I was recently introduced to a client who couldn’t decide if it was better to purchase a home and get a mortgage or keep renting. She had been renting the same home for over 8 years. She was comfortable and she was really reluctant to make any big changes, like taking out a mortgage Calgary.
Really, the main reason she was even considering this was that her landlord is planning to redevelop the home and build an infill.
What to do?
Own a home with a Mortgage or Keep Renting with no mortgage?
My client currently pays $1,200 per month for rent but her rent hasn’t changed for many years. To get a comparable place, she would have to spend $1,500 per month. This client has been saving for many years and has enough for 20% down.
She wanted to purchase a condo in the same area that she currently lives. After reviewing all her information we determined that she would purchase a condo for approximately $300,000 with 20% down. This purchase price and subsequent mortgage would keep her payments within her budget.
My client then went to her bank to find out what she needed to do to withdraw some of the money from her investments and RRSP’s to purchase her first home. The investment adviser at her bank asked what she was planning to do. He then said that she should re-think purchasing a home and just keep renting. The investment adviser said that her investments are better left with the bank than used as a down payment for the purchase of a home.
Later that day, she advised me that she had changed her mind and didn’t want to purchase a home anymore. She just wanted to rent.
As a home owner and former banker myself, I was really surprised by the advice that her investment advisor was telling her. I thought I would give her a little analysis to compare investing in a home (where there is no capital gains on any increased value) versus investing in mutual funds with the investment adviser at her bank.
Home Purchase of $300,000 with a mortgage of $240,000
Let’s consider a purchase price for the condo at $300,000. I estimate that the property taxes were $150 per month and the Condo fees were $250 per month. These were average numbers for condos that she had previously been looking at.
I also assumed that the rent payments for a similar property is $1,500 per month. Again this number is average for the area she was looking at.
At current interest rates, her payment would be $1,522.29 per month. This total payment comprises a mortgage payment of $1,122.29 per month, property taxes ($150) and condo fees ($250). Therefore she would be paying $22.29 extra per month to own a home instead of renting a similar home.
After 5 years, for the home that she owns, she would have made total payments of $91,337.19 versus total mortgage payments (assuming no rental increase) of $90,000.00.
After 5 years, her mortgage balance would have decreased from $240,000 to $204,703.72. That works out to be $35,296.28 of equity that she has gained by owning the home. She gained no equity in the rental property and she is still debt free with no mortgage either.
I then compared the home value after 5 years assuming that the property value increased by 0%. 1%, 2%, 3% and 4% per year. No one knows how much it will increase, therefore I thought that these 5 scenarios would offer a reasonable comparison.
I then compared the $60,000 that she would potentially use for her down payment. If she was renting, then these funds would still be invested and generating a return. I compared the final value of the $60,000 after a compounded annual return of 2% through 18%.
If she purchased this condo with $60,000 down, then after 5 years she would have $95,296.28 in equity build up. Her $60,000 would have effectively gained $35,296.28 even if the condo didn’t increase in value at all over the 5 year period and she is only paying an extra $22 per month to own versus rent.
If she wanted to generate a similar increase by investing in mutual funds, or some other investment, she would have to receive a 10% annual (after tax) return on the $60,000 investment.
Needless to say, she has decided to start looking for a condo to own, instead of rent! She doesn’t really want to go into debt and get a mortgage, however the principle reduction and gain in equity is excellent.
Are you currently renting? You don’t need 20% down to purchase your first home like this client did. You can purchase with as little as 5% down. If you have excellent credit, then you are also allowed to get a loan for the down payment, as long as you can afford the payments with the mortgage.
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