Buying vs renting a home

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Don’t roll your eyes just yet. This is not another debate as to whether renting is better than buying or conversely. I am actually not advocating for either option. I have been both a renter and a homeowner. In fact, I have rented more than I have owned.

I noticed there is a lot of calculators out there to help people determine which option would make the most sense financially.

Most of these calculators are flawed for various reasons; the biggest one being that they calculate based on gross income instead of net. They also don’t take into account non-financial factors, which could have a huge impact on your decision.

So, I have come up with my own analysis: non-financial factors and financial ones.

buying a home is a long-term project

Where do you see yourself in five years? As a rule of thumbs, five years is the minimum amount of time you need to stay in a property to break even or be ahead financially.

During the first five years, you pay more interests than principal on your mortgage. You also need to recoup the closing costs you paid.

Don’t get fooled by crazy real-estate markets like Toronto or Vancouver. It can be tempting to sell  after a year or two, but you would actually be losing money by doing so.

if you need to buy a car or two, keep renting

Transportation costs in Canada are very high. They can -and will- eat-up a huge chunk of your income.

if you have student loans or credit card debt, keep renting…

…at least for the time being. Pay-off your debt or significantly lower it before looking at buying. Debt repayments are a huge financial burden.

A lot of recent graduates seem to be obsessed with becoming homeowners as soon as they receive their degrees. It sounds a little bit crazy to me.

So, you have determined the above first point applies to you and the second and third don’t. Let’s do some basic math.

35% of your net income is the maximum for housing costs

Lenders always use gross income to qualify people for mortgages and other loans. The problem with that is your gross income is not what is deposited in your bank account.

Always use your net income and really avoid going over 35%.

compare apples with apples

Compare the cost of renting and buying based on similar properties in similar neighborhoods. Renting or buying a two bedroom apartment will cost more than a one bedroom or a bachelor. You can find rental info on Craigslist or Kijiji.

include very comprehensive costs

Buying costs do not stop at the mortgage payment. Unfortunately, too many people can’t seem to look past this.

If you are buying a condo or townhouse, include: mortgage, strata/condo fees, monthly portion of property tax & any other municipal taxes, monthly portion of home insurance, monthly portion of Hydro and monthly portion of maintenance.

If you are buying a single, detached home, include: mortgage, monthly portion of property tax & any other municipal taxes, monthly portion of home insurance, monthly portion of maintenance and monthly portion of all utilities: hydro, gas, water….

a word on maintenance costs

As a homeowner, the biggest difference from being a tenant is that you are responsible for repairs and maintenance. And yes, you will encounter these! The costs will be different if you own a condo or a single detached house.

In a condo building, most of the maintenance costs such as landscaping, snow removal, elevator etc…are usually included in your strata/condo fees. Big ticket items, such as the roof, are shared costs. You are only responsible for repairs inside your unit. Costs are overall lower. Take 0.5% to 1% of the proposed purchase price. That’s your yearly costs. Divide by 12.

For a single dwelling, you are 100% responsible for all the costs and they are usually higher. Use 1.5 % to 2% of the proposed purchase price.

You may not spend the amount in a given month or year, but it is best to err on the side of caution.

final word

If the number you end up with is lower than the renting cost AND does not exceed 35% of your net income, happy house-hunting! Otherwise, keep renting and invest the difference.

If home ownership is important to you, you owe it to yourself to do the above basic calculations.

There will always be opportunity costs whether you own or rent. The answer to this old age question is not so clear-cut anymore.

 

5 thoughts on “Buying vs renting a home

  1. millennialmoneyclub says:

    What I did in my mid-20s was buy a 4-unit using FHA 3.5% down financing. I lived in one unit, and rented out the other three. You only have to live in it for 12 months, and then you can move wherever you want and rent out the unit you used to live in.

    So in this way, I both invested in real estate and bought a home.

    I wouldn’t have thrown 20% down at a 4-unit (if I’m investing in real estate, I’d rather put my money in the big stuff, not little 4-unit deals), but because it was only 3.5% down to live for free, it was a no-brainer.

    And because I only put 3.5% down, I had a decent chunk of money left over (+ cash flow from the tenants) to put into “real” real estate in the form of two private placements (a beachside development deal + a buy, rehab, retenant, refi apartment syndication).

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    • Stephanie says:

      Thanks for stopping by. In Vancouver -Canada-, this would require an awful lot of money upfront. A 4-unit lot would be very expansive. The minimum down payment here is 5%, but if you are using part of the property as rentals, you might be required to put the full 20% down to obtain financing. Not sure where you live in the States, but the Canadian real-estate market is overall pretty hot.

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      • millennialmoneyclub says:

        Yes, the FHA program here in the States presents an amazing opportunity for young people to get into property early. The loan limits for an FHA loan vary by area. For example, in my area, the FHA loan limit on a 4-unit in 2017 is a little over $1.2 million. So to get into a $1.2 million property, you would only need to put $42,000 down.

        This is pretty stinking amazing considering that in 30 years when the mortgage is paid off (by the tenants over the years), the buyer is sitting on a 7-figure property they own free and clear that cash flows thousands (if not by that time tens of thousands) of dollars a month that they got into for only $42,000.

        The only kicker is that on all 1-4 unit mortgages in the United States, if you’re putting down less than 20%, you have to pay extra “mortgage insurance” because your loan is considered riskier than a property financed with at least a 20% down payment. But hey, if it cash flows, it cash flows!

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      • Stephanie says:

        It seems like there are more flexibility in the US. In Canada, mortgages on rental properties do not qualify for mortgage insurance, so you have to put a full 20% down payment.

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