Allison, 28, is sick and tired of doing laundry off-site. It is a 20-minute trek to the closest laundromat. Yes, it is pleasant in the summer. No, it is not pleasant in the winter. She also hates leaving her rambunctious golden retriever in a 600-square-foot apartment all day. Finally, she just wants a home to call her own. For all these reasons, she is taking the plunge from renter to owner.
For Allison, and countless other first-time buyers, becoming a homeowner may also be a sound financial decision, depending on the size of down payment that they are able to make. Along with being a source of pride, there's the strong likelihood that ownership will increase one's net worth as the property grows in value.
But don't count on any quick gains, since the housing boom appears to be over for now. The Canadian Real Estate Association, for one, is expecting sales activity to slow down for the remainder of this year and on into 2011. This should have a dampening effect on prices.
However, regardless of the state of the housing market, becoming a homeowner is not just about making an investment. For first-time buyers, it's a life-altering decision. Your choice of home will be influenced by where you want to live, what you're looking for, what you can afford, and what sacrifices you may need to make. You'll lose the flexibility that comes with renting and the fact that, as a renter, you don't have to pay for repairs or maintenance.
In the case of Allison (at her request I am using a fictitious name), she has managed to put herself in a favourable financial situation. She saved $60,000 over the past five years, which for most people is a decent down payment. Looking to buy a $300,000 home, she descended on her local bank to obtain a $240,000 mortgage.
Grant Mackenzie | |
"That is the hardest part of the process: deciding on a mortgage and trying to decide how long to get it for; one-year, five-year, adjustable?" Allison told me. She chose a 30-year amortization period, and a five-year fixed rate of 3.99%. Her monthly payment will be $1,140.
Grant Mackenzie, CEO of the mortgage lender Macquarie Financial Ltd. in Toronto, says fixed terms make sense for newcomers to the housing market. "One of the common mistakes first-time buyers make is getting an adjustable mortgage rate, then rates spike," he says. "And the buyer doesn't know when to lock in."
As a first-time buyer, once you have determined the principal amount of the mortgage, the term and the interest rate payable, you can then analyze whether there's a financial advantage to buying as opposed to renting. This can be done through rent-vs.-buy calculators such as the one provided by CanadaMortgage.com.
The first step is to plug in the dollar amounts that correspond to your current monthly costs as a renter, and your future monthly costs as a homeowner. As the table below shows, Allison's monthly expenses as a homeowner would be $1,640, up from the current $1,075 that she pays as an apartment tenant.
Expenses | Buying | Renting | |
Maintenance | $100 | N/A | |
Mortgage | $1,140 | N/A | |
Rent | N/A | $900 | |
Taxes | $100 | N/A | |
Utilities | $200 | included with rent | |
Cable/Internet/Phone | $100 | $100 | |
Parking | N/A | $75 | |
Total | $1,640 | $1,075 | |
Should Allison buy now or wait? The answer will depend on the assumed rate of return she would earn on the $60,000 she has already saved, plus the $565 that she would continue to save every month by renting instead of buying.
In using the CanadaMortgage calculator, you should make realistic assumptions about the rates of return you expect to earn on your savings, since the calculator doesn't. Whatever you do, don't rely on the preset rate of 10%, which these days is an unrealistically high average annual return. By comparison, the average five-year GIC in Canada over the past 10 years returned only 3.1%.
Five questions to ask yourself
What's the local market condition? Do you plan on moving? Do you have a steady source of employment or other income? Can you still maintain a financial cushion? Can you truly afford it? |
Had Allison made her decision on the basis of an assumed 10% rate of return on her savings, she would have continued to rent for five years, while saving for a bigger down payment. At the end of that period, her initial $60,000 plus the $565 per month, invested at 10%, would have grown to a total of $134,908 for a down payment.
But if the assumed rate of return on savings were a much more realistic 3.1%, buying would be a more attractive option because Allison's total savings for a down payment, including the previously saved $60,000, would have grown to only $105,100.
Even if a lofty rate of return of 10% on savings is assumed, buying now may still be the best financial decision for Allison if the value of her newly purchased home rises. Assuming an average annual appreciation of 4% over the next five years, buying would be a break-even proposition; she would be no better or worse off financially than if she continued to rent. But if the value of the home goes up at a higher average rate than 4% a year, buying will trump renting.
After having reviewed the numbers, Allison has made up her mind. "I'm ecstatic about purchasing my first home, and although the calculator (assuming a 10% rate of return on savings) says renting would be the best financial choice for me right now, I disagree," she says. "Home ownership is exactly what I've been working toward in the last five years."
For Allison, qualitative factors seemed to weigh more heavily then quantitative ones. And that is fine because although a house is an investment, it is also going to be your home.
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