“To rent, or not to rent?”
That is the question facing a lot of young people today. In my position, I have heard just about every consideration and factor people use to make this decision. The overwhelming comment I hear is “I don’t want to pay someone else’s mortgage”. I’ve said it, and to an extent, I still agree with it.
I have to frame my recommendation based on the bigger picture. The decision is often more complicated than people anticipate. Different factors I consider when helping someone decide on whether they should ‘pull the trigger’ on a house purchase are: cash flow, risk exposure, equity, unexpected costs, and liquidity. Cash flow is by far the biggest consideration.
When I was starting my career as a paramedic in Sudbury, my wife and I entertained the idea of purchasing a house. My views on paying someone else’s mortgage were set in stone, and I wanted to move away from renting as quickly as I could. What stopped us (and I’m glad it did) was cash flow. We had an awesome renting situation and if we were to jump into a position of ownership, it would have made our financial situation tight. We would have had to pull back on other expenses (mainly luxuries), to accommodate the mortgage. In essence, we would be ‘house-poor’.
This has to do with your down payment. If you save $30,000 for a down payment, you may feel prepared for the purchase. What happens if you use all of your savings to buy a house, then lose your job or have an unexpected expense? Are you in a position where buying a house means sacrificing your emergency fund? We can transition the conversation to the use of debt instruments (credit cards, lines of credit, etc.) as a temporary ‘fix’, but I think most people would agree that going into more debt is not an ideal outcome.
It’s hard to argue against the investment growth attached to real estate. In MOST cases, real estate grows in value, but we are currently living in a ‘bubble’. The unfortunate thing about bubbles is that they eventually burst. We are strolling into a period of time where home owners are statistically making less (compared to the cost of living), saving less, and in more debt. The idea that a 25 year old can be a home owner on a normal income is becoming less appealing (and more unlikely) because it puts them in a large financial obligation that is unsustainable. This becomes even more apparent in bigger cities like Toronto and Ottawa. I was working with a couple a few months ago and their view on their house was that they would ‘keep it as long as they could’. Building equity is great, but sacrificing stability and flexibility is sometimes too high a cost.
If you’re a renter, you may have experienced the inconvenience of having to call your landlord when the hot water tank stops working. Now imagine if you had to pay for the repair yourself? Stack this on the unexpected costs from lawyers, accountants, taxes, etc. and it can make a manageable mortgage seem overwhelming.
Liquidity is simply the ability to get cash from your investment. If you had to sell everything you own and cash in all of your investments, how hard would it be to sell your house? And would you have to sacrifice the equity you were building to sell it quickly? Today in Kingston, we’re in a seller’s market. When the market shifts, the buyer will hold the power to get the most bang for their buck, and it makes it hard to protect the equity you hope to rely on in the future.
New home buyers may have heard of assistance programs like CMHC (Canadian Mortgage and Housing Corporation) and the government’s First Time Homebuyer’s Incentive. These are offered to help young people buy their first house, because even the government realizes that there is a housing bubble. CMHC fees (1.8-4% of your mortgage) are essentially a mortgage insurance that you must pay into unless you can produce a 20% down payment on your first home. This coverage protects both the buyer and the lender in the event that you can’t pay your mortgage.
The First Time Homebuyer’s Incentive is a bit different. The government essentially steps in and funds 5%-10% of the value of your new home with the stipulation that you pay them back the same percentage when you sell. This means that if you buy a house for $300,000 and they give you $15,000 (5%), you’ll owe them 5% of whatever you sell the house for. A few years go by and you sell the house for $350,000. You’ll also be writing a cheque to the government for $17,500.
There’s always a catch, and with this incentive, the catch is that the government gets to participate in the built-up equity within your home without taking any risk. Whether you sell based on your own decision, or the house is forfeited to the lender, they will get their money back. So the question I get asked is, “When would it make sense to do this”? and it’s a great question!
There are two streams of thought in my mind. First, I try to remember that ‘cash flow is king’. If the 5% from the government allows you to have more flexibility with your cash flow to save and invest, you may come out ahead. This way of thinking holds true as long as you don’t actively put money into your house. For example, if you were to buy the house and take the government incentive, you have created some flexibility with your cash flow. If you were to take your excess cash flow, save it, and use it to re-do the kitchen, you’ve increased the value of the house, and in doing so, the value of the government’s return on it’s investment.
Now there’s also the second consideration, and that is CMHC fees. If you have to pay CMHC fees, your mortgage is subject to an insurance cost of at least 1.8%. Currently, on the CMHC mortgage calculator, the rate is 4%. So, you buy your house for $300,000 and you have your 10% down payment. Whether you take the government incentive or not, you’ll be subject to CMHC fees. On the other hand, if you have 15% on your own and use the government incentive to take you to the 20% threshhold, you’ll end up potentially saving money. For example, a $300,000 house with a 15% down payment would result in a mortgage of $255,000 + $10,200 in CMHC fees (4%). A 20% down payment would save you the CMHC fees and in order to forfeit the equivalent amount to the government’s investment return, your home’s value would have to grow to a value of $504,000 ($25,200 = 5% of $504,000). That result is unlikely, and if it happens, you wouldn’t have much to complain about UNLESS the equity in the house was built on costly home improvements.
What’s the Real Return on Investment?
For math students, think about it this way. Every dollar you put into your house, you’ll repay at least 5 cents (but usually more) to the government. A $10,000 renovation may raise the value of the house by $15,000, of which the government will recapture $750. You still make $4250 in equity, but instead of paying back just 5%, you’re siphoning off 7.5% of your additional investment back to the government.
So, my final thoughts on buying a house as a young adult?
Don’t get sucked into the idea that you “have to own a house by the time you’re in your mid 20’s”. Without wanting to sound disrespectful, it’s an idea ingrained in our minds by an older generation who had different considerations to deal with than we have today. If you want/need to buy a house, be prepared for the reality and expect the unexpected costs that are associated with ownership. If you can take part in the housing market without stretching yourself too thin, it can be a good way to build long-term equity, but it’s not the guaranteed investment it’s made out to be. The fact that the government is increasing support for young buyers is a telling sign that they recognize the unsustainable growth that the housing market has been subject to over previous years. If you decide to buy a house, think about how the different programs and incentives will hinder you or benefit you in the long run.