I’m getting a new deck this summer. The fence in the back yard is falling down and desperately needs replacing, and my last attempt at making a patio in the back yard has turned into a muddy mess. So, it just makes sense to get a low deck built while the contractors were here anyway.
I wish I didn’t have to bother with this. I wished I just rented. Sure, people always complain about not being able to fix up a place when they rent, but I’d really rather move to a place with a nice fence and deck instead of shelling out $5000 to build a new one.
Yes, $5000. And half of that is just for the lumber. This is in Canadian dollars, but convert it to whatever currency you like and it’s still a lot of money. Every year, actually, there’s something that costs a lot of money in a home. It’s really made me understand that housing is not an investment. It’s a consumable item that’s not much different than buying a movie or a good set of tools. Whether it’s worth the cash outlay depends on a lot on how you plan to use it, how long you’ll own it for and what your rental alternatives would be.
Try here for a calculator to figure out if you should rent or buy a home. When I ran my own numbers, I would have come out ahead by $60,000 if I had rented for the past 16 years instead of purchasing my home. And I’ve owned my house during the biggest run-up in property values in history! The number that tanked my calculations (on the calculator and in real life) has been the endless repairs and upgrades I’ve done to my home. Yes, the $50,000 reno made a kitchen just the way we like it, but I could also have taken 10 around-the-world trips for the same amount of money that would also have left a smug smile on my face. The deck and fence are just the tip of the iceberg.
Every year in a house something goes wrong that costs between $3000 and $10,000. I’m getting to the point in home ownership that I’m now aware that those things actually get used up over a decade or so and need to be replaced AGAIN. That new furnace? It was $6000 to replace and, oh wait, it’s not new anymore. It’s almost 10 years old and will probably break next winter. And that’s in addition to the $150 annual servicing it requires. Ditto for my new (no, wait… it’s 8 years old) roof. The floors need re-sanding. I just got some very old, weird plumbing re-done ($4000) but it didn’t stop the drain from backing up in the basement last winter (fixed it for free! Yay!) I know I’m just griping, but I really want to impress upon you gentle readers that real estate is a consumable item.
If you think I’m spending a lot of money on fixing up a house, trust me, I’m pretty average. I do a lot of the work myself, which I do enjoy, but really… every weekend? Couldn’t I just go watch a movie or something? Or maybe volunteer with Habitat for Humanity if I wanted to look butch in work boots. I still spend the 1-2% of the value of the house on maintenance that is generally expected. So why don’t I sell? Because I don’t want to pay $30,000 in sales fees, legal fees and taxes to get rid of it.
I’m not saying buying a home is always a dumb idea. I’m also not jumping all over real estate as an asset just because it’s gone down in value recently. I am hoping, though, that people will be more willing to listen to reason now than there were during the market mania of the past few years. I have bit my tongue as friends line up to buy fixer-uppers, over-priced condos and particle-board mansions lost in suburbs that I would never normally visit. Take it from me, a veteran homeowner, that there are a few things to consider if you are thinking of buying a house.
1. The rental market is not the same as the housing market.
I know many people look for a home in a completely different neighbourhood than where they rent. Once people enter the housing market, they realize they can get a nicer house in a neighbourhood that is further away, more run-down and so on. And yet, they compare the cost of owning there with the cost of their current rent in their downtown, genteel neighbourhood. This is like comparing apples and oranges. I try to tell them that it would also be cheaper to rent in that neighbourhood – have they ever looked into it? Most of them, incredibly, tell me that they’d never rent in this area. They’re only there to buy.
If you are comparing direct costs of renting and buying comparable properties in a comparable neighbourhood. Then decide. The rental and real estate markets are not as related as you might think. In fact, as more people buy there are fewer renters, which creates a seller’s market in real estate and a renter’s market in renting. And of course it can go the other way.
2. Actual costs of home ownership
For some reason, people think that renting is throwing away your money. It’s not. It’s the consumable element of housing coming into play. It costs the landlord a certain amount of money every year for you to live there. In addition, they will charge a premium or take a loss on their investment, depending on the market at the time.
As an owner, I ‘throw away money’ on property taxes, heat, hydro, mortgage costs and the aforementioned repairs. Those last two items are the biggest. Maintenance is about 1-2% on average, and a typical mortgage rate is about 5-6% over the past 10 years. That means that I will end up paying roughly double what I borrowed by the time the house is paid off, i.e. a $100,000 mortgage costs you $200,000 by the time it’s paid off. You can save quite a bit if you pre-pay the mortgage, but then, you could save even more if you bought it in cash. For most people, though, your property needs to appreciate at the same rate as your mortgage interest in order for you to make money, otherwise your interest payments are ‘throwing away your money’ no less than rent ever was.
There are two lessons to be learned here – one is that you should get a small mortgage that you can pay off aggressively. If you’re a couple looking to buy, get a mortgage that you can still afford even if one of you loses your job. You’d be foolish to assume that neither of you will be unemployed, return to school, get sick or have kids in the next 25 years. A small mortgage will help protect you from being forced to sell in a bad market.
The other lesson is that the mortgage payment is just the beginning of the home ownership costs. You still have to pay heat and hydro, possibly cable and property taxes. My own mortgage is about a third of my monthly housing costs.
Then you’ve got the other 6-8% per year in consumable costs (maintenance and interest charges). Take a good hard look at these costs and decide if you couldn’t use the money somewhere else. Yes, my house has increased in value over the 16 years, however, my down payment alone would have also doubled in the same time period even in a very safe, guaranteed investment.
3. Pay attention to inflation
A typical mortgage rate over the last 10 years has been about 5-6% during a period while inflation has been trickling in at 1%. This is important because it’s very different from what my parents would have experienced with their mortgage. Inflation is great if you’re in debt. Your wages hopefully rise with the tide while your debt payments recede into oblivion. My parents’ mortgage payments would have been laughably tiny after a decade of 1970s inflation. However, if inflation stays low, so will your wages. This means the payments you’re making now will have roughly the same impact on your household budget in 25 years. This means that if you’re stretching to make payments now, that feeling won’t go away until you’re ready to retire.
This is called being ‘house poor’ and it is sometimes praised as a ‘forced savings plan’ because you keep on making huge housing payments instead of spending money on other things. This is all fine, unless those ‘other things’ happen to include food, travel, a movie once a month or the financial capacity to have children. An unbalanced budget will leech the fun out of life and it will go on for most of your adult life or until you sell. If you look at the housing market and realize you can’t afford a reasonable house without pouring everything you’ve got into it – you can’t afford a house. Stop there and reconsider your next move.
4. Factor in your personal stability
Owning a home is a very weighty thing. It’s usually a huge amount of equity but it’s tied down. It means you can’t be kicked out by a greedy landlord, but it also means that escaping crappy neighbours can take most of a year to manage a sale. It’s an impressive sum in your net worth, but chipping off small pieces of equity is barely worth the trouble. A secured line of credit is usually only 1% more than an unsecured line of credit, and the bank would be just as happy to lend you money if you had $100,000 of equity in bonds than in real estate.
The problem with home ownership is that selling a house is very expensive. As withmany investments, your chance of profit goes out the window when you are faced with fees. Selling a home is a process full of fees that usually run 5-8% of the total value of your home. This is insane. This is especially insane if you don’t really own all that much of your house. You pay these fees on the full value of the house even though your equity is relatively small. This often wipes out any profit you’ve made.
For this reason, it’s generally most profitable to buy a home that you will be in for a long time.
Under 10 years is not a long time, in case you were wondering.
If you are not sure about where you’ll be working, if you’ll be working, if you’ll be single or if you’ll have 3 children… then you should wait to buy a home. Buying and selling often will burn up any investment value you have in the property.
5. When should you buy a home?
You’re probably thinking I’m completely against the prospect and, to be honest, I’m extremely sceptical. I purchase my house for half of what it’s worth and I still don’t think I made the right choice. I could probably have done better by renting. The real problem is that there’s a lot of unknowns involved. If you spent some quality time with that online calculator, you probably quickly realized that small factors have a big impact on the end result. You don’t know what interest rates will be in 20 years, or whether inflation will sit at 2% or 2.5%. I don’t think you need to go crazy trying to micro-manage the decision. Just do the math, weigh your options, make sure you’re making sense, and then go in with your eyes open.