You might be at the stage in life where you are considering buying yourself a home or wondering if it’s better to continue renting. But with prices soaring, potential buyers need to consider the risks and weigh up all their options.
Credit scores, financial stability, and not knowing where you will be in the next 5-10 years can make planning for your future daunting. Additionally, it might help if you considered the global markets and where we are heading, with remote work becoming the norm and rentals making more sense.
But what makes sense for Canadians right now? Do you continue renting or invest in real estate?
Access Your Credit Score
In determining whether to rent or buy a home, you need first to know your credit score. Your credit score reveals how responsible you are financially.
There are two leading credit reporting agencies available to Canadians, namely:
If your credit score is down, begin to build a positive score rating to prepare yourself for future purchases. To increase your credit score, you can do the following:
- Ensure your credit cards are always paid up to date, as every transaction will get added to your credit history.
- Avoid taking more credit than you can afford. Pay your monthly balances on time.
The Financial Customer Agency of Canada (FCAC) advises Canadians to always check their credit history before analyzing their buying or renting options. It’s essential to have an above-average credit score, as rentals in Canada have been rising, and you can get disqualified if you have a bad score. It makes more sense for a landlord to choose someone who is financially responsible and appears to be trustworthy.
To Rent or to Buy?
After improving your credit score, it’s time to decide whether you want to rent or buy a home. Renting has lower costs than buying, but buying creates more benefits if your financial situation is favourable.
There are a few questions you should ask yourself before you decide to buy or rent:
- How soon do you want to rent or buy a home?
- Do you have enough money to buy a home, or will you need to apply for a mortgage?
- Do you have the resources and money for home repairs?
- How often do you plan to move around or stay in one place?
These questions will guide you to make the right decision for you and your family. Don’t rush when you are unsure, but instead take the time to reflect.
The 5% and 40% Rules
There are two rules that potential buyers choose to follow – the 5% rule or the 40% rule. Whichever rule you choose to follow will be personal preference.
The 5 percent rule
When you’re deciding to rent or buy a home, you need to consider all the costs that come with owning a home. It may seem complicated, but put into simple terms, it means the following:
Owning a home has annual unrecoverable costs that amount to about 5% of the property’s value. This is not dependant on whether you own a home or not. If you’re paying less rent for a home that’s similar to yours, then it’s best to continue renting. If you’re paying higher rent than a similar home to yours, then it’s better to buy a similar home.
Unrecoverable costs include the following:
- Maintenance to your home. This does not include renovations, as it increases your home’s value – 1% of your home’s value annually
- Property tax – 1% of your home’s value annually
- The cost of credit – 3% of your home’s value annually
The total unrecoverable costs should be 5% of your home’s value annually. If you rent a house and 5% less than the value of a similar house – calculated yearly – then continue renting. If you can buy a house and the property’s value is 5% less than the rental amount, consider buying.
The 40 percent rule
Your housing costs include taxes, heat, principal, and interest.
The 40% rule states that you must meet your housing costs along with your other debt, such as your credit card, with no more than 40% of your gross income. Most lenders follow this rule in Canada. With 50% to 60% of your net income, you need to cover the rest of your housing costs, such as transportation and food, also known as fixed costs. If you can’t afford these percentages, then you will struggle financially with a mortgage.
The Advantages and Disadvantages of Buying a Home
There are numerous pros and cons when it comes to deciding whether you should buy a home. Consider each one before making any decisions.
Pros of buying a home
- Build equity – Equity is the part of your home that you own and isn’t under a mortgage. By not paying rent to a landlord, you buy into your home’s equity. As equity builds, the value of your home increases.
- Control over creativity – Buying lets you get creative with your home. You can hammer nails into the wall, add additional rooms, etc. You’ll have full creative control over your personal space.
- Improve your credit – Your credit score increases every time you make a payment towards your mortgage on time. Even though your mortgage may have lowered your score when you first took it out, it will improve as the loan amount decreases, and it gets seen as responsible debt.
- Stability – The chances of you getting evicted are zero! If your mortgage repayment is at a fixed rate, you’ll always know what to expect with monthly payments.
- Maintenance – Owning your own home means you are not bound to specific contractors when you need to make repairs or attend to maintenance issues. However, living in a condo might be different as you pay monthly fees to the homeowners association to cover maintenance work using their contractors.
- Privacy – A nosy landlord is not scrutinizing your every move!
- It’s a good investment – Owning a home makes future investing easier. Once your mortgage gets paid entirely, you’ll have a guaranteed asset for life.
Cons of buying a home
- High upfront costs – Monthly interest rates and insurance payments will be higher if you have a lower down payment.
- Repairs and maintenance – Owning a home make you responsible for all maintenance and repair costs. It’s wise to keep money aside each year to cover these costs.
- Less flexibility – It’s not easy selling your house quickly, as owning a home comes with commitment and responsibility. It’s less flexible due to you getting tied down to one location.
- Higher mortgage payments – Compared to renting, paying a mortgage loan can be more costly.
- Less disposable income – Paying for a mortgage can be a costly affair and leave you with fewer funds to put into savings or investments.
The Pros and Cons of Renting a Home
Just like buying a home, renting comes with pros and cons.
Pros of renting a home
- Less maintenance and hassle – Maintenance and repairs are done through your landlord or property manager, saving you money and effort.
- Cheaper – Renting a home is usually less expensive than paying for a mortgage. Renting is an affordable option if your income is lower and will provide you with more disposable income to save and invest.
- Flexibility – When renting, you can’t get tied down to a location, making you flexible to move when your lease ends. If you feel the wanderlust bug bite, you can pack your bags and leave with little responsibility.
Cons of renting a home
- Maintenance and repairs – No matter the size of the repairs or maintenance, you can’t do anything without your landlord’s permission. This includes any form of renovations.
- Unpredictable expenses – Monthly expenses are unforeseen as your rent can get increased by your landlord. This is inconvenient as you could be struggling financially and not able to afford the increases.
- Lease rules – You need to follow the rules of the lease. Some landlords don’t allow pets.
- Eviction fears – You can get evicted for any reason.
- No equity – Renting means you lose out on building equity. Your monthly rent goes to paying the homeowner’s mortgage.
Rent or Buy?
Before you choose whether you should rent or buy a home, you need to analyze your financial situation and re-evaluate your goals. Where can you see yourself in the short term and the long term? Do you know where you want to live? All these questions need to get analyzed on a deep level.
How stable is your job?
It won’t be easy convincing a lender to give you a mortgage if you don’t have a stable job. You’ll also struggle to pay your bills without a job and might get behind on mortgage payments.
Location is everything
The property market in Toronto and Vancouver is a lot pricier when it comes to mortgages, whereas rentals in these areas are cheaper. Before buying property, it’s best to compare mortgage payments and rental costs in the neighbourhood you’re considering.
Generally, if you’re going to be paying above $3,000 monthly on rent, then there’s a possibility you can do better with a mortgage.
Do you plan to live in the same house for a long time?
The more time you live in a home, the better the investment becomes. This is due to the number of costs involved when transferring real estate.
Commitment is long-term
Buying a home is pricy as you’re paying for home insurance, utilities, property taxes, a mortgage, and maintenance. These are for the long haul, and you need to be ready for it.
How to Know You're Ready to Buy
You’ll know you’re ready to buy when you feel you’re ready to settle down and not move for at least the next five years. Buying is an excellent option if you’re starting a family and want a place to call home.
If you have a steady income and not planning on changing careers anytime soon, you could be ready to buy. If you’re self-employed, consider that you need two years’ worth of income proof for the Canada Revenue Agency’s Notice of Assessment.
Being emotionally and financially ready can mean that you’re prepared to buy a home. You’re responsible enough to take care of your mortgage payments, utilities, repairs, etc.
How to Know You're Ready to Rent
If you’re not ready to settle and not sure of your long-term plans, then consider renting a home. Maybe you see yourself travelling more often or changing your career soon. These are signs rather to put any mortgage dreams on hold.
Having a lot of debt can count against you when applying for a mortgage, and it might not be affordable for you. Focus instead on getting your bills up to date and improving your credit score before making any big purchases, like a home.
If you don’t have a downpayment saved, then it’s a good idea to continue renting. Save for a few years, and once you have a little nest egg saved, you can approach a mortgage lender.
If your job is not permanent, or you’re self-employed but don’t have two years of income proof, buying is not an option. Spend time-saving for a downpayment and accumulating proof of income to make yourself look more attractive to a mortgage lender.
Should You Rent or Buy a Home?
It’s a personal choice, and only you will know if it’s right for you to be a homeowner. Spend time assessing the pros and cons of buying and renting a home before you make any decisions.
Renting provides more flexibility to move around, whereas buying a home will keep you in one location for a more extended period. Think about how committed you are, and consider both the 5% and 40% rules to make your decision-making easier.
If you’re still unsure about making a decision, speak to a mortgage broker who can assist you with all your questions and who can guide you into making the right choice for your situation.