglect the sum of expenses on insurance of property, title and life of the borrower, appraiser services, etc. due to their insignificance (these expenses are usually present with the mortgage method and are absent with the funded).
Thus, the loan balance at the end of the month is the balance at the beginning minus the annuity payment and the amount of the additional repayment (for the increase in the borrower's income and tax deductions received by him during the period).
Deposit method of buying an apartment (calculation methodology)
Let's also say a little about the calculation methodology for the cumulative method:
At the beginning of the analyzed period, a person (or family) put on deposit amount equal to his initial contribution on a mortgage.
Every month he replenishes the deposit for the amount allocated to them to solve the housing problem (minus rental costs). This the amount grows with the growth of his income - as a result, the share of income allocated to solve the housing problem remains fixed
The interest received on the deposit is added to the main deposit amount and will also be spent on the purchase of an apartment in the future. Capitalization may be monthly (if deposit conditions provide such an opportunity) or annual.
We consider a fixed deposit rate. In practice, this is not so, since there are practically no long-term deposits on the russian market today (with maturity of 10-15 years). However, we can’t exactly assume how the deposit rate will change in the future, so we will build on the current market rate.
The rental rate is determined for the same the apartment we are going to buy.
At the same time, we calculate the expected value of the apartment in a given period of time, as the product of its initial cost and inflation rate.
The housing problem is resolved when the amount accumulated on deposit exceeds the current value of the apartment in the market.
How is it now more profitable to buy an apartment: take a mortgage or save on deposit?
Immediately, we note that depending on the cost of the apartment, the amount of equity available in your income, your tax deduction rights and other factors, the result will vary greatly. If you want to know the solution, which will be more profitable for you, please use our a calculator. Here we will try to calculate a certain average expectation, considering what is more profitable in today's Moscow market for typical buyer.
|Price||8,000,000 rubles||The average price of an apartment in Moscow. For this amount it is realistic to buy one-bedroom apartment in the outskirts of the capital and a one-room apartment closer to the ring line.|
|Own equity||3,200,000 rubles||Under statistics, the average initial payment on a mortgage in Russia is 40%.|
|Rate rent||35,000 rubles||Approximate rental rate for an apartment with the specified parameters (depending on the number of rooms, the value will differ)|
|Rate on mortgage||12.5%||Average rate on mortgage loans issued in rubles, Bank of Russia data|
|Rate by deposit||9%||Average rate on long-term deposits (up to 3 years) in rubles, Bank of Russia data|
|Expected apartment price growth||4%||Medium term forecast of the audit and consulting company PwC on inflation in Russia for 2018-2022.|
|Expected rental rate growth||4%||Look higher.|
|Expected personal income growth||6.5%||Medium term forecast of the audit and consulting company PwC for inflation in Russia at 2018-2022 is 1.5%. Since we carry out calculations in nominal prices, then you need to add the inflation forecast (4%, see above).|
|Month personal income||110,000||Average the salary in Moscow, according to Moscow City Statistics, is about 55,000 rubles per person. We consider that both family members have income.|
|Income to spent on housing (solve housing problem)||55,000||By According to russian statistics, the share of payment in income for the Russian Federation ranges from an average of 30% to 40%. Since the income level in Moscow is higher, then with the specified salary we consider acceptable share of 50%.|
|Tax deduction||4,000,000||Maximum the amount of deduction in the Russian Federation per person 2,000,000. Consider a family of two people, respectively, a deduction of 4,000,000. We assume that previously the family did not purchase housing, therefore it has a deduction in full and also entitled to a deduction on mortgage interest.|
|Capitalization interest on deposit||Annual||Assume that interest income will be capitalized annually (this is also tantamount to annual extension of the deposit without partial withdrawal).|
Thus, for the average Moscow family, the deposit method of buying an apartment preferable (the amount of savings of about 400 thousand rubles). However mortgage will solve the problem faster - 8 years instead of 9. Thus, our situation just the very case when different criteria give different results (recall that this is due to the effect of the tax deduction, which with deposit the method will be received by the family only after buying an apartment).
Conclusions: in which cases a mortgage is more profitable than a deposit
A mortgage is usually more profitable in the case of short loans for small amounts, when the effect of a higher mortgage rate is offset by the quick repayment of the loan.
For the same reason, a mortgage is more profitable when person owns big initial payment in the total cost of the apartment
Mortgage is more profitable in growing real estate markets, when a high rate of price growth compensates for losses in expensive mortgage interest
A mortgage is more profitable if you can count on large tax deductions (many family members participate in the transaction, each of which has a deduction right; the price of the apartment allows all these family members to receive their deductions), since deductions lead to large interest savings (due to faster receipt thereof than with a deposit) + do not forget about the additional deduction on mortgage interest
A mortgage is more profitable with a low difference between the rates on deposits and loans (usually this happens during a recession in the economy, when the demand for credit is low, and people, on the contrary, tend to save their money)
A mortgage is more profitable with an increase in the ratio of the buyer’s income to the cost of the apartment (since ceteris paribus the buyer will be able to quickly reduce the amount of interest payments)
But, of course, it’s impossible to say right away. Need to be counted in each specific case individually.
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