Monday, November 30, 2009

Home Sweet Home

Last week I discussed home ownership vs renting. This week I wanted to take a look at owning a little bit more.

Someone once told me to buy the largest home you can afford. I didn't really discuss this with him at all, but it certainly was an appealing statement. After all, who doesn't want to own a large beautiful home. Since then though, I've heard some compelling reasons to do the opposite.

The argument is that if you can afford to make the higher payments for the larger home, you can afford to make additional payments to a smaller home. Most banks allow you to make both increased payments every month and a lump sum payment every year (usually on the anniversary). The amount of these prepayments vary from bank to bank, but they all go directly to the principal amount.

The other way to increase your payments on the home is to get a shorter amortization. Meaning you pay your home off in 15 or 20 years instead of the standard 25 years (or 35 for a lot of people in Vancouver).

By paying this less expensive home down faster, you pay less interest and more principal. You can then end up owning the home you originally wanted (or a better one) mortgage free faster.

Stealing some number from a seminar I just had with Doug Fordham, CA, here's an example. Although the number are a little low for the Vancouver area. For simplicity it ignores housing value increases.

If you have $20,000 down and can afford $1,500 per month you can either purchase a $250,000 home with a 25 year amortization or a $175,000 home with a 12 year amortization. If you choose the $175,000 home after 12 years you're mortgage free and can then sell the home and then buy the $250,000 home. It would then only take you 5 years to own the $250,000 home. 8 years sooner than buying it directly. You can then either move to a bigger home again or invest the difference. Either way, you are way ahead by not buying the largest home you can afford.

The other nice thing about buying a home that is more affordable, is that you don't have to panic when interest rates rise 1%. Which also means you can take advantage of choosing a variable rate interest rate. Or, if you're not comfortable with going variable at least you can choose a shorter term.

The Wealthy Barber Recommends a 5 year fixed rate and it is one of the only things I disagreed with in the book. According to Dr. Milevsky's Research Findings, choosing a variable rate mortgage would have saved consumers $20,000 in interest payments over 15 years (based on a $100,000 mortgage). It also states, consumers would have been better off borrowing at prime rate (variable) compared to a 5-year fixed rate 89% of the time.

With Variable your mortgage is generally lower than the fixed rate too. So if you pay the same as you would have with fixed you end up paying more of the principal down every month.

Couple other things to consider when you are purchasing a home. If you put less than 20% down you will have to get a high ratio mortgage, which means you have to pay for CMHC insurance. Also, you may want to look at the different mortgage options available. Right now I'm looking at the RBC Homeline plan. It's a mortgage with a line of credit (LOC). As you pay down the mortgage, the room on the LOC automatically increases. So you don't have to go beg for money at the bank when you need it later.

Something I seriously considered and ran the numbers on over and over again was moving. BC is the most expensive province to live in, in all of Canada. Over $200,000 more to live in Vancouver than Calgary or Toronto for example (the closest cities in pricing to us). BC in general is $100,000 more than any other province.

However, we decided we love BC too much to move. Living in BC is a choice though and we recognize that it has a cost. So while we could own a large single detached home 20 minutes out of Ottawa, we've decided we'd rather buy a town home and stay here in Surrey, BC. The cost for the two homes is about the same. Now that I recognize that as a choice though, I'm not resentful about owning a town home when I'd rather have a detached home. Like I said before, it's all about the choices we make.

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