Buying vs. renting is one of those eternal questions that millions of Canadians will ask and answer throughout their lives. But, even if your parents believe it is, it is not a simple question !
You may have heard that renting is "dead money" that you're throwing money down the drain if you don't buy a home. However, it isn't a fair comparison. The truth is that even a house you own, whether with or without a mortgage, has a certain amount of "dead money" attached to it. So, from a financial standpoint, the rent vs. buy debate is far more complicated than "buy a house as soon as you can afford it." (And that's without taking into account the recent drop in housing affordability).
Here's some more information about the renting vs. buying debate in Canada. The short version is that it will be determined by various factors, including your lifestyle, finances, and the local real estate market (or where you want to live).
Renting vs Buying a Home: Pros and Cons
The rent vs. buy debate is about much more than money. The lifestyles of renters and homeowners can differ significantly, which you should consider along with your financial situation. Here are some of the benefits of renting and purchasing a home, taking into account both lifestyle and financial considerations.
Advantages of Renting
Flexibility: Renting does not bind you to anything. If you plan to move soon or on a regular basis, renting allows you to leave a place as soon as your initial lease, which is usually 12 months, expires. This isn't really possible with a mortgage because there are financial penalties for breaking a mortgage and taxes to pay whenever you sell a property.
Less Expensive: Renting is generally less expensive than buying a home, at least in the short term. If your household income is insufficient to qualify for a mortgage, renting is usually a more cost-effective option. Renting, on the other hand, can provide you with more disposable income to spend or invest if homeownership isn't for you.
Alternative Investments: Just because you're a renter doesn't mean you can't save for your future. Renting allows you to invest the extra money you save in the stock market, a GIC, your own education, or even start a business. If you work hard and get lucky, some of these could pay off even more than owning a home !
Advantages of Buying
Stability: When you own a home, you have complete control over the situation. You don't need to ask a landlord or property manager if you want to paint, replace the floor, renovate, or add an ensuite; you just do it! Owning a home also means you won't be evicted unexpectedly because your landlord's second cousin's 19-year-old daughter needs a place to stay for 6 months each year.
Capital Gains: If your home's value rises, being a homeowner means you'll keep the extra equity and realize capital gains if you decide to sell (minus capital gains tax). If you're renting, the only person who benefits is your landlord – if you're really unlucky, a price increase may result in your landlord selling the house or raising your rent! Of course, if prices fall, it is the homeowner, not the renter, who bears the brunt of the loss.
Equity: Every monthly payment on a mortgage helps you build equity in your home. While some of your mortgage payment is used to pay interest on your loan, the remainder is used to pay off the principal. Interest will make up a larger portion of your payment at the start of your mortgage, but it will decrease over time.
Investment: Part of the allure of homeownership is the fact that it makes investing in your future simple. You won't have to worry about stocks, bonds, or other financial products if you pay off your house because you'll have a guaranteed asset that will last you the rest of your life (unless you want to). Property prices are generally stable (until they aren't, but that's another storey), so it's a safe bet. If you're looking for a straightforward long-term investment strategy, homeownership comes with one built-in.
The 5% Rule For Renting vs Buying
When people discuss the costs of owning a home versus renting one, they frequently misunderstand and underestimate the costs of owning a home. The 5% rule is a good rule of thumb for deciding whether to rent or buy, and it will also help clarify the actual costs of renting and buying. It's a little tricky, but we'll guide you through it step by step.
Here's the complete 5 percent rule:
Total Unrecoverable Cost
What is the total cost that cannot be recovered ? The total unrecoverable cost is the amount you pay for a property that you don't get back in the form of residual value. When it comes to paying off a mortgage, the residual value refers to the home equity you've built up over time, which is a financial asset you can use in the future.
The total unrecoverable cost when renting is simply the amount of rent you pay. This is because you don't own the house, and your rent isn't used to buy an asset or make an investment.
The total unrecoverable cost is more complicated when you buy a house. It's made up of three different non-recoverable prices:
• Property Investment Taxes
• Maintenance of your residence
• The credit interest rate
The 5% Rule of Thumb
This is where the 5% of the total comes from. Each year, property taxes are around 1% of your home's value, maintenance costs are also around 1%, and the cost of credit is typically around 3%. That means that the total annual unrecoverable cost of a home you own should be around 5% of the total value.
So, if you can rent for less than 5% of the annual value of a comparable home, you should probably keep renting and invest the difference in an RRSP, TFSA, or the stock market. Buying a home where the property value is less than 5% of the rent is probably a good option.
Now, this is a simplification of an already-simplified rule, and there's a lot more to it if you want to fully comprehend it. Ben Felix, a financial planner with PWL Capital in Ottawa, has created a video about the 5% rule that is specifically tailored for Canadians.
The important thing to remember is that renting or buying is not always a better or superior option. Even a fully paid-off house has overheads that you will have to pay in perpetuity. Renting allows you to make other investments and respond more quickly to opportunities that arise in your career or other areas of your life. If still, you're unsure about which option is best for you, talk to Guglu Homes, a leading financial advisor and mortgage broker in Canada.
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