Know the pros and cons when it comes to investing in real estate, and why waiting may be wise.
It’s one of the most important questions you’ll ever answer – should I rent or buy? The choice you make could have a long-term impact on your financial situation.
Keeping up with friends who’ve decided to purchase a home should not play a role in your decision. Ultimately, it’s about timing and what works best for your unique situation.
Why there’s no rush to buy a home
First, let’s shatter the myth that says you should jump into the real estate market as soon as possible. Home ownership does not automatically offer the highest returns, especially now that the market has risen so strongly over the past decade. Your decision about buying should be based on affordability and need, not expected short-term investment gains.
Some personal finance writers have debated whether you’d be better to rent for your entire life and invest the extra money you pay each month for owning a home – that includes mortgage interest, on-going maintenance and everything else. The Ontario Securities Commission funds an investor education website that includes a calculator to test out various scenarios.
In Canada’s major cities – including Vancouver, Calgary and Toronto – rental prices are not keeping pace with property prices, meaning many renters are living in neighbourhoods where they could not afford to buy a home.
The advantages and disadvantages of “forced savings”
For most people, owning a home is both a lifestyle and a long-term investment decision. The numbers support this decision, as two in three Canadians own their homes.1 The reason is simple: people put a great deal of intrinsic value in owning the roof over their heads and paying down a mortgage forces them to build financial assets.
Over the years, this “forced savings” approach becomes easier as wages increase and the share of income earmarked for a mortgage steadily declines. However, during the early stages of a mortgage these financial pressures can strain lifestyles and even relationships.
Why delaying a home purchase could be a very wise move
Delaying a home purchase may be a sound option for many people because it allows you to build a larger down payment. This allows for the potential to reduce your monthly mortgage payments. And if you manage to put 20 per cent down, you avoid mortgage insurance – which can cost as much as 3.35 per cent of the value of the mortgage.
A larger down payment also puts you in a much stronger position if housing prices take a short-term drop. With a 20 per cent down payment, a 10 per cent drop in your house value would still leave you with significant equity. With only five per cent down, you’d be in negative territory.
Try out the cash flow test run
Delaying a home purchase not only creates the opportunity to build a bigger down payment, it allows you to get a feel for how your monthly cash flow will change once you’ve bought a house. At minimum, you should save the difference between rent and your expected monthly mortgage payment. Take it to the next level by adding up and banking all non-mortgage costs, including property taxes, insurance, heating and other utilities. Condo buyers also have to factor in strata/maintenance fees.
The longer you maintain this “cash flow test run,” the bigger your down payment will be. Plus, putting your estimated budget for home ownership to the test will help you establish a financial comfort zone, helping you avoid becoming “house poor” – or being unable to afford anything other than your basic living expenses. After all, your goal is to own a great home and still have enough money to enjoy the rest of your life.
Expect the unexpected
When you work out a budget for the costs of buying versus renting, mortgage payments and other ongoing expenses are easier to estimate. The big unknowns are unforeseen repairs. A common rule of thumb is to budget for one per cent of the purchase price of the home for regular maintenance.
From a renter’s perspective, squirrels are a cute feature of city living, while a sudden thundershower is a perfect way to water trees and plants. But a homeowner may feel differently after discovering a squirrel has chewed a hole in their roof, causing rainwater to flow down walls and across ceilings, eventually flooding the basement.
The Canada Mortgage and Housing Corporation (CMHC) urges homeowners to put five per cent of take-home earnings in a special fund to cover emergencies, such as major house repairs or the loss of a job. Even if you can afford to buy a brand new home in your ideal neighbourhood, you need to account for repairs and upkeep as well.
Buying can help you create your own living space
Wanting to own a home isn’t just about money – it’s also about creating a truly unique living space that fits your personality. Renters, on the other hand, have few incentives to invest anything into customizing their home and they could be forced to move if the building is sold.
If you’re planning to have children, the stability of staying in one neighbourhood for an extended period may be important. As your family grows, the math behind the buy versus rent calculations may point to a purchase.
Why buying a “starter home” may not be right for you
For many, the next step is purchasing a “starter home.” Consider, though, that buying a less expensive home with the intention of eventually trading it in for a larger one in a nicer area involves major costs – including real estate agent commissions for selling the starter home, one-time taxes on the new home, closing costs and moving expenses. Added up, they could easily overtake any increase in your starter home’s value.
Owning for a relatively short time also increases the risk that the home’s value may decrease and not have time to recover. While house prices tend to rise over time, there may be short-term dips in the market. Renting in the short term avoids these risks and could actually get you into your dream home sooner.
Go big and go home
Delaying your home purchase may give you the ability to avoid going the starter home route, opening up the opportunity to buy the “forever home” that will serve you and your family for many years.
Buying a more spacious house before starting a family allows you to grow into it. Meanwhile, you can follow the lead of many first-time homebuyers and rent a part of the house to generate extra income. Then, once your family grows, you can convert the apartment into bedrooms and bathrooms for your kids.
Buying a home can be immensely rewarding and a wise financial decision. Prudent financial security planning, which may include renting a little while longer, can help ensure you achieve your goals while also keeping your finances in great shape.
1 Statistics Canada, 2011 National Household Survey: Homeownership and shelter costs in Canada, September 2011
The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature, and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.