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.
Monday, November 30, 2009
Monday, November 23, 2009
Throwing Away Your Money
I used to be quite convinced that renting was just throwing your money away. Over time though, I've learned that everything is not quite so black and white.
I like what was said about it in The Wealthy Barber. It states that shelter is a necessity and there are only two ways to get it. You either rent or you own. It's no more throwing away your money than buying groceries or clothes.
If you think of owning as an investment, like most investments, you need to be in it for the long term. Prices fluctuate, there are market corrections, and in the short term the value of your home could decrease. So one obvious time where renting makes the most sense is when you don't plan to live in an area for very long. Also, sometimes the area you want to live in might not be a great investment area. So you can't count on the home increasing with value or increasing with a decent return on investment.
So like everything else you need to evaluate whether renting makes sense for you and for your situation. Regardless of owning or renting, you don't want to spread yourself too thin. So, if you can't afford to own, Don't Do it!
Now that I've said that, given the right circumstances, I still see more benefits in owning over renting for most people in most normal circumstances.
The biggest argument I've ever heard for renting, is that you can invest the money you save by renting. That is assuming that renting is cheaper of course, which it probably will be if you put less than 20% down. To make a fair comparison of rent to mortgage you need to add the maintenance costs and/or strata fees to the mortgage. So if for example you save $100/month by renting you could then invest that difference.
While I think it's theoretically possible to make more money renting and investing the difference, I haven't seen it in practice. The problem with that theory is that you need to be able to make more money than the increase in the value of a home would have been.
The magic number everyone seems to like to use for housing price increases is a 6% per year increase on average. Of course the real number will vary drastically based on a number of factors including location. But, for arguments sake, let's assume that 6% is correct for you. It almost seems logical that if you could earn more than 6% on an investment (say 8%) you'd be better off renting. The problem is that this doesn't take into consideration the 6% is on the total property value not just your personal investment.
Let's say you put $7,250 down on a $145,000 condo. The following year the value goes up by 6%. That's 6% on $145,000, not $7,250. That's $8,700 which is more than 100% increase on your investment. Before you say I ignored the interest payments to the mortgage, I haven't really. Ignoring the equivalent in rent which you'd have to pay as your alternative, you paid $7,250 plus 100 more per month. Even then, you invested $8,450 for an increase of $8,700.
In my case I put nothing down and the value of my condo has increased by about 41% in 4 years. Now that's a higher than normal growth and it was luck and not skill on my part that I got in when I did. There is no investment I could have made that would have gotten me the same growth if I had invested it elsewhere. None that I know of anyhow!
Some other benefits I find to renting over owning:
As long as you don't experience sky rocketing interest rates, your payments will generally remain unchanged. Whereas rent will continue to increase and close that $100 gap. When you do sell, you also get some if the rent equivalent money back which would never happen with renting. Or if you stay put and don't move, eventually your mortgage is paid off, all you have left to pay is the maintenance fees and taxes. That certainly leaves you with more money to invest than the renter at that point.
Even without selling you build up equity in your home. Equity is the difference between what your house is worth and what you owe. So another advantage is that you can borrow against this money. Like anything this can get you into trouble too, so you need to be careful. Using this money allowed me to get out from a debt burden I couldn't have done without selling my place.
Another example of using the equity would be if you needed to make repairs in order to sell, but couldn't afford it until after it was sold. Also, at some point in the future I'd also like to purchase a second home for and investment and this is likely the best way for me to have the down payment.
So while rent is a valid option for providing shelter and might be the best option for some people, I still see more benefits to owning in the long term. Hopefully this helps someone. If not, I still enjoyed getting my thoughts written down somewhere. Feel free to correct me on anything you think I went astray on.
I like what was said about it in The Wealthy Barber. It states that shelter is a necessity and there are only two ways to get it. You either rent or you own. It's no more throwing away your money than buying groceries or clothes.
If you think of owning as an investment, like most investments, you need to be in it for the long term. Prices fluctuate, there are market corrections, and in the short term the value of your home could decrease. So one obvious time where renting makes the most sense is when you don't plan to live in an area for very long. Also, sometimes the area you want to live in might not be a great investment area. So you can't count on the home increasing with value or increasing with a decent return on investment.
So like everything else you need to evaluate whether renting makes sense for you and for your situation. Regardless of owning or renting, you don't want to spread yourself too thin. So, if you can't afford to own, Don't Do it!
Now that I've said that, given the right circumstances, I still see more benefits in owning over renting for most people in most normal circumstances.
The biggest argument I've ever heard for renting, is that you can invest the money you save by renting. That is assuming that renting is cheaper of course, which it probably will be if you put less than 20% down. To make a fair comparison of rent to mortgage you need to add the maintenance costs and/or strata fees to the mortgage. So if for example you save $100/month by renting you could then invest that difference.
While I think it's theoretically possible to make more money renting and investing the difference, I haven't seen it in practice. The problem with that theory is that you need to be able to make more money than the increase in the value of a home would have been.
The magic number everyone seems to like to use for housing price increases is a 6% per year increase on average. Of course the real number will vary drastically based on a number of factors including location. But, for arguments sake, let's assume that 6% is correct for you. It almost seems logical that if you could earn more than 6% on an investment (say 8%) you'd be better off renting. The problem is that this doesn't take into consideration the 6% is on the total property value not just your personal investment.
Let's say you put $7,250 down on a $145,000 condo. The following year the value goes up by 6%. That's 6% on $145,000, not $7,250. That's $8,700 which is more than 100% increase on your investment. Before you say I ignored the interest payments to the mortgage, I haven't really. Ignoring the equivalent in rent which you'd have to pay as your alternative, you paid $7,250 plus 100 more per month. Even then, you invested $8,450 for an increase of $8,700.
In my case I put nothing down and the value of my condo has increased by about 41% in 4 years. Now that's a higher than normal growth and it was luck and not skill on my part that I got in when I did. There is no investment I could have made that would have gotten me the same growth if I had invested it elsewhere. None that I know of anyhow!
Some other benefits I find to renting over owning:
As long as you don't experience sky rocketing interest rates, your payments will generally remain unchanged. Whereas rent will continue to increase and close that $100 gap. When you do sell, you also get some if the rent equivalent money back which would never happen with renting. Or if you stay put and don't move, eventually your mortgage is paid off, all you have left to pay is the maintenance fees and taxes. That certainly leaves you with more money to invest than the renter at that point.
Even without selling you build up equity in your home. Equity is the difference between what your house is worth and what you owe. So another advantage is that you can borrow against this money. Like anything this can get you into trouble too, so you need to be careful. Using this money allowed me to get out from a debt burden I couldn't have done without selling my place.
Another example of using the equity would be if you needed to make repairs in order to sell, but couldn't afford it until after it was sold. Also, at some point in the future I'd also like to purchase a second home for and investment and this is likely the best way for me to have the down payment.
So while rent is a valid option for providing shelter and might be the best option for some people, I still see more benefits to owning in the long term. Hopefully this helps someone. If not, I still enjoyed getting my thoughts written down somewhere. Feel free to correct me on anything you think I went astray on.
Wednesday, November 18, 2009
Financial Choices
This may seem to be a strange way to start off a financial blog by talking about choices. Actually, it was the realization of the choices I have available to me that got me on the path to financial enlightenment. My wife and I were struggling with a very serious debt load and were wondering how we were going to be able to pay our bills for the month. It was then that I picked up the book Rich Dad, Poor Dad and started reading.
It opened my eyes to a whole new way of looking at my finances. I started to take serious looks at statements I had just taken for fact, like "your home is your greatest asset". I'll get into the specific things I re-evaluated and the conclusions that I came to in future articles. The point here is that I learned to do my homework, look around at my current situation and evaluate if I was making the right decisions or not.
Really finances are all about choices. Do I spend my $20 on a new Barenaked Ladies CD, go out for dinner, or buy the new Star Trek movie. Do I pay down my mortgage faster or contribute more to RRSPs. The choices are endless.
I think we all feel "trapped" at some point in our lives. Like the choices have been made for us and we're not happy with where we're at. I know it was that way for me at least.
I was at a point where I hated my job and my financial condition. Yet, I felt like I had no choices. Like I was trapped. I couldn't get another job because of previous choices I had made. I didn't have my degree. I didn't have experience with the main stream programming languages. I couldn't get a raise. The list goes on and on.
Then one day it just "clicked". I wasn't dead yet. Nothing was written in stone. So, if I wasn't happy with my choices, it was time to make new ones.
So, I decided I wanted to go back to school. I didn't really want to pursue programming anymore so I was looking for something more along my interests. I weighed all my options and decided to go for my CGA designation. I could do it part time so I didn't need to quit my job while my wife is finishing her nursing degree. Besides I hear they pay well when you're done ;)
Even though I still have a long way to go and I'm still working my crappy programming job, I have hope again. I'm making the choices for my future instead of letting them control me.
Then I noticed choices everywhere. Even the things I decided not to change are still my choices. After reading Rich Dad, Poor Dad, I scared my wife as I contemplated selling and chosing to rent. With the equity we had it would have been enough to take us straight out of debt. Instead we decided to use the equity to make our debt more managable while keeping our home.
I even contemplated the idea of moving to Ontario where the housing prices are MUCH more reasonable. While I still think that would give us a leg up financially, I can't tear myself away from this beautiful province I grew up in. But at least it gives me perspective when I think I can only afford this 2 bedroom condo. That's a choice in itself and no one is forcing me to live in this beautiful place.
The choices that everyone has are virtually endless. So it's always frustrating for me to hear someone say they have no choices and they're stuck. You won't always like the choices you have, but you'll always have choices.
Some choices are opposites and you have to choose the best one for you. For example, I want to be an accountant, but I don't want to go to school. So I had to decide which one was more important to me. Obviously I'm now enrolled. :)
Some choices just take time. Like I want a large detached home in the lower mainland of BC right now, but it's not going to happen over night. However, I am making decisions that will make that dream a possibility one day.
If you're not happy with your current choices, make new ones. You are the only one stopping yourself from being happy. Sometimes it's easier to just do nothing and blame circumstances or other people for your situation. Let me tell you what I realized though. It's not them it's you. Avoid the temptation to be lazy and let things happen. Evaluate your situation and if you aren't happy do something about it. Once you start to look you'll be overwhelmed with the choices you have available.
In future articles I'll talk more about the specific decisions. Like renting vs owning, which mutual funds to invest in, etc.
It opened my eyes to a whole new way of looking at my finances. I started to take serious looks at statements I had just taken for fact, like "your home is your greatest asset". I'll get into the specific things I re-evaluated and the conclusions that I came to in future articles. The point here is that I learned to do my homework, look around at my current situation and evaluate if I was making the right decisions or not.
Really finances are all about choices. Do I spend my $20 on a new Barenaked Ladies CD, go out for dinner, or buy the new Star Trek movie. Do I pay down my mortgage faster or contribute more to RRSPs. The choices are endless.
I think we all feel "trapped" at some point in our lives. Like the choices have been made for us and we're not happy with where we're at. I know it was that way for me at least.
I was at a point where I hated my job and my financial condition. Yet, I felt like I had no choices. Like I was trapped. I couldn't get another job because of previous choices I had made. I didn't have my degree. I didn't have experience with the main stream programming languages. I couldn't get a raise. The list goes on and on.
Then one day it just "clicked". I wasn't dead yet. Nothing was written in stone. So, if I wasn't happy with my choices, it was time to make new ones.
So, I decided I wanted to go back to school. I didn't really want to pursue programming anymore so I was looking for something more along my interests. I weighed all my options and decided to go for my CGA designation. I could do it part time so I didn't need to quit my job while my wife is finishing her nursing degree. Besides I hear they pay well when you're done ;)
Even though I still have a long way to go and I'm still working my crappy programming job, I have hope again. I'm making the choices for my future instead of letting them control me.
Then I noticed choices everywhere. Even the things I decided not to change are still my choices. After reading Rich Dad, Poor Dad, I scared my wife as I contemplated selling and chosing to rent. With the equity we had it would have been enough to take us straight out of debt. Instead we decided to use the equity to make our debt more managable while keeping our home.
I even contemplated the idea of moving to Ontario where the housing prices are MUCH more reasonable. While I still think that would give us a leg up financially, I can't tear myself away from this beautiful province I grew up in. But at least it gives me perspective when I think I can only afford this 2 bedroom condo. That's a choice in itself and no one is forcing me to live in this beautiful place.
The choices that everyone has are virtually endless. So it's always frustrating for me to hear someone say they have no choices and they're stuck. You won't always like the choices you have, but you'll always have choices.
Some choices are opposites and you have to choose the best one for you. For example, I want to be an accountant, but I don't want to go to school. So I had to decide which one was more important to me. Obviously I'm now enrolled. :)
Some choices just take time. Like I want a large detached home in the lower mainland of BC right now, but it's not going to happen over night. However, I am making decisions that will make that dream a possibility one day.
If you're not happy with your current choices, make new ones. You are the only one stopping yourself from being happy. Sometimes it's easier to just do nothing and blame circumstances or other people for your situation. Let me tell you what I realized though. It's not them it's you. Avoid the temptation to be lazy and let things happen. Evaluate your situation and if you aren't happy do something about it. Once you start to look you'll be overwhelmed with the choices you have available.
In future articles I'll talk more about the specific decisions. Like renting vs owning, which mutual funds to invest in, etc.
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