Welcome to this month’s installment of Dear urbaneer, where we are put to the test, as our clients challenge us with tough housing questions. This month, we respond to a client who echoes the sentiment of a number of harried house hunters in the City of Toronto.
Firstly, thank you so much for your support during the last few months of our house hunt. It’s been emotionally draining, to say the least. Given our series of bidding war fails in the purchase department, we're wondering if it is time to re-tool our housing strategy and ramp our budget up to the max. We’re a little scared of becoming house poor, but at this point, we feel like sacrifices in our lifestyle might be worth it, just so we can get the house we want. It’s for our long-term benefit anyway, right?
Bummed Out Buyer
Dear Bummed Out:
Firstly, let us commend you on your patience and perseverance, two qualities that are becoming increasingly necessary in the swiftly moving Toronto housing market. And you’re not alone. House hunting requires a special kind of fortitude, as we’ve talked about in “A Real-Time Tale On The Struggle To Buy Toronto Real Estate In Spring”.
With the property prices escalating as they are, wouldn’t conventional wisdom suggest that you should pull out all the budgetary stops just to gain passage into the market - and then ride that wave of investment off into the future?
Stretch That Budget To The Max?
The simple answer is 'Yes and No". From our experience, most Buyers start searching for houses in their 'preferred budget', which can be $50,000 to $250,000 less than what they're either qualified or willing to spend. We frequently caution our Buyers not to spend too long attached to the idea that they can secure a property for less than their ideal; for every month that they remain conservative in their search, values rise. It comes down to missing the opportunity to secure the better 'more expensive but ultimately within budget house' for less money now than if they delay on hope. Taking too long searching in one price point and then - months later - increasing your budget to a sum you were always qualified to spend won't serve you well in an escalating market.
At the same time, when there is a widening gap between affordability and housing - as there is in Toronto - you’ve got to recognize (and reconcile) the potential vulnerabilities that emerge when you’re stretched to the budgetary limit. Furthermore, you’ve got to acknowledge the long-term impact on your financial life if you’re planning on skipping a few rungs on the property ladder.
And being “house poor” doesn’t mean that you’ll need to brown bag your lunch and cut back on vacations for just a couple of years. When you are talking in the dollar amounts alongside the relationship of property prices to incomes in the City of Toronto, that timeline is super extended. There are a number of elements to consider before you stretch that budget to the max.
Since prices are so high, shouldn’t we buy a house today that will serve our needs tomorrow? Like when we plan to have a family?
This is becoming a more common approach for Buyers in the City of Toronto, because of the combination of three factors: the price of homes means that more Buyers are becoming limited in what they’ll be able to purchase; it is very expensive to move in Toronto, given the additional taxes and closing costs; and the cost of raising children is very expensive as well.
So, when you are using your starter home as your forever home, you’ve got to look at some financial scenarios in your future. Let’s say that you’ve got a home in mind that has the potential to grow with your family, but it’s got the price tag to match, that’s going to put you at the outside limit of your max mortgage amount today.
The assumption too, is that over the years your income will grow and the mortgage will reduce, which should loosen up some cash flow. However, as any parent will tell you, things change when you have children. And not just sleep deprivation.
It starts with your maternity/parental leave. Your home may have the space to accommodate your bundles of joy, but you or your partner’s income will be possibly be reduced (unless your employer tops you up) during the first year of each child’s life, if you choose to take leave. That will keep that ratio between income and expenses dangerously out of whack.
And then there is the cost of child care when you return to work. Studies show that the cost of raising a child in Toronto under 18 runs from $10,000-$15,000 a year. That’s a lot of extra spending to add to a cash flow that might be crunched by the mortgage already. Here is an article from the Globe and Mail about balancing your house hunting budget today to accommodate you in the future called “House Shopping? Make Sure Your Mortgage Doesn’t Leave You “Baby Poor”.
Buying A House Is Kind Of Like Forced Savings, Right?
So, really there is no harm in directing the max amount towards your mortgage payment and skipping putting cash in savings, right?
While there is no question that real estate offers an excellent upside investment potential, you’ve got to temper your expectations somewhat. Because prices are so high and because they’ve climbed so rapidly, the sense is that they will keep on going, right? What you’ve paid today, although is at the absolute max, will seem like a bargain in years to come, right?
Firstly, you’ve got to realize that home ownership, while an excellent investment, is unlikely to offer the same, super-lucrative returns that many Baby Boomers are realizing now, having purchased a couple of decades ago. We touch on this in our Spring Forecast Part Two (coming soon!). It has to do with entry point into the market, as well as debt load when you make the purchase.
You’ve also got to remember that the market works in cycles, and that a pullback in values (even a small one will count) is inevitable at some point. When your debt amount is so close to the purchase price, it doesn’t take much to drain the asset out of your asset.
Also - you may be thinking that your home could be your retirement nest egg. According to a recent survey by Sun Life Financial, 24 percent of Canadians plan to use their home to fund their retirement, which is a risky strategy. Here is an article from the Financial Post called “Canadians think their homes will fund their retirement” that expands on the study. While no doubt you'll be able to use your equity years down the road to support your retirement, you shouldn't lay all your bets on a single investment.
There is also the common belief that, because you've invested heavily in your home, you don't need to put money aside for emergency and other savings. Wrong. Home equity is illiquid, meaning that you’ll be at the mercy of the market if you need to sell to get to cash in an emergency savings situation, which could bring a whole new meaning to house poor. Furthermore, if you’ve used up your RRSP savings to use as a down payment to increase your home shopping budget, you may be widening that gap even more.
And if building home equity is what your ultimate goal is in your house purchase, you’ve got to remember that paying your mortgage down is actually the most reliable way to do so - not banking on property prices continuing to rise to increase your net worth.
No matter how you slice it, becoming house poor and forgoing savings in the process is ultimately not a wise move.
I’ll Just Buy A Fixer Upper With A Lower Down Payment...
You may be lured into buying a fixer-upper at a much lower price point, thinking that you can get more budgetary power there. While in theory this is true, there are certain elements in the Toronto housing market that make this a little tricky.
For one thing, 'fixer-uppers' are not the bargain hunter’s dream that they were a few years ago. The serious limitation of stock has caused these prices to rise too. The reality is, the lower the price point, the more it is going to cost you in the long run, which will extend your 'house poor' run.
Take this scenario for example: You’ve got two homes for sale. The first is $1.2 million, fully renovated. The second is $900,000 and will need $300,000 of renovations to get it to the same standard. If you buy the first one with a $240,000 down, it’s actually more budget-friendly than if you buy the cheaper home with a smaller down payment of 10 percent. Essentially, the lower the purchase price, - the more the actual cost required to invest because demand for cheaper properties under $1mil have an exponentially greater demand. This, of course is in addition to the potential extra costs and headaches that you’ll encounter as you renovate. Click here to read our recent post, called “Move-In Ready Or Fixer-Upper. What’s Your Housing Match?”
The best way to avoid the pitfalls of being house poor and maintaining quality of life? Buy a home that fits your budget comfortably; make sure that the property of choice meets your property goals for the timeline that makes most sense for your lifestyle as well. Your home provides you shelter, but it’s also the setting where your life unfolds. It’s got to be comfortable in every way.
Buying a home goes far beyond the house hunt. You’ve got to have a solid strategy, backed by research and a good dose of common sense, that will only boost your happiness and your financial health in the years of your homeownership. Have questions? Please know we’re here to help!
~ Steven and the urbaneer team
earn your trust, then your business
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage - (416) 322-8000
** Did you also know Steve leads a Student Mentorship and Internship Program for Canadians being educated in the field of housing? Consider visiting our sister site called Houseporn.ca