Transitioning from renting to buying: Here's what you need to know
There’s an idea that over the long term, renting is actually more cost effective than buying. All of those extra costs that come along with a home make ownership unattractive. Property taxes, repairs and maintenance make for a negative dividend; unlike many stocks that pay dividends to investors, homes take money away.
But there’s a case to be made for owning your own home. When you own a home, the rent doesn’t go up at the landlord’s whim. When you own a home, you’re free to maintain it to your own standard (which may be much higher than that of a frugal property manager). When you own a home, nobody can kick you out because they think they can find someone else to pay higher rent.
And despite what many experts say on the subject, I argue that home ownership is the more cost-effective option in the long run, if done right. Many comparisons that show renting is cheaper compare the average rented home to the average owned one, ignoring the fact that many more apartments are rented than owned, and many more houses are owned than rented. The math doesn’t show that it’s cheaper to rent; it shows that it’s cheaper to live in a smaller home.
The market has a say in all of this, too. Simple economics wouldn’t allow for millions of properties across the country to be rented out at a loss. Landlords make money because, over time, the cost of owning a home is lower than the cost of renting one.
There are many benefits to homeownership, but the transition from renting to buying isn’t seamless. Your mortgage lender will have fewer opinions about what colour you can paint your walls than a landlord, but they’ll have a lot more questions about your bank account. And if something needs fixing, it’s on you.
With that in mind, here’s what you need to know about the transition from renting to buying:
You need a down payment
To get a mortgage, the first thing you need is a down payment based on the purchase price of the home. The minimum is 5% of the first $500,000 and 10% of anything over that (or 20% if the home is worth more than $1-million). To afford the average apartment in Toronto priced at $552,2691, a first time homebuyer in Ontario will need a down payment of at least $30,227.
Saving that amount of money is no small task but there are tools available that can make it easier. A high interest savings account can help your money grow faster than in a regular savings account. And if you qualify as a first-time homebuyer, you can use a government program called the home buyers’ plan to withdraw money tax-free from your RRSP to buy a home.
You need to pay closing costs
To buy a home, you need a lawyer. And to get a lawyer, as we’ve all learned from watching TV, you need money.
With due respect to real estate lawyers, this type of law doesn’t make for exciting TV. Luckily for first-time homebuyers, that means you won’t need fistfuls of cash to hire a real estate lawyer. The typical transaction will cost around $1,500.
This expense is well worth it, however. Your real estate lawyer will make sure there are no problems with your purchase agreement, do a title search to make sure there are no legal problems with the home you’re buying, purchase insurance that protects your title to the home, and make sure your money gets safely to where it needs to go. Plus, your lawyer is an added layer of protection in case something goes wrong with the transaction.
The amount you can borrow for a mortgage will be limited
Lenders use a calculation called your debt service ratio to determine how much mortgage you can afford. Your debt service ratio compares your income to your total cost of owning a home, which includes your entire mortgage payment, property taxes, heating, and ½ of condo maintenance fees. To be approved, your home cost can be no more than 39% of your pre-tax income.
Lenders also use a second calculation that adds your other debts into the mix. Your credit card payments, car payments etc. added to your home costs can total no more than 44% of your pre-tax income.
There’s also the small matter of the stress test- a wrinkle in this calculation stemming from government regulation that requires you to qualify for your mortgage at a much higher interest rate than you’ll actually pay. Even though today’s best 5-year fixed mortgage rates are currently around 3.39%, the benchmark qualifying rate is 5.39%.
If all this gives you a headache, a mortgage affordability calculator can do the math for you.
Mortgage rates are going up
It wasn’t long ago that homeowners thought 5+% for a mortgage was an amazing deal – that’s about where mortgage rates were in the mid-2000s before the great recession. Rates fell steadily for a long time until they reached a low in late 2016, but now they’re going up.
Mortgage rates could rise sharply over the next few years, especially variable mortgage rates which are tied to the prime rate in Canada. The Bank of Canada, whose policies directly influence variable-rate mortgages, has been raising rates steadily over the last couple of years and is expected to continue.
There are a few things to be concerned about when it comes to rising mortgage rates.
The first is affordability. When rates go up, you’ll need to make bigger payments to cover your mortgage. That directly affects the amount you can afford to borrow to buy a home. The only way to afford a more expensive home is with a bigger down payment.
The second is renewal. If you buy a home this year, and rates rise sharply after that, there’s a chance that you might not be able to afford your new payment when it’s time to renew your mortgage. The stress test mentioned above is meant to mitigate this, though.
Home prices are a consideration, too. If rates go up, home prices could come down. That means there’s a possibility that you could end up owing more money on your home than it’s worth.
It is possible to go from renting to buying, and for many people it will be a positive change for both lifestyle and finance. However, there are barriers to entry and risks to be aware of. Save more than you think you need, and leave room in your budget for mortgage rates to go up.
– Jordan Lavin for Ratehub.ca