When I published my last blog post on the fact that it does not always make sense to keep the matrimonial home in a divorce, I received emails from people heading into a divorce for whom that issue was timely. Should they rent or buy another home, they wanted to know?
Then I heard from a younger woman whose friends and family are badgering her to buy a house. She earns a good living, saves money every month, and pays rent. For some reason, her entourage is bugged by her rent payments. “Why throw your money away every month?” they ask. “Why not grow some equity in a place that’s your own? It’s a great investment!”
Don’t you love it when your uncle Bob or the person in the cubicle next to yours gives you unsolicited advice when they haven’t the faintest clue what they’re talking about? Unless Bob is a real estate expert or a successful investor, why would you listen to him?
More importantly, do all these people who are giving you advice know the first thing about your goals and values? Does owning a home even fit into your plans? Unless these people know about your plans, the market, and your financial situation, they are in no position to comment.
Full disclosure: I am a real estate investor. I have been purchasing rental properties for the past thirteen years. I say this because I want you to know that I am a big fan of real estate as a means of growing wealth.
And yet, there are times when it does not make sense. Let’s consider a few situations and scenarios that might give you cause to reconsider owning.
You have credit card debt
I know what you’re thinking: “Why is she talking about credit cards again? What is it with her? What does credit card debt have to do with buying a home? And so what if I have credit card debt? It’s not uncommon.” Annoying, but pertinent. The argument that so many people use for buying a house is that it is a good investment. But is it really?
Not when you have credit card debt for which you are paying a fortune: 18% – 29% interest. There isn’t a house in any neighbourhood, in the entire country, that can compete with costs like that.
If the goal is to make the wisest possible choice with your cash – that is, a good investment – why would you put it into a property that will behave like a liability (i.e. cost you money) the entire time you own it and net you maybe a 4% annual return, if you’re lucky, when you are shelling out 18%-29% in interest costs on credit card debt?
Do yourself a big favour: Pay off all your credit cards, learn to live without carrying a balance, and then address the other considerations. Just because a lot of people go into home ownership with credit card debt doesn’t make it a good choice.
Your future appears to hold more questions than answers
If you’re headed into a divorce and you’re not sure how that’s going to impact your finances, you’re in a job with a shaky future, or you’re dealing with a health issue, it’s worth taking the time to ask a few questions before buying a(nother) home:
- Do I have a secure income? If you work for the federal government, you may have fallen victim to all the craziness going on with the Phoenix pay system. Some people have not been paid in months. Months! What would that do to your ability to cover a mortgage?
- Do I have sufficient income to cover the many costs of home ownership (i.e. repairs, maintenance, carrying costs, etc) as well as the new costs added to my daily life courtesy of the divorce/possible job loss/health issue?
- Are there any pressing issues that will take up a lot of my bandwidth in the next year – health issues, ongoing nastiness from the divorce, mounting legal bills, challenges regarding the children?
Rushing into a purchase because you’re trying to finalize a separation is rarely a good thing. If you’re facing a lot of brain-sucking issues at the moment, it may be a good idea to rent for a year, giving yourself time to adjust to your new situation, wrap up some of the loose ends, and evaluate what’s really in your highest, best interests.
This isn’t just about divorce. Fifteen months before I lost my first husband, Malcolm, to cancer, we bought a house in the country. What were we thinking?! I wasn’t thinking – that was the problem. I just wanted to support Malcolm in any way that I could, and I neglected to carefully evaluate our situation. He was seriously ill and I was dealing with a business that depended entirely on him. These factors alone should have stopped me cold. Not only did we buy a house, though, we bought one in the country, completely ignoring the Golden Rule of Real Estate: Location, location, location.
It was a costly mistake that I paid for dearly after Malcolm’s death. Continuing to rent would have been a much smarter option all around. I would have saved tens of thousands of dollars had I resisted the urge to become a home owner at that time.
Decision-making under the influence
One of the best pieces of advice I received as a thirty-two-year-old widow was this: Don’t make any major decisions for the first year after a traumatic experience. Focus on finding your new normal, then start sorting out the big stuff.
If you’ve just been through a difficult situation, give yourself ample time to think. What seems like a huge priority at the moment might evolve with time and distance. Owning a house is a big responsibility. If it’s a good idea all around, it will still be a valid choice in a year’s time. Plus you’ll have more time to grow your down payment.
Speaking of down payments
How much of a down payment do you have? Is it the bare minimum or do you have the full 20% to avoid paying CMHC insurance? Use this calculator to figure out how much more you’re going to pay to own the house if you have less than 20% to put toward the purchase. This is another cost that needs to be factored in.
Rent payments ≠ Mortgage payments
I hear this argument all the time: I bought a house because because the mortgage payment was the same as my rent payment. The implication is that there is an equal exchange when, say, you swap $1,500 in monthly rent payments for $1,500 in mortgage payments. The problem is that they are not equal. Not even close.
Rent payments include most of the costs of living in a residence, not including utilities and content insurance. However, when you are a homeowner, the mortgage payment is just the beginning. Here is a list of other costs that are not included in the mortgage:
- property taxes
- repair costs
- maintenance costs
- landscaping/yard maintenance costs for houses and townhouses
- condo fees (for condos)
- insurance for the structure, at replacement value, over and above content insurance
The other mistake people make is talking about equity accumulation with every mortgage payment without also considering the interest costs. Let’s face it, for the first couple of years, you’re pretty much paying off the doorknob while the majority of your mortgage payments are chewed up by interest costs.
According to Credit Karma: “It comes as a surprise to some that most of your initial payments on a loan are used to pay interest. For example, in a 30-year mortgage over 83% of your payments are used to pay down interest in the first year, while only 3% of your payments are used to pay down interest in the final year. This is the primary reason why little equity is built in the first few years of a mortgage.”
Sure, you build equity, but you do so very slowly in the beginning. Owning a home really pays off after several years of ownership when there is greater principle pay down and, you hope, some growth in the value of the home (i.e. equity appreciation).
What can you really afford?
Lenders will look at your income and some of your expenses, wave their increasingly grumpy financial wand, and tell you what you can afford according to their requirements. But that’s not the whole picture. In their calculation of income to expense ratios, they only factor in a fraction of your expenses. They have a number for heating costs and they look at the property taxes. They also look at how much debt you’re already carrying. What they won’t consider, though, is the fact that you pay more than $1,000 per month per child in daycare costs. Or the fact that you have significant medical expenses to cover, and so on.
In ten years of working with families to rehabilitate their finances, I can’t tell you the number of files I’ve seen where people end up being house poor because they maxed out their buying potential without considering their cash flow needs.
Here’s an idea: If you’re keen to buy a house, run an experiment for six months. Go to a mortgage broker to determine how much lenders think you can afford in a mortgage. Then, figure out what the property taxes, insurance costs, repair, and maintenance costs would be – use the suggested numbers in this article if you’re unsure of average costs. Take the total, subtract the amount of rent that you pay, and put the balance in a savings account every month for six months. The idea is to take the total amount out of your cash flow for half a year and see how you do. You’ll know in a hurry if you can comfortably afford to pay out that much cash month in, month out.
The other benefit is that you’ll have six months’ of additional savings to add to your down payment, or your investments, when the experiment is done.
Is there any chance that you might need to move sometime in the next five years? If so, you might want to hold off on buying given the costs involved and the time it takes to realize a profit from the purchase.
I was curious about how long people tend to stay in their houses, so I turned to Dawn Goodridge, a Realtor in Ottawa, to see if she could dig up some stats. Here’s what she said: “I tried my contacts at CMHC and StatsCan and they said “nope”. You may have triggered an experiment down the road. Nothing on my OREB site either. From a purely personal perspective as a Realtor, my first time home buyers tend to stay 4-7 years. The move-up folks are generally staying 5-20 years. The retirees are all over the place. That seems to really depend on their health and if they decide to travel more, etc. Sometimes, they buy downtown thinking that is cool and then hate it.”
So, no stats for you.
The upshot is that buying a home is often more of an emotional decision than a financial one. That’s cool, as long as you know what you’re getting into. Let’s just not pretend that it’s necessarily a great investment.
And tell Uncle Bob to leave badgering to badgers. They, at least, are qualified.