Rent Vs Buy is a million dollar question for a lot of first-time-home-buyers. Buying a home is one of the biggest purchases of a persons life and that is why many first time home-buyers question should they continue to Rent Vs. Buy? Here’s a guide that answers a first time homebuyers rent vs buy question.
Mike and Sarah (lets call them M&S) live in Toronto and are in mid late 20s, both are employed full-time. The couple have some disposable income now that they finished paying their student debt. They also have savings of approx. $55,000 on which they earn 4-5% per annum. The couple rent a one bedroom and den for $2,550 per month and pondering their own Rent s. Buy decision. They are also wondering what can afford to buy and more importantly if buying a good decision.
Real Estate prices in Toronto
According to Toronto Real Estate Board (TREB), the average price of a condominium apartment in Toronto was $616,000 in Q4 2019. Assuming that Mike and Sarah buy an average priced condo for $620,000. How does buying a condo apartment stack up against their monthly rent of $2,550.
Two big closing costs incurred when purchasing real estate are Land Transfer Costs and Mortgage Insurance or default insurance (applicable if borrowing more than 80% of the purchase price). Let’s explore them in some more depth.
Land Transfer Tax:
Land transfer tax is a tax most provinces charge to transfer the onwership of property from one person to the next. All provinces have some form of land transfer tax or fee. Homebuyers in the City of Toronto incur an additional municipal tax.
To encourage home ownership; Ontario, British Columbia, Prince Edward Island and the City of Toronto offer land transfer tax rebates to First-Time Home-Buyers (FTHB). In case of M&S, the land transfer on their purchase will be $8,800 for the province and $8,800 for the City of Toronto. However, as FTHBs, they qualify for a rebate of $8,475 and they will end up paying $9,300 in land transfer costs on their first home.
Mortgage default insurance, is mandatory in Canada for down payments between 5% and 20%, also known as high-ratio mortgages. Canada Mortgage and Housing Corporation (CMHC) provides the required default insurance. It is calculated as a percentage applied to the total mortgage amount. Depending on the down payment, these insurance costs can range from 0.6% to as high as 4.5% of the mortgage amount. Since M&S borrow almost 95% of the purchase amount, mortgage insurance cost for them is 4.5%.
On-going costs of buying a home
Lets explore the couples purchase costs and on-going monthly costs in more detail. From a cash flow perspective, buying a condo requires higher payments initially. Buying costs M&S ~$3,500 compared to their current rent of $2,550, almost a thousand dollars more than their current rent.
One of the main reasons why buying costs more (in terms of cash flow) than renting is because the money borrowed for the purchase is returned (called mortgage payments) with each mortgage payment, and these payments include both interest on the money borrowed and some principle paydown such that the loan is paid back over an agreed timeframe. Thankfully, M&S have the disposable income to afford this extra cash outflow.
Fast forward 10 years…
M&S are now married and have a 2 year old with another one on its way. They have thoroughly enjoyed living in their condo. With a growing family, the condo now feels a bit cramped and the couple have decided to sell it to buy a larger home.
Lets explore how their rent vs buy decision panned out. Home prices appreciated on an average 4% during this time with the inflation at around 2%. The table below estimates their rent payments and tenant insurance payment over 10 years had they continued to Rent. It also estimated their costs of ownership (interest payments, property tax costs, condo fees and the cost of selling their condo). Their condo has is now worth $920,000 compared to their purcase price of $620,000. Compared to renting, they saved $330,000.
Most importantly, they now have substantial equity in their current condo for a large downpayment for the bigger space required for their growing family.
To sum it up
Owning a home has many benefits. You build equity over time by paying down the mortgage. It is also usually a good investment, the price of a home appreciates over time. It can also provide more privacy and peace of mind than renting. M&S decided to purchase a home and clearly did very well.
However, home ownership may not be for everyone. It is a committment to own a home. During the inital years, it is more expensive to own than renting. You are also responsbile for the maintenance of the home, so it can also be more work.
Before you make the leap from renting to owning, analyze your current financial situation and short-to-medium-term goals. Also consider the stability of your job, the city where you want to live in, your life style choices. Homeownership is a big step. The question is not rent vs buy, the real question is are you ready to own.