The cold figures for comparing rent to mortgage

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

16 September 2007

Ephraim Wachira asks a seemingly straightforward question: “show me in cold figures which is better between a rent of about 6,000.00 per month and a mortgage.” The direct answer is  - the mortgage. The reason is that at the end of the agreed period, the house becomes yours and you stop paying. With rent, you pay until the day you die!

But there are other differences between the two. First, rent agreements (leases) last for only about two to five years and then they have to be renewed. Mortgage contracts on the other hand, go for ten to twenty years.

Secondly, rent increments are usually clearly indicated (when and by how much) in the agreement while most mortgage contracts usually leave that matter in the hands of the lender. For this reason, the mortgage can be seen as “riskier” – but the eventual benefit is much greater.

However, Ephraim’s question is about a figure of Sh 6,000 per month and we might ask two further questions from this: First, how much mortgage can he get with this amount. Second, can he purchase the house he is living in by converting that amount of rent into mortgage payments?

The answer to the first question depends on two variables – the interest rate charged by the lender and the duration of the mortgage. Many financiers in Kenya today are lending at roughly 15 percent per annum on a contract lasting about 15 years. With these values, it turns out that Ephraim can only afford a mortgage of about Sh 420,000.

The second question is not so easy, but we can get an idea from the previous answer. This is by asking if a house worth Sh 420,000 (land and building) charge rent of Sh 6,000 per month. The answer is simply NO! But how much rent can it cost?

The answer to that depends on several things including which town the house is located in and how good the landlord (and the tenant) is at negotiating. However in Nairobi, the value of a house is approximately 150 times the monthly rent.

Thus a Sh 420,000 house can only charge about Sh 2,800 per month in rent. Using the same factor of 150, it turns out that the house for which Ephraim pays Sh 6,000 per month rent is worth about Sh 900,000 in value.

That leaves Ephraim with two choices: either move to the (smaller) Sh 420,000 house or look for extra money to afford purchasing the one he is leaving in now. But how much extra? A Sh900,000 mortgage paid over 15 years at 15 percent per annum would require Sh 12,800 per month. That is, more than double his current rent!

That might sound discouraging, but it is “the cold figures”. The “warmer side” is that after 15 years, you will own the house – and it will be worth a lot more than Sh900,000 by the time you finish paying! How much more exactly? Well, that’s a story for another day.