Deciding To Buy

To own or not to own

For many, home ownership is a compelling dream.  We look forward to the freedom and security of owning our own home and are more than willing to make the sacrifices required to achieve our goal.  These include working hard and finding ways to save the money we ‘ll need to make our purchase.

But owning a home is not for everyone and you must consider your personal needs carefully before taking on this large responsibility.  Your decision to buy should include an assessment of your financial situation and how well you manage your money.

Remember, the primary purpose of buying a home:  to provide you/or your family with a comfortable place to live for several years or longer.

When should you buy?

Much has been written about the “right time” to enter the real estate market and become a homeowner.  The decision is especially challenging when the market seems to be changing.  If housing prices are falling, people tell you to wait until the market ‘bottoms out’ before buying.  When prices are increasing quickly, there’s an urgency to buy now and avoid being left behind.  Unfortunately, even the so-called ‘experts’ can’t accurately predict when a market will reach its peak or lowest point.

Think of your primary residence as a long-term investment.  No matter when you buy in a market’s cycle, home ownership will always be one of your best investment opportunities.  Rather than trying to “out-guess” the market, your decision on timing should focus primarily on your current financial situation.

Financial consideration

One easy way to evaluate your buying decision is to ask yourself, “If all else where equal, would I rather rent or own my home?”  It’s safe to say that most of us would opt for ownership.  So how do you make the financial choice?  By thinking about where you’d like to be in the future.

Let’s examine the housing situation of two couples, today and 25 years from now:

Ian and Elizabeth – today

Just rented a two bedroom apartment for $750 a month.  If they remain renters, they’ll pay a total of $328 998 in rent over the next 25 years (assuming an average rent increase of 3% annually).  That money is gone.

Doreen and Tom

Bought a three bedroom house for $145 000.  Their monthly payments today are $755 (6.9% mortgage rate amortized over 25 years).  Assuming this represents their average monthly payment* over the next 25 years, the’ll pay a total of $266 500 for their house – more than $100 00 less than Ian and Elizabeth paid in rent.

*This average encompasses both high and low payments as mortgage interest rates change over time.

Take a look at the financial position of these two couples 25 years from now.

Ian and Elizabeth

Are still renters, currently paying $1 525 in rent each month.  Although their incomes have kept in pace with the rising cost of living, now they’re worried.  Once they enter their retirement years, their rental costs will continue to grow while their income will remain the same.

Doreen and Tom

After 25 years, have paid off their mortgage and own their house free and clear.  Their home’s value has appreciated an average of 2% each year and is now worth approximately $230 000.  Their only cost to live in their home are taxes, maintenance and utilities, which their retirement income more than covers.

Making your money work for you

There are two additional and related factors that make home ownership financially attractive in comparison to other investments; leverage and capital gains exemption.  When a relatively small amount of your money controls a much larger asset, that’s called leverage.  For as little as 5% of a home’s purchase price, you hard-earned cash can be used to acquire a house with hundreds of thousands of dollars.  The more your money is ‘leveraged’ in this way, the greater the financial return on your initial investment (down payment) as the value of your house increases.  Few other major investments can be purchase with as little of your money.

The increase in a home’s value is called a capital gain.  When the value of most investments such as stocks or term deposits increase, you pay tax on the capital gain.  However, the government allows Canadian taxpayers to be exempt from paying capital gains when their principle residence increases in value.

Personal Money Management

The decision to buy versus rent depends on more than just investment opportunities.  It also hinges on your ability to purchase a property and keep up with the monthly financial obligations necessary to own it.

Another key consideration is how you manage your money.  The effort to save for and buy a home may require you to make significant changes in your way of life.  Do you have the temperament to be a home owner?

Checklist:

  • Over the years I have demonstrated the ability to save money and I am generally pleased with the amount I have saved so far.
  • I’m ready to change my spending and lifestyle habits to support the additional costs of paying for and maintaining a home.
  • I have worked hard to earn a good credit rating and continue to use credit wisely.
  • I’m prepared to enter into a long-term commitment for my family’s security, both physical and financial.
  • Pride of ownership is important to me and I would enjoy the chance to take care of my house, inside and out.

Affordability and your decision to buy

Perhaps you’ve considered the points raised so far, and have decided to buy a home.  Then a quick glance at the costs of today’s property prices, and your enthusiasm is quickly dampened!

If it makes you feel any better, most people are equally surprised when they first contemplated today’s home prices.

So…the good news!

A 25 year snap shot:

If you purchased a home in Edmonton in 1988 (25 years ago), the average median sale price was $88 600.  25 years later, that same property would be worth $334 500.  The mortgage would be paid, and you would of gained $245 900 in equity growth!

Where do you want to be in 2038?

Matching dreams with reality

Most first-time buyers want their dream home right away.  White picket fence, trees shading a huge yard, several thousand square feet of living space…you know the picture.  Your dreams may be somewhat different, but just as appealing.

The best way to deal with reality is to match your financial capabilities with the home that meets as many of your needs as possible.  Many first-time buyers purchase what is commonly known as a ‘starter home’.  There’s nothing wrong with this approach.  In fact, it’s good common sense to avoid buying a home that will stretch your budget to its breaking point.  Remember, the starter home is just that – a way to get started in a long term real estate investment.

Understanding the market

The housing market fluctuates, experiencing both strong and weak periods.  History has shown, however, that the market will rise in the long run.  Predicting how the market will go is nearly impossible, and if you wait around forever for the market to be perfect, you’ll waste a lot of potential investment money on rent!

Having said this, chances are you still want to know how the market works, because there are periods when it’s best to be a buyer
(and conversely) times when it’s best to be a seller.  You can see what the current market is like by asking your real estate agent how the current market compares to the past 12 months.

A good overall economy naturally produces a stronger market with more people looking to buy.  A strong economy also produces more construction and housing developments, opening the market to more new homes.

Buyer’s Market

Ideally, the best time to buy is during a buyer’s market, when many sellers want to sell but few buyers are looking to buy.  Homes take longer to sell, so buyers can take more time to make decisions.  To sell a home in this market, sellers have to list at aggressively competitive prices, and sometimes even offer other incentives.  If you have to sell your home during a buyer’s market, the good news is that you’re able to take advantage of these same conditions when you go to buy a home for yourself!

Seller’s Market

The opposite of a buyer’s market is a seller’s market.  Few homes are on the market, but buyers are plentiful, which results in fast home sales at prices close to, or even above, the listing prices.  Some homes sell even before they’re listed.  Because of the rise in sales, some owners may decide to take on selling their homes themselves.  In a seller’s market, buyers have less negotiating power and less time to decide, and may even find themselves in a bidding war.  So if you’re buying in a seller’s market, be prepared to make quick decisions.  Have all your homework done and your financing arranged.

Seasonal influences

Winter in Edmonton is notorious for being cold and unpleasant.  People don’t like to venture out much, unless it’s for necessities like groceries or to go to hockey games or do an activity like skiing.  Besides, who wants to look for a home when they’re busy buying gifts for the holiday season?  The winter months also tend to be slower for the real estate market because a lot of people with children don’t like to move during the school year.  A lot of properties aren’t on the market simply because sellers know their homes look best in the summer with the flowers, the leaves, and the sunshine.  This means there’s a good possibility that the homes on the market at this inhospitable time of year must be sold, so you may find a good bargain.  You just have to deal with snowdrifts and chilly temperatures on moving day.

Interest rates

If you need a mortgage to purchase your home, you’ll find that interest rates make a big difference in how much home you can afford.  When interest rates are high, fewer buyers tend to be in the market for a new home.  You can see the logic:

A 4.5% interest rate on a $200 000 mortgage loan will cost you approximately $9 000 in interest in one year, while the same $200 000 loan at a 7% interest rate will cost you about $14 000 in interest!

Different types of mortgages can increase or decrease your interest rate from what banks consider the current standard.

Government programs and incentives

Canada Mortgage and Housing Corporation (CMHC) is a Crown corporation, of the Government of Canada.

One of the main functions of the CMHC is to manage the federal Mortgage Insurance Fund (MIF), to provide protection to banks reluctant to enter the mortgage lending market.

Today its main function is managing providing insurance for residential mortgage loans to Canadian home buyers.  This insurance protects mortgage lenders against mortgage defaults on mortgages for which insurance has been purchased (mandatory on loans with less than 20% down although lenders may require it on loans with more than 20% equity if they perceive additional risk of default).  Besides mortgage insurance, the agency provides financing to housing projects and renovations, does housing market analysis and funds research into housing design and technologies along with the National Research Council.

The economy

The overall health of the economy is probably the most influential factor.  Broadly speaking, when the economy is sluggish, so is real estate.  This is generally measured by economic indicators such as employment rate, manufacturing activity, the prices of goods and services and so on.

People need to feel safe and secure in there current and future financial positioning.  Job stability, pay increases, and minimal inflation rates help buyer’s feel confident in their purchasing decision.

Ultimately, it’s both buyer’s and seller’s economic perception that drives the influence of today’s real estate market.

Is it the right time to buy?

This is a personal question only you can answer.

Buying a first home is one of life’s major milestones.  You can do this successfully and have fun along the way if you do a little homework and make good home buying decisions.

Doing well on your first home gives you the credit, down payment and appreciation needed to move up to your dream home, and for most people, the key to a stable financial future starts with buying your first home!

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