Question. Hi, I’ve been renting an apartment for the past few years, and it’s great. However, I’m wondering if I should buy something instead? Many of my friends have recently bought houses, and they’re encouraging me to do the same. I guess it seems like a natural progression to buy something eventually, but I really like my apartment, and so I’m feeling somewhat conflicted. Can you help me with this decision?
Answer. Eventually, most of us will find ourselves in a situation where we need to evaluate the merits of a real estate purchase, or where we are trying to weigh the pros and cons of renting versus buying.
Like so many other things, there is no universal right or wrong answer here. A house isn’t always a good purchase, nor is it always a bad purchase. For some people, and at some times in their lives, purchasing may be the better choice. At other times, renting may make more sense.
A real estate purchase is not to be taken lightly. Indeed, for many of us, buying a house represents the largest single purchase we ever make in our lives. So how can you decide what’s best for you? Let’s take a look at our top 5 things to consider, as you evaluate this very important life event.
Buying a House: Top 5 Things to Consider
1. How long do you plan to live in your house?
In most cases, buying makes more sense when you plan to live there for a long time, but may not be the best decision if you plan to move again in the short term. Why? There are two key reasons – mortgage interest, and transaction costs. Although your mortgage payment may remain fixed for a period of time, the amount of each payment that is allocated towards interest versus principal is not fixed. And in early years, mortgage payments are overwhelmingly interest, which means very little is going towards actually buying the property. As for transaction costs, buying and selling real estate is not like buying and selling stocks on an exchange. Real estate transactions typically involve commissions, inspection fees, HST (on a new property), land transfer fees, title registration, and other closing costs. So, while there are lots of stories of people who have “flipped” a property and made a handsome profit in a short period of time, the reality is that it seldom makes financial sense to buy a property if you plan to move again within a few years.
2. How secure is your job?
This is somewhat related to the previous point – you might be planning to live in your house for a long time, but that plan could be out the window in a hurry if you lose your job.
Unfortunately, a job loss can one of those things that’s a complete unknown until it becomes a reality. However, there can be some factors to keep in mind when it comes to the likelihood of job security – for example, government employees typically enjoy much greater job security than those who work for small start-up firms.
Further, job security might not be related to a job loss, but could also be related to relocation. If your company has operations elsewhere, or is expanding operations to a new jurisdiction, ask yourself how likely it is that you will be required to relocate.
In short, if you feel that your job may be in jeopardy for any reason, renting may make more sense, at least until you feel you’re in a position where you employment and income is more stable.
3. How much do you have saved for a down payment?
Almost no one buys a house with cash. For the most part, if you’re buying, you’re borrowing.
According to Canadian lending standards, if the purchase price of your property is $500,000 or less, you’ll require a minimum down payment of at least 5% of the purchase price. So, for example, if the property is $400,000, then you would require at least $20,000 for a down payment, at which point you could borrow the other $380,000 (95% of the purchase price) through a mortgage.
However, note that 5% is the absolute minimum requirement. This, in no way, means that you should only put down 5%. The larger the down payment, the more you’ll save in mortgage interest in the long term.
Keep in mind that the down payment requirements vary depending on the purchase price. For a property that costs $500,000 to $999,999, the minimum down payment is 5% of the first $500,000 of the purchase price, and then 10% for the portion of the purchase price above $500,000. For properties that cost $1 million or more, the down payment is 20% of the purchase price. Although these prices would be extreme in some parts of Canada, $1 million in considered average in others.
4. How much can you afford?
When you apply for a mortgage, a bank (or whichever institution you deal with) will assess your circumstances in order to determine how much they will lend you. Of course, the bank wants to be repaid, so they have to determine what the maximum amount they can lend.
In order to make that determination, two key measures are considered, which are your:
- TDSR – Total Debt Servicing Ratio
- GDSR – Gross Debt Servicing Ratio
To find out how to use these ratios to determine your own borrowing capacity, check out the Canada Mortgage and Housing (CMHC) website.
However, just because you can afford to borrow a specific amount of money, doesn’t mean that you should. Unfortunately, although it seems obvious that borrowing the absolute maximum an institution is willing to lend you is not necessarily a good idea, many people do exactly that, and borrow at the upper limit of what they can afford.
5. Renting versus Buying a house – How do your monthly costs measure up?
Some people feel that rent is just throwing money out the window, and that buying a house is an investment. That’s simply not true. Further, there are many hidden costs of ownership, including:
- Mortgage interest – this is perhaps the most overlooked cost of ownership. Consider a mortgage for $400,000 @ 6.5% for 25 years. How much interest do you think you’d pay over the 25 year period? Over $403,000. More than the amount you borrowed in the first place.
- Property tax – unlike a mortgage, property taxes never go away. And likely never decrease, either. This is another significant cost incurred by owners.
- Maintenance and repair – again, renters are typically not responsible for the general upkeep and maintenance of the property, whereas owners are.
You may be thinking, what about heat, electricity, internet, cable, water, etc? Of course, you’d be right to think about those things as well, as they also represent significant costs associated with owning. However, in most cases, a renter pays those costs as well, so they usually aren’t unique to owners.
In short, when doing this comparison, make sure it’s realistic, with all costs and expenses included in your calculations.
The decision to rent or buy is one that most of us face sooner or later. A real estate purchase is a big decision, and should be made with care. Don’t forget, it’s not always just the math – buying a house is also a lifestyle choice, as there are many other personal factors to consider as well.
If you have any other questions about renting versus buying, or about any of our other products and services at ModernAdvisor, just ask us.