Money Tip: Buy a home you can afford
November has been designated as Financial Literacy Month (FLM) by the Financial Consumer Agency of Canada, a Federal Government body tasked with educating consumers about financial products and services. As part of FLM, Glenn Cooke of Life Insurance Canada organized a campaign by a dozen bloggers to publish their best financial tip. This post is [...]
November has been designated as Financial Literacy Month (FLM) by the Financial Consumer Agency of Canada, a Federal Government body tasked with educating consumers about financial products and services. As part of FLM, Glenn Cooke of Life Insurance Canada organized a campaign by a dozen bloggers to publish their best financial tip. This post is my contribution towards this initiative.
We recently sold our home we lived in for close to a decade and moved to another one. Just for fun, I decided to crunch the numbers to see how profitable an “investment” housing was in the past decade. It turned out that owning a home was very profitable indeed due to falling interest rates and rising home prices — Ottawa home prices are up an average of 5.5 percent over the past decade according to Teranet-National Bank House Price Index. Add in the value derived from a home in the form of imputed rent and subtract expenses like property taxes, maintenance, mortgage interest, insurance etc. and housing turned in double digit returns. And in cities like Vancouver, home owners saw gains of 8.4 percent in price level increases alone.
But if you adjust your forward assumptions a little — stagnant or worse falling home prices and moderately increasing interest rates — it becomes clear that housing has the potential to quickly turn into a millstone around one’s financial neck. Assuming one has a mortgage balance of $300,000, even a 1 percent jump in interest rates say five years into the future will translate into an extra $2,500 in interest payments alone. And that may even be a conservative assumption. After all, interest rates were 5 percent or more, not so long ago. If interest rates go up by 2 percent instead of 1, you are looking at an extra $5,000 in interest payments.
I’m not arguing that one should not buy a home. Rather, one should buy a home only if all the costs of home ownership can be comfortably accommodated in the family budget. That may mean buying a home based on conservative assumptions, not the maximum mortgage a bank is qualifies one for. After all, a bank only cares about whether you’ll pay your debt back, not whether you have enough left in the budget for such things as retirement savings, kids’ education or even an occasional beach vacation.
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- Is Canadian Real Estate Overvalued?