Week 17: Should I Rent or Buy a Home?
MONEY SMART CHALLENGE
Money Smart Weekly Conversation Fact: People generally think that it is much better to buy a home rather than renting one. Surprisingly, there are a lot of good reasons why you might want to consider continuing to rent.
Should You Rent or Buy a Home?
Is it better to rent or buy a home? Many people ask this question, but often only hear one answer. People in North America generally think that it is much better to buy a house or condo rather than rent one—and they have good reason for thinking this. In most markets, home prices generally rise around 4% each year. So if you buy a home for $250,000 and put 5% down, you will invest $12,500 of your own money. If your home then goes up in value by 4% in one year, your home will have increased in value by $10,000. That’s a return on your investment of 80% in one year! Who wouldn’t want to do that? Why would you want to rent when you can make this kind of money owning a house? Surprisingly, there are a lot of good reasons why someone may not want to do this. Keep reading to find out more.
1. How often do you plan to move?
If you move every few years or even more frequently than that, renting may be your best option. Every time you buy a home you have to pay for closing costs, a home inspection, moving costs and possibly an appraisal. These costs can quickly add up to thousands of dollars. Then when you sell your house, you have to pay a realtor a commission. On a home that sells for $250,000, the realtor’s commission could be as much as 7%, or $17,500. Your house will have to go up a lot in value over a few years for you to even break even on this deal let alone make money. While home prices tend to go up over time, they don’t go up every year. In fact, they can go down for a number of years as well. For someone who moves often, buying a house every few years can be a risky investment.
2. Do you have a down payment?
In Canada, you usually have to have a down payment of between 5% and 20% to buy a house. If you can find someone who is willing to give you a mortgage with nothing down, don’t necessarily jump at the offer. This can be a poor decision. If you haven’t been able to save a decent amount of money for a down payment, then this probably proves that you can’t afford to own a home. Read on to find out why this is usually true.
3. Can you afford the monthly mortgage payments?
The greatest difficulty in owning a home is not coming up with a down payment, it’s being able to afford the monthly mortgage payments. Mortgage payments must be paid each and every month without fail. If you buy more house than you can afford, you will struggle to make the payments. As our neighbours to the south have unfortunately demonstrated, it is easier to get a house then it is to keep it. Recently there have been more foreclosures in the U.S. than at any time in the past 40 years. The amazing thing is that 100% of the homeowners now in foreclosure once qualified for their mortgages. So the issue is not qualifying for a mortgage. It is being able to actually afford a mortgage along with the other costs of home ownership.
4. Your rent does not equal a mortgage payment
Many people think that they can afford a mortgage because they pay the same amount as a mortgage payment in rent each month. This is a common mistake. Your monthly rent payment does not equal a mortgage payment. Just because you pay $1,000 a month in rent does not mean that you can afford a $1,000 mortgage payment. The true cost of home ownership is often around 40% higher than your mortgage payment alone. When you add on all the extras like property taxes, strata fees, utilities, insurance and normal maintenance and repairs you can easily be looking at an actual monthly housing payment that is 40% higher than your mortgage payment alone. Make sure you keep this in mind when you begin looking to buy a home.
5. Prove to yourself that you can handle a mortgage
When most people learn that the true cost of a mortgage is possibly 40% more than their actual mortgage payment, you would think that they would scale back their expectations and look at buying a less expensive home. However, people don’t usually do this. They still try to buy the biggest or best house that they can possibly afford. If you think that you might fall into this category, set up an experiment to prove to yourself and your partner that you can actually afford the home you want.
Figure out what 40% of your rent is and then deposit that money into a separate savings account on the first day of each month. Do this for six months and then reflect on your experience. Did you struggle with making that extra payment, or did you learn to make it work? Were you late with your payment, or did you learn to faithfully pay on time? If your experiment was a success, you are probably ready for a mortgage and have some more money saved towards your purchase.
6. What the bank will lend you?
Regardless of how big of a mortgage you think you can afford, the bank will only lend you a certain amount of money. You will need to make sure that your expectations are in line with your bank’s or credit union’s lending guidelines. Banks will allow you to spend up to 32% of your income on your mortgage payment plus heating and taxes. This is called your Gross Debt Service Ratio (GDSR).The other ceiling they set is called your Total Debt Service Ratio (TDSR), and it cannot exceed 40% of your income. This means that all of your debt payments cannot exceed 40% of your gross household income. If your TDSR is anywhere near 40%, your mortgage payments will be a struggle for you. Again, you may qualify for a mortgage, but will you truly be able to afford it?
7. Long-term benefits of home ownership. For all of the cold water we have thrown on buying a home, there are many more great reasons to buy one:
After 25 years, you don’t have to pay “rent” anymore because your mortgage should be paid off. However, if you don’t follow a budget and you spend more than you earn, this will not be the case. Many people keep refinancing their mortgage to consolidate their credit cards and line of credit. If you do this, owning a home won’t get you ahead, it will just prolong the pain of being in debt.
• Once you pay off your mortgage, you may be able to afford to retire because you will be rent free (meaning you don’t have to make a mortgage payment every month). Retirement is much easier when you can cut rent or a mortgage payment out of your monthly living expenses.
• When you are old and need more care, you can sell your home and use the proceeds to pay for your medical needs.
8. Tip for aspiring business owners: Build your business first then your house.
If you are building a business or planning on it, it is often wise to focus your resources on getting your business established first and then buy a house. People usually spend as much on a house as they can afford. So if you buy your house first, then you will likely have little left over to build your business. Of course, if you can buy a cheap home and get a mortgage with a very low interest rate, then buying can make sense. However, the principal of building your business before your house is usually a good rule to follow.
At the end of the day, only you can to decide if renting vs. buying a house or condo is best for you. Buying a home is likely the biggest financial commitment you will ever make, so just because everyone else is buying, doesn’t mean you should too. You don’t have to buy a home to live a happy, successful life. However, if you can make it work, a home can become a great asset to you.
When it comes to renting or buying a home, there is no right or wrong answer. It is all about the lifestyle you chose to live and what works best for your situation and your budget.
Great Tool: Renting vs. Buying Calculator
Here is a great, user-friendly calculator that can give you a good idea if renting or buying is better for you.
Buying a House
6 Things No One Tells You, Including How Much of a Mortgage You Can Afford
By Julie Jaggernath from www.mymoneycoach.ca
Ever wonder what no one tells you about buying a house? Or maybe you’re house-hunting and wondering how much of a mortgage you can afford? The size of your mortgage, in addition to your down payment, will determine what price range you want to be looking in. And there’s no shame in starting small because there are a lot of overlooked expenses for first time home buyers.
Here are 6 things no one tells you about buying a home but which can help you decide how much of a mortgage you can afford:
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Money Smart Week 17 Question: Which is the “Money Smart” choice for you right now; renting or buying a home?
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