Did I just make a big mistake by buying a house?

MoneySense Editor-in-Chief Duncan Hood did the unthinkable!

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From the September/October 2014 issue of the magazine.

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SEPT COVERA few weeks ago—after spending much of the last decade warning readers against the perils of Canada’s overheated housing market—I did the unthinkable: I bought a place. When I told MoneySense investing columnist Norm Rothery, he was dismayed. Didn’t I know that homes in Toronto are way overpriced? Why would any sane person pay such a ridiculous sum for such a tiny shack?

He has a point. Canadian homes are indeed rather pricey by almost any measure: the cost of buying versus renting, historical house price trends, even by basic affordability measures. I have predicted several times that the market is due for a nasty 20% correction. So how could I—a happy renter for many years—suddenly turn around and squander my life savings on an overpriced pile of bricks?

The reason is simple: I want to eventually retire with a paid-off house, and I was running out of time. Besides, I don’t see my house as an investment, as a means to an end. It’s a purchase—it’s what I’ve been saving my money for. But I haven’t completely lost my mind. I did do some risk analysis before buying. If you’re wondering whether your house purchase is at risk, read on for three easy tests to find out how safe you really are.

Can you afford it? Rather than assuming I could afford my house because they approved my mortgage, I decided to subject my finances to a more rigorous test recommended by the Globe and Mail’s Rob Carrick. He advises that you take your after-tax monthly income and subtract not only the mortgage payment on your new house, but all of your other non-discretionary monthly payments, such as property taxes, utilities, car loan payments, daycare fees, home maintenance costs, and even 10% for retirement savings. If the percentage of your income consumed by those costs is 75% or less, you can do it. If not, you’re taking a risk. (For the record, I passed.)

What happens if house prices plunge? I still think we could see house prices drop by 20% in the medium term, so I decided to model what would happen if they did. I’m not planning to sell for at least 20 years, so I’m not concerned about my home’s short-term resale value. My big concern is ending up “under water.” That’s what happens if your house price drops so dramatically you owe more on your mortgage than your house is worth. Because your bank views your house as collateral for its loan, you could have trouble renewing your mortgage. The solution was a cushion in the form of a large down payment. If you make a down payment of 20%, you can withstand a 20% drop without any issues, and as a bonus, you don’t have to pay CMHC mortgage insurance either.

What if interest rates suddenly jump? The last big risk is a hike in rates. You can protect yourself in the short term by taking out a fixed-rate mortgage. (Mine was the standard five-year fixed variety.) But eventually you have to renew, and rates could be much higher by then. So I visited an online mortgage rate calculator and looked at what my monthly payments would be if rates doubled. I could still afford my payments, but I could see rates going even higher, so I plan to aggressively pay down my mortgage with pre-payments (extra payments) over the next five years to give myself some wiggle room.

So do I feel like I got a good deal on my house? Not at all. By historical measures, I overpaid by quite a bit. But it was either that or no house at all, and I don’t regret my decision—in fact I love my new house. Of course, now that I’ve finally bought, house prices are sure to plunge, but the important thing is I’ll be okay if they do.

 

9 comments on “Did I just make a big mistake by buying a house?

  1. Wouldn’t it have been better for you to wait a couple years until prices DO drop 20% and THEN buy? Wouldn’t you have been further ahead?

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  2. “I overpaid by quite a bit. But it was either that or no house at all”

    That’s a false dichotomy. You forgot “or continue to rent and save.”

    Even the goal of retiring with a paid-off house is unnecessary: if you have an envestment portfolio providing the funds you need to pay the rent through retirement, you’re set. Or, you can buy your downsized place closer to retirement, rather than getting a mortgage now.

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  3. WELL, HE DIDN’T FOLLOW HIS OWN ADVICE. FEEL SORRY FOR HIS FOLLOWERS.

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  4. I understand.
    We too have held off and now we are ‘over’ it.
    We will be buying because we prefer to own the home when we semi-retire.
    I don’t know that I am the retiring type.

    The problem is utilities are going up too and we want to go with solar hot water, a few solar panels and
    a few other alternative power sources.
    Alternative power is becoming more mainstream and we (married couple) think it will be more so in a decade.
    Plus where we live water cost is a factor too.

    The irony is because we held off we do have some great investments now. That would not have happened if a dwelling and mortgage had been a priority. Of course, the other point is, you have to live somewhere.

    All the best with the new acquisition.

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  5. But what if prices never drop 20% and he keeps waiting? It’s very difficult to predict the market. I don’t think we ever thought it would get this high. Predictions for the housing market to drop have been going on for over 5 years now. So I think what Duncan did was smart. The longer he waits, the more risk he’s taking by not being able to pay off the mortgage before his retirement He worked it out based on his own earnings and what he could afford. He’s not predicting anything this way, he’s protecting himself by working out what is definite. Congrats Duncan!

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    • I am running the same type of risk analysis and trying to decide what makes more sense for us. The current cost of borrowing makes the case of buying initially appealing. Once I factor in future maintenance cost with the house up-keeping and increasingly higher interest rates (I opted to keep it variable) the buying option would only support a 7-8% price correction in a discounted basis (3% pa on a 320K morgat. of a 400K house). A potential 20-25% correction (in my simulation starting in 2017) would bringing us to about 40K underwater position (also discounted).
      All that been said, I am strongly thinking in buying mainly because Sudbury rental property inventory is not as good or as plenty as the one in Toronto (I am relocating for work).
      Other point I am considering is that with so many people counting on the sale of their house to provide for their retirement, I cannot imagine a scenario in which the government would increase prime and help correct the market in the near future.

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  6. Your decision to buy makes sense to me, Duncan. Mr. Carrick chooses to rent and seldom says a good word about buying. Maybe a little “sour grapes” happening there?

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  7. Buying vs renting is such a major (and very personal) decision. As a result, any advice and predictions given in the media can only be done in very general terms. There are so many variables involved when deciding personal finances.

    I could see how it would erk some people who have been waiting for prices to fall that this guy bought already; but his reasoning seems sound:

    20% down for that cushion;
    make your own budget and financing rather than ask the banks what they would like to lend you (like Gail Vax-Ozlade likes to say: banks are NOT your friend.. duh)
    prepare mentally and financially to make pre-payments during your fixed term

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  8. You want to retire into it?! Cripes, man! You could have bought a house in Florida, one in Arizona, kept your apartment, and still had money left over for the price of Toronto digs. That would have given you lots of (warmer) retirement options. …And maybe even some rental income between now and then.

    Reply

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