Largest purchase of your life
Purchasing a home is the largest single expense in your life, so why would you overpay? A home and even condominiums costs hundreds of thousands of dollars at the minimum to buy. Having a huge mortgage on the property is the cancer to eroding your wealth. Getting this purchase wrong and you could be paying for it for the next 25 years! That is why today we discuss the greatest house debate: rent vs buy.
The smart folks out there take their time with this purchase as it may be a decision they have to live in for 25+ years. It’s the largest physical item you’ll own and will be your pride and joy.
If you have not had a chance to read our Mortgage Talk series, check them out here:
- How long should I take to pay off my mortgage?
- How to pay off your mortgage faster
- Variable vs fixed rate mortgages: which one is right for you?
Today we take the most detailed look into the housing industry’s greatest debate: rent vs buy. We will explore which option is best and how not be overexposed on your mortgage!
True cost of a mortgage
Please sit down for this one. You will be utterly shocked at the true cost of purchasing your home using a mortgage. According to livingin-canada.com the average price for a house in Canada is $480,000. Do you even have that kind of money?
Using mortgage calculators from the National Chartered Banks in Canada we have the following situation:
- Home price of $450,000
- 5% down payment of $22,500 for first time home buyers
- 25 year mortgage with monthly payments of $2,500
- Interest rate of 4.64% is used is on a five year fixed term (rate obtained from Royal Bank of Canada)
The amount of interest paid on this mortgage is $303,000 – 67% of the value of your home! You’ve now paid $753,000 for a home excluding any renovations and additions needed to keep up with the debt trapped Joneses next door!
Not only is the interest horrendous but how can you afford the down payment when you are carrying credit card, auto loan and student debt? Will you have to borrow for the down payment from a line of credit that is carrying interest in most cases double the mortgage rate?
We are currently in a low interest rate environment meaning in the future interest rates will increase and having more debt now means having less money in the future.
Go to a store today and take a look around, everyone is shopping for a deal, they are trying to save, well why are we not doing that with life’s largest purchase? If you get life’s largest expenses right you will have money to finance those dream vacations.
Emotions of home ownership
A home is not a house. When buying a home it is hard not to become emotional about this purchase, it’s the item you will be living in for many years. Being comfortable, safe, and in the desired location are important things to everyone. Let’s take a look around for a moment.
I have seen it with myself and with friends, we venture into a house showing and came to the conclusion it was the house of our dreams finding out two weeks later there is a better one around the corner. It is human nature to want things we do not have and to always look for better. It is the keeping up with the Joneses disease all over only in a different form.
I get it, I really do that you’ve fallen in love with this house and you’ll pay anything to get it. Write down what the priorities are in life. You’ll see that you want other things in life that require more money.
Unless you learn to live comfortably you will find another better dream home the instant you move into last week’s dream home. So look around and follow your priorities, don’t get wrapped up in a bidding war, you’ll pay more for it than just money and that’s your freedom.
Rent vs buy: the debate has begun?
The gloves come off in rent vs buy. As we have seen above the cost of the $450,000 home is really $753,000. Assume you put into the home $45,000 for renovation over the 25 year period bringing the total spent to $798,000.
- Finishing the basement – $20,000
- Redoing the kitchen – $15,000
- Redoing the bathroom and making a second one $10,000
According to a blog post from Rentseeker.ca the average rental price for a three-bedroom apartment in Canada is $1,535. A three bedroom apartment is a sufficient size for the modern family. The cost of renting over 25 years is $590,000 (2% inflation per year).
Now time to figure out if purchasing a house is worth the investment.
Cost of house = $798,000
Cost of renting = $590,000
Your home would have to increase 135% in order to break even. BUT wait what if we took the difference between the mortgage payment and the rental payment and invested that over 25 years?
Mortgage payment = $2,500
Rent payment = $1,950 (average across 25 years)
The difference of $965 per month invested at 2% (rate of return is below historical average rate of return in a balanced portfolio) would in 25 years become $282,000. This investment reduces the cost of renting which is evidenced in our revised figures are below:
Cost of house = $798,000
Net cost of renting = $308,000
Rent vs buy debate: the winner is
I’ll let you be the judge of who wins the rent vs buy debate. I’ll suggest the following:
Bulls of the housing market argue the house wins because:
- There is strong expectation that the value of the house in 25 years will at least double eliminating the entire cost and then some.
- You get less house when you rent vs buy.
- Renting a comparable size home is far above cost of a mortgage.
Bears of the housing market argue renting wins because:
- 4% investment growth rate is below what the 25 years expectation really would be driving down the cost of renting much further.
- With renting you have the flexibility to move, almost every year, if you wish.
- No timing the market with renting, good renters are always in high demand.
Ways to save on your mortgage
Debt is the cancer of the financial world. It erodes financial security and cripples you from achieving freedom and happiness in life. Is owning a house a SMART investment?
Here’s a few steps to help you reduce the real cost of your mortgage. Utilizing any one of these steps could help you save huge amount of your money and live a life with less debt!
Step 1: Live by your means
Step 1 Part 1: Determine what your means are
Take a look at your life and determine what size of home do you need; how many bedrooms, bathrooms, how many square feet. Do you need to live near work or school? Have you considered the need for a garage? Once you have these figured out it is much easier to find the perfect place that not erode your wealth.
Step 1 Part 2: Can your means fit into the budget?
Within the financial world a general guideline is to have your housing costs (mortgage, property taxes, insurance, hydro, etc.) equal 30% of your after-tax income. Purchasing a house that allows you to live within the 30% is ideal providing you do not have credit card debt.
Step 2: Increase the down payment
A larger down payment (double of the down payment in the scenario above) means $20,000 less interest over the 25 years! That’s more money in your pocket. It will take more time to save up for a down payment however just because your friends are buying homes too early in life does not mean you have to. Live at home if you can, rent if you must, the down payment should be cash not on credit.
Step 3: Pay your mortgage
Accelerated payments is a great way to tackle the principal portion of your debt. By going with accelerated weekly payments you can save $50,000 of interest, that’s 6% on the total price of the home. Now where can you get a guaranteed 6% rate of return?
Step 4: Read your contract
Anniversary payments: Every year you can make a lump sum payment that goes directly on the mortgage principle. Using that bonus from work or your tax refund is a great source of this extra cash. Plus you can sleep better at night knowing you just filled a large portion of the giant debt hole.
Step 5: Shorten your mortgage
Amortize your mortgage over a shorter period. On the above scenario changing your amortization period from 25 to 20 years will save you $65,000 with monthly payments and $100,000 on accelerated weekly payments! Talk about a great way to save!
Step 6: Pay cash (if you can!)
Pay cash for the entire house. Yes that’s right, save the money and pay in cash! You won’t make any friends at the bank but you have enough friends already and they’re not trying to steal your money.
Despite the many financial pitfalls of home ownership there are more than enough easy ways to reduce your debt. Following these steps, you should be able to reduce the true costs of your mortgage.
Have you considered purchasing a home with another person? This may be a great way to cut the overall purchase price and expenses in half! Millennials in major cities are purchasing homes together as the current prices are far too high for just one of the them to buy. Just like any partnership or business it is very important to make sure you have a co-ownership agreement in place to specify the responsibilities of each party and what the exit strategy is. Consider what happens if one owner wants out while the other(s) do not.
Perhaps an easier way to save is simply renting out a vacant room or town in the house to generate additional income which will make your house more affordable. You will further save on utilities especially in the common areas of the house as there will be more than one person using them. A common saying is “two can live cheaper than one”.
YOUR NEXT MOVE: RENT VS BUY
Your next move is a big one. If you have not yet purchased a home, should you? In looking at the analysis if you expect the home to double in value in 25 years than buying a house makes more financial sense. However we must consider that the interest rates will raise and in 25 years the housing market may be a downturn. That is why using the ways to save are so important to making your largest purchase work in your favour. Don’t let the biggest purchase of your life cripple you for life, enjoy your home, make it your own, don’t let it make you.