Buying A Home

For many people, homeownership ranks near the top of their financial goals. Buying a home is seen as a major milestone in life. You get a job, buy a home, start a family, then your kids go out and do it all over again.

Unfortunately, in many cities around the world the prices of homes have been rising at an unsustainable rate, far outpacing increases in income. Buying a home has become an incredibly expensive proposition. It’s a financial decision that should be considered carefully.

For those who plan on buying a home in the near future, I’d suggest the following:

• Run the math on renting vs buying — you may be surprised by the result
• If you’re still in favour of buying, make sure you understand the “all-in” costs of homeownership
• Create a savings plan to get you there

The Rent Versus Buy Debate

The debate over renting or buying a home is a classic argument in the personal finance world.

Jim Collins’ article, Why Your House is a Terrible Investment, is a good starting point.

Common wisdom holds that “buying is always better than renting”, or “renting is just flushing money down the drain”. It’s simply not that simple.

The truth is that in some scenarios, buying a home is better than renting, and in some other scenarios, renting a home is better than buying. I know it’s not a satisfying answer, but it’s the reality. Depending on the some assumptions (home purchase price, home price appreciation rate, mortgage interest rate, rent price, opportunity cost of your down payment), the answer can swing either way.

As a result, it’s very important that you run the math on whether buying is a home is better than renting a comparable home. You can use this calculator which I’ve built to run that Rent vs Buy math. You should try out a few different scenarios so that you get a good sense of how much the answer can change even after making small tweaks to the assumptions.

Once you realize that either renting or buying can be the better long-term financial decision, it becomes clear that this decision is mostly a lifestyle choice. I’ve written further on this in my article, The Soft Side of the Rent versus Buy Equation.

The point being — give the option of renting a fair shake. Don’t blindly assume that buying a home is always a better financial decision.

The “All-In” Costs of Homeownership

While the cost of a mortgage may be the biggest cost when buying a home, it’s far from the only cost that you’ll incur. Before making the decision to buy, be prepared for the other “hidden” costs of homeownership:

• Property taxes
• Maintenance and repairs
• Homeownership’s insurance
• Condo fees / Strata fees / HOA
• Closing costs to buy a home (legal fees, home inspection, land transfer tax, etc.)
• Costs to sell a home, if and when you move (broker’s fee) — often ranges from 4 to 6% of the total home sale price

Over and above your mortgage, this can add up to thousands of dollars when you first buy your home, thousands of dollars per year in ongoing costs while you own your home, and tens of thousands of dollars when you eventually sell your home. These costs are definitely not a rounding error that you can sweep under the rug.

Make sure that you do your research so that you can reasonably estimate what these costs might be. It would be worthwhile to talk to other homeowners in your area to get a sense of what these costs might be.

Check out Zillow’s estimate of the “Hidden Homeownership and Maintenance Costs” by U.S. metro region.

Creating Your Savings Plan

Now that understand what the “real” costs of buying a home are, its time to put a savings plan in action.

I firmly believe that you should target to save up a down payment of at least 20% of the purchase price. By doing so, you’ll avoid paying for mortgage insurance (called “CMHC” in Canada; “PMI” in the U.S.). If you don’t have a 20% down payment, you’ll need to delay your purchase so that you can continue saving up, or adjust your expectations downwards and opt for a cheaper home.

In addition to the down payment amount, you’ll need to save a few thousand dollars extra for your closing costs (legal fees, home inspection, land transfer tax, etc.). Before jumping in and making an offer on a home, talk to a local real estate lawyer to get a sense of the typical range of closing costs in your area.

To summarize: your target savings goal should be 20% of the purchase price of the home plus a few thousand dollars for closing costs. To meet your savings goal, consider setting up regular automatic deposits and bear down until you get there.

While you’re saving up for your home downpayment and closing costs, this money should be held in low-risk investments such as a high-interest savings account. Your home purchase fund should not be invested in the stock market.

As discussed previously in this course, stocks can be extremely volatile in the short term. If you invest your house fund into the market, you risk losing 40%+ of your money when it comes time for you to buy a home. Not a great idea. Since you need this money in the short term (<5 years), the prudent move is to forfeit the potential investment gains, and keep your money invested in something offering low risk and low reward.