Most Canadians dream about buying and owning their first home

A significant rite of passage, buying a home is not only a big financial deal, it's a big life deal.

Most people assume it's better to buy a home than to rent, and to be honest, I have a bias toward home ownership, too. That being said, I have counseled people on the merits of renting. But there are circumstances where renting maybe better for you.

RENT OR OWN

Every new homebuyer should first understand the differences between "renting and saving" and "buying and owning."

For most people, renting is better on cash flow, not just because mortgage payments are often higher (although with the current interest rates that may not be the case) than rent but because of all the other costs associated with owning a home, such as condo fees, property tax, insurance and maintenance.

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The idea of building equity can justify the increased strain on cash flow, but renters can build equity through renting and saving.

RENT AND SAVE

Lets use an example of a 26 year old female first time buyer. She is currently paying $600 per month in rent. She shares a three-bedroom condo with two roommates and has saved $25,000 to buy her own place. She has found a two-bedroom condo for $300,000 but is nervous about taking the leap.

Based on a five-per-cent interest rate, a $275,000 mortgage would require monthly payments of $1,600. Condo fees and property taxes would add $350 per month, bringing the total monthly cost to almost $2,000. That's a big increase from $600-per-month rent.

BUY AND OWN

Let's assume she buys the two-bedroom condo and we look ahead five years. In that time she will have paid down her mortgage balance to $243,395, which means she has built up $31,605 of equity (assuming no growth on the property).

What will her situation look like five years from now if she continues to rent? In the rent-and-save scenario, if she can afford $2,000 per month to buy the home, theoretically she should be able to save $1,400 per month ($2,000 less $600 rent). If she were to save $1,400 per month for five years, she would have $84,000 in savings or an investment (also assuming no growth). This simplified mathematical analysis makes rent-and-save look like a better financial option after five years than buy-and-own.

There are some factors effecting these numbers. Interest on savings are pretty low right now so the $84,000 would maybe earn somewhere between 2%-4% depending on what type of investment (safe, risky, term etc.). The property market currently is appreciating at a rough level of 5%-8% so that gives a bit more clout to the house side.

CAN SHE SAVE THE DIFFERENCE?

The biggest challenge in renting and saving is, of course, the saving part. Few of us have the discipline to save $1,400 per month for five years.

Buying and owning for some is a means to force savings, with mortgage payments seen as one of the most important payments you make.

Although using our example even if our buyer is a pretty good saver, she does not think he can save $1,400 per month. She's also concerned about becoming house-rich but cash-flow poor. She wants to enjoy life, and buying a house would drastically reduce extra cash flow.

One option is to get a roommate in the new condo to help pay expenses. If we use $800 per month the costs will drop to $1,200 per month. If she continues to rent and saves the difference of $800 her roommate is paying, she will have $48,000 after five years.

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If we work backward to figure out how much she needs to save per month to have the same $31,605 equity in the home, she would have to put away about $525 per month.

INVESTING VERSUS REAL ESTATE PRICES

In this example, I have assumed no growth in property values or alternative investments. So if our buyer asked me which would give her a better return, investing in real estate or mutual funds?

Real estate agents are likely to tell you that owning is a great investment because house prices are going to go up. Investment professionals will tell you that investments have performed better. The problem is no one knows which will do better in the future. Owning your own home is always a great feeling whereas renting is paying someones mortgage. You get to choose nice things like the colour of the rooms and can have a pet if you choose to which the rental may not allow.

So although there are advantages to buying a house, it may not always make sense.

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