Buying vs. Renting

At some point in their lives, most Canadians have probably asked themselves whether it is better to buy or rent. Unfortunately most people look at it solely from the perspective of comparing monthly payments, but there is so much more to it than that. Ultimately, the decision is a personal choice, but it helps to look at ALL the pros and cons of buying to determine whether home ownership is right for you.

Some advantages of buying a home

Owning a home is generally considered to be a sound, long-term investment that can provide satisfaction and security for you and your family.

Each month when you make your mortgage payment, you are building equity in your home.
Equity is the portion of the property that you actually build through your monthly payment versus the portion that you still owe the lender.

At the beginning of your mortgage, more of your payments go toward paying off the interest and less toward paying off the principal. But the longer you stay in your home and the more mortgage payments you make, the more principal you pay off and the more equity you accumulate.

Most mortgages also offer you the option of making additional monthly or annual payments to reduce your principal faster. Some prepayment privileges, for instance, enable you to pay up to 20% of the principal per calendar year. This will also help reduce your amortization period (the length of your mortgage), which, in turn, saves you money.

There is also a tax advantage. If your home is your principal residence, any profit you make when you sell it is tax-free. A home can appreciate – or increase in value – as time passes, building more equity. As you build up equity, it’s usually easier to upgrade to a more expensive home in the future thanks to the profit you’ll make when selling your current home.

As an owner, you can also decorate and improve your home any way you like. Ownership tends to give you a sense of pride and can offer you and your family stronger ties to the community.

If you do decide that home ownership is right for you, it’s important to choose a home you can afford. If you can’t afford to buy your dream home, purchasing a more modest home can be a great place to start building equity that one day may allow you to buy the home of your dreams.

Since we’re currently in a buyer’s real estate market and interest rates have been dropping, now may be an ideal time to enter into home ownership for the first time.

Some disadvantages of buying a home

Since it’s easy to get caught up in the excitement of buying a home, it’s important to remember that home ownership has some additional responsibilities as well.

For one thing, a home can be expensive. Chances are, your monthly payments will be more than what you are currently paying in rent when you factor in such things as your mortgage, property taxes, repairs and general maintenance.

Owning a home ties up some of your cash flow and is likely to reduce your flexibility to move to a new location or change jobs.

While your home might increase in value as time goes by, don’t expect to get a big return quickly. There are no guarantees that your home will increase in value, particularly during the first few years. In the beginning, you could actually lose money if you sell because your home may not have appreciated enough to cover the real estate fees, and moving, renovation and other selling costs.

Real estate is, however, usually considered a good investment over the long term.

When making the decision about whether to buy or rent, it’s important to carefully choose a home you can afford, and then weigh the pros and cons. Millions of people enjoy the rewards of home ownership but, ultimately, it’s a personal decision based on your own priorities.

Switch After 12 Months?

One of the advantages of variable rate mortgages over fixed rate mortgages is they are easier to get out of...or at least a lot cheaper. To get out of a fixed rate mortgage, you need to pay what’s called an Interest Rate Differential. Ultimately it’s a formula that most people won’t understand, which typically results in a ridiculous penalty to get out of the mortgage. Variable rate mortgages are a little more straight-forward in that the penalty to break them is three month’s interest. Still not a “cheap” exit but there are times where it makes sense to pay the penalty to break the mortgage.

One year ago, people were paying prime rate for new variable-rate mortgages and 18 months ago it was prime + 0.60%. Today, the market is down to prime – 0.70%, or thereabouts.

For those who got their mortgage 12-18 months ago, many wouldn’t even consider refinancing as an option. But, I would argue it could be a very financially smart option.

Let me illustrate.

First, let’s assume our hypothetical borrower has:

• A 5-year variable-rate term
• A $300,000 mortgage amount
• A 25-year remaining amortization

Now, suppose:

• Our homeowner's mortgage is at prime rate (2.75%) today
• She switches to a new variable-rate mortgage at prime – 0.70% (2.05%)
• Prime rate increases 25 bps on Sept. 8
• Rates then stay put until June 2011 (according to most economists)

Here are the results:

• Interest savings: $10,014 (hypothetical over 60 months)
• Penalty: $2,062 (three-months of interest)
• Discharge Fee: $250 (depends on lender and province)
• Net benefit of breaking early: $7,702 (roughly)

Remember, the savings is in the spread against prime so whether prime goes up or down over the remaining term of the mortgage, the savings is the same. For most people, saving thousands over 3-5 years isn’t exactly the worst idea. So, if you’re currently in a variable at prime rate or above, find a mortgage planner to see if it makes sense to switch.