To Own or not to Own, is that REALLY the question?

Real estate prices are way up.
Regardless, many people feel ownership is THE best path to security and wealth.
Homeowners, especially new ones, get caught between what the bank says they can afford, and what the REAL monthly costs are.
There are options, is renting one of them?
Sara offers real and impactful insight in this episode of SARA MAKES SENSE.

Related blog post: https://www.wddevelopment.ca/blog/

Got a question for Sara? Send her an email at ask@saramakessense.ca and she might respond to it in an upcoming episode

Sara's website is https://www.wddevelopment.ca/ 

Transcript

Sara McCullough: (00:01)
Yeah. I know I'm completely not ready. So let's do this thing.


Sara McCullough: (00:13)
Bidding wars, multiple offers; we're all familiar with the phrase above list, mortgages that feel like I don't know…buying a home and real estate in 2021. So home ownership though, not real estate, home ownership, that's always a big topic. And in Canada we love to own, whether it's the house we live in or the cottage we go to, we love owning. And then there's that investment property seminar that we did over the weekend, because renting is throwing money down the drain and who would want to do that? I mean, you can increase your net worth. There's a lot of free advice out there too. Your parents have opinions, your siblings, your friends; they all weigh in on this decision. Our society tells us that home ownership is the smart, responsible way to be wealthy. And if you're trying to figure out how all of that relates to you, specifically to you, specifically now; hurray, your timing is great. I'm Sara McCullough and in this episode of Sara Makes Sense we give you the space to think about it, maybe out loud while I talk out loud about how to make a decision about your home.

Sara McCullough: (01:43)
So you've made the decision to buy a home, or maybe you’re upgrading your home or changing your location. So now you've gotta deal with the real estate market; after you've made the decision to buy, now you're gonna think about how much can I afford? Well, that depends. And everybody hates that answer, but the good news is in this episode, I'm gonna give you some ideas on how you can figure out what you can afford. So you're probably familiar with lenders ratios, which is great. So lenders say 30 to 40% of your income, which sounds manageable until you realize that lenders mean 30 to 40% of your gross income. That's your before tax income. Like you have a choice in whether you pay income tax or not. So, okay the lenders I mean are a little bit biased. They're gonna make money when you borrow the money.

Sara McCullough: (02:44)
So I looked at, remember Josh and Anna from episode four, I wanted to find a calculator that would, you know, give me a sense of what the online calculator said that they could afford. So I used the Canadian Housing and Mortgage Corporations’ affordability calculator, it only asked me five easy questions and their objective, right? So it asked me my annual household income, my down payment amount, the interest rate on my mortgage, the province I was living in. So those are pretty easy. Like we're at four outta five. And then the fifth question was monthly expenses other than housing.

Sara McCullough: (03:29)
Well, I mean, I, they gave me an estimate. So I put that in. So I put Josh and Annabel's information into the objective affordability calculator and it spit out an amount that worked in the price range that they wanted to buy in. That's exciting. And even better, I moved over - they have a handy graph on how Josh and Annabel's money would be spent after their purchase. And the graph told me that 35% of their income was available for the mortgage, which falls right in that midrange of those lenders ratios that other monthly expenses would take up 36% of their income. And 29% of their money is left over. That's what it says on the graph and that sounds great, 29% of your money every year just left over. The problem is their income tax rate because I've seen their tax returns. And I know how to calculate your average tax rate and their average income tax rate is 24%. So 29% of their money isn't left over 5% of their money is left over.

Sara McCullough: (04:52)
And we all miss some of our monthly expenses when we're trying to figure out how much we spend. And once you buy a house, your monthly expenses change because you not only have property taxes and utilities, which most of us know, and we can estimate those, but you're going to have expenses like maintaining the house and putting in things that you love into the house and making it yours. So none of this means that you absolutely can't buy that house, I think it's important that you go in understanding what's likely to happen after you buy the house. And therefore, what can you afford? Most of us don't want the house to be our whole life. We want our house to be part of our life. So when I work with clients and I calculate what you can afford, we're gonna start with your after tax income, because that's the money that you can manipulate. Then we're gonna put in an amount for maintaining your home. You've bought it. You're gonna wanna maintain it.

Sara McCullough: (06:04)
Generally speaking, you'll see estimates that maintaining a home costs between one to three or three to 5% of the purchase price of your home per year. This is an amount that clients often either forget or they underestimate. And I know what you're thinking. I haven't spent that on my house. Sara, if you look at the length of time that you've owned your house and the repairs that you've done and the upgrades that you've done, or the upgrades that you're pushing off and stalling on, you probably have spent about 3% of the purchase price every year on maintaining your home because it's such an unusual amount and it occurs often infrequently, it's easy to forget. But here's the thing, if you leave it out of your equation, you're going to be using that line of credit 12 years later, wondering why your debt level overall, isn't going down. And that's really frustrating for people. So we're gonna look at your after tax income. We're going to look at the cost of the mortgage, the cost of maintenance and then we're going to look at the other fixed costs that you have, because that gives us a really solid sense of how much money you've already spent. And then we can see what money is actually left over.

Sara McCullough: (07:35)
Moving on to another conversation. Annabelle's sister Joanna also recently came to me asking what kind of house could she afford? She already had a number from the lender and that number easily fit into the lenders ratio of 30 to 40% of her income. But she just wasn't sure. And so we had a meeting to talk about what would this mean for her if she went with this number, because it was a big mortgage, what would it mean? How could she buy? What was even possible? And so when we worked with her numbers, if she had gone with the lender's mortgage amount, she would've actually been slightly short on money every single month, partly because she had a slightly unusual tax situation where 50% of her gross income goes for taxes and taxable benefits at her company. So that's a whole other conversation. But remember, as a client, your tax situation is unique and lenders are working with your before tax numbers. So can you see where those standard ratios don't really give you the information that you need to make a balanced decision?

Sara McCullough: (08:58)
So once you work through the numbers, you also have to figure out at the same time, what do I want? Remember, we're not talking about real estate now, we're talking about your home. So, depending on your situation, you're gonna need to think about what do I want, or what do we want? And sometimes when it's a we - sometimes you want different things. So how do you reconcile that? Maybe you want to own because you want security. Maybe you want to own because you want a neighborhood to fit into. Maybe you want to own because you want to build wealth. There's a prestige to owning. There's kind of a, a disparaging connected to renting.

Sara McCullough: (09:46)
Prestige is an interesting word. The Latin root of the word prestige means conjuring tricks. And I am confident when you think about owning a home, you do not want to be in a position where you are then having to conjure tricks to continue to own and maintain that home. So, when you think about owning a home, it needs to be ranked on your entire list of either what you want or what we want. So when I have this conversation with clients, I talk to them about all of the other goals that they might have. What if you want to change your career, or what if you're planning to continue your education? Are you planning a wedding? Are you planning to have children? Would you like to retire early? Is traveling frequently important to you? Do you have other fixed costs and other parts of your life that are really, really important for you to maintain?

Sara McCullough: (10:49)
So remember a house isn't always an either, or, but when you look at a house purchase with this list, it gives you a good sense of which house is going to be the best fit for you. And I'm gonna give you a couple of different examples here. Several years ago, I was working with a couple we'll call them Brad and Laura, and they were looking for a bigger house. They had one child, they owned a townhouse and it was just feeling too small. So when they started looking, they were looking at houses around $750,000, and they couldn't really see anything that they loved. And then they fell in love with a house that was $950,000. So that was a stretch. However, this house had the space for Laura's mom to move in, which was in their plans. This house had a great location for them. And it had the outdoor space that they were looking for now, as well as the indoor space for more kids. So, yes, the payments meant that over the next few years, they would have to focus on the house and the house was going to be a noticeable presence in their month to month income, but long term, that was a trade off they were willing to make.

Sara McCullough: (12:25)
The next client I want to tell you about came to me after she lost her husband. So Jane lost her husband very soon after a move to a fairly large home. And now all of a sudden she was in a four bedroom home all by herself. And there was still a mortgage on this home and the life insurance payments didn't cover the missing income and it didn't protect Jane through her retirement. So now what? We talked about, her goals and owning a big home wasn't one of them. And when I raised the idea of renting, she wasn't sure; she had always owned. Renting was, again, that idea of slightly irresponsible, slightly silly throwing money away. So when we discussed what she really wanted and what was important to her, and we took out a mortgage number out of her list of payments and put in a rent number, she got to do all of the other activities that she wanted.

Sara McCullough: (13:42)
So with a smaller rental, she was able to do the amount of travel that she wanted. Now, this was multiple conversations over a period of time. Remember this was a big decision for her. She had not only recently moved to the area she had recently lost her husband. So this was about 18 months of Jane staying in the home, but really working through what if, so she had 18 months of being able to look at possibilities, consider trips, other goals, activities that were important to her and after 18 months, she sold that home, moved into a rental and she doesn't miss owning.

Sara McCullough: (14:32)
So let's talk a little bit about owning and increasing your net worth. And this idea that, um, a house is a way to be wealthy. And we've seen all kinds of headlines, especially recently, that Canadians’ net worth is increasing by leaps and bounds. People tell me all the time that my house is my retirement plan. And then they usually pause because they kind of think, well, wait, well, I'm gonna downsize at retirement. Because houses aren't liquid assets, to retire comfortably you need to have an income coming in. Your house doesn't do that. You can't chip off a few bricks to pay for the groceries. It's an all or nothing deal.

Sara McCullough: (15:23)
So if your house is your retirement plan, you're gonna have to sell it and then you're gonna have to live somewhere. So if you're kind of walking around with this idea that paying off my mortgage is for savings, and then I'm gonna have all these savings at retirement. Remember to access those savings, you're gonna have to sell the house. So then I can promise you, you are gonna be renting in retirement. There's no other calculation here that works. So again, it's not about right or wrong here. It's about what works for you with your goals, with your income and with your plans; both now and long term. And you said downsizing, you know, in 18 years of advising, most downsizes are downsizes in square footage only, not in price. Why? Often when we're moving and downsizing, um, either after children leave or close to retirement, there's different things that we want.

Sara McCullough: (16:35)
So we want a certain location, or we want nicer fixtures, or we want certain features in the house and the price stays the same or very close to the same. And so the amount of money left over to invest, doesn't stretch to cover your needs. And in fact, in 18 years of advising the two hardest plans that I've ever had to do; the plans where I couldn't get the clients anywhere close to what they told me their goals were involved a focus on real estate. One of them had bought purchased multiple rental properties. The other one had bought an extremely large, extremely expensive family home. And again was going to use it as for savings. I couldn't get those plans to support an income anywhere close to the client needs.

Sara McCullough: (17:37)
So that brings up this idea of rentals. Well, I can invest in property. Maybe.  Remember to make that work you need to pay off your investment property’s mortgage. You, as a retiree, need free cash flow. In fact, you need enough cash flow to carry the cost of the house because we've already talked about the maintenance; which is ongoing, the cost of renters; because they're not always predictable and then you need to meet your own needs But then you say, but Sara I'm gonna see gains - real estate just goes up it never goes down. We've had more record breaking months in the last three years than I can remember. All right, since 1982 Canadian real estate has had an average growth rate of 1.8% a year. And nobody believes me when I say that, I can't see your face right now, but I've got a pretty good idea.

Sara McCullough: (18:41)
So those are the government stats. Um, if you head over to the blog, I've got a blog on this podcast, and it gives you the link. So, since 1982 Canadian real estate has had an average growth rate over that time of 1.8% a year; inflation over that time has averaged 2 to 3% a year. So good investment? And remember that growth rate of 1.8% doesn't include the inflation you're gonna see on property taxes, maintenance, costs, utilities, things that renters do that you don't expect. So again, have I seen it work for some clients? Yes, but you have to be disciplined and it has to be part of a bigger plan and your income needs to support it as an investment.

Sara McCullough: (19:47)
So, if you're still kind of feeling like real estate is the best way, the fastest way, the only way to secure your net worth because renting is throwing money down the drain and in fact, one of my clients said to me the other week, well, you're just making the landlord rich when you rent. Couple other facts, Canadian home ownership sits at around 66%. And when you look on a worldwide basis, we sit about middle of the pack. So two thirds of us own the homes that we live in. Country with the lowest home ownership, Switzerland, approximately 43% of the Swiss own the home they live in. All right? So now let's look at which country has the highest net worth. I think we're probably clear that Canada actually doesn't have the highest net worth - Switzerland does. So, real estate isn't the only way to build net worth and for you it may not be the best way. And if there are other parts of your life that are important, and if you need your income to support other goals and dreams and expenses; remember to look at a house purchase in the context of the rest of your life.

Sara McCullough: (21:23)
Remember Joanna from about 15 minutes ago and her lender amount that was, you know, falling in those standard ratios was actually gonna take 60% of her take home income and was actually gonna leave her slightly underwater. Once we worked through her plans and I understood a little bit more about what was important to her and what type of house she would be comfortable owning; we actually found a plan that balanced off the timing of the purchase, the price of the purchase, continued savings that actually maximized her net worth. And it wasn't buying a house right away. And it wasn't at the price point that the lender approved her for. Remember in life that we all have pieces of our plans scattered here and there. And from time to time, we need someone who can cut through the noise. Someone who not only gets to know you as a person, but can also really show and make sense of your financial plan; not just the numbers, but truly what the numbers mean for you. This relationship and this plan belong to you, not your planner. I'm Sara McCullough. Thank you for listening to Sara Makes Sense.

Disclaimer: (22:44)
The information in this podcast is intended for general information and illustrative purposes.  For advice relevant to your specific situation, meet with a qualified financial planner, lawyer, or accountant before making any changes to your situation. Sara's designations and licensing include:  Certified Financial Planner, Registered Financial Planner, Certified Divorce Financial Analyst, and holding an insurance license.