I noticed in his latest blog post that Tyler Cruz is looking at leaving the renting world and buying a house. This a big move for anyone and I can understand how nervous he is feeling. So I figure I will put together this little post on the old buying vs. renting argument and give some Dot Com mortgage tips as well.
The House You Live In Is Not An Asset
Many people view their house as an asset – and the biggest asset at that. The truth of the matter is your primary home is not an asset, it’s a liability. You see, assets make you money. However, the only way you can make money off your house is if you sell it for more than you bought it for. Until then, you have to pay maintenance, hydro, cable, property tax, mortgage, repairs, etc. Housing costs are among the highest recurring cost a family can take on. Would you call something that takes thousands of dollars each month to maintain an asset?
Let’s say you sell your house for more than you brought it for because the market is on fire. This is the situation I am in now. I bought my house about a year ago for $411,800. Right now it can sell for $525,000. That’s a pretty good profit, right? Many people can’t make $100,000 a year but my house has gone up by more than that during this time frame and I didn’t have to do any work. But let’s look at the numbers a little more closely.
First of all, you have to live somewhere – shelter is one of the basic requirements of life. So if I sell my house, I have to find another one. And guess what? My house is not the only house that went up in value – every house in my area went up! So if I brought another house that is of equal features to my current one, have I really made a gain? Some will say I could downgrade, or move to a cheaper market. Ya right! How many people downgrade their house? Most spend more money and upgrade.
This is not to say I am against home ownership. I am completely in favor of owning your own home. I just want people to understand that the house one lives in is not an asset, and it won’t become an asset until the day you sell it. Until then it’s a huge liability.
Renting Is Not Throwing Away Money
When I was renting I couldn’t keep track of the number of time my parents told me that renting was just throwing away money. I was paying someone else’s mortgage, they would tell me. I’m sure you have all heard the same thing from your friends or family members. At first this seems to make sense. Why pay $1,500 a month for rent when you can pay $1,500 a month for a mortgage and own your own home? There is one major flaw with this argument – the house you rent now isn’t the house you want to own.
When renters become owners, nearly 99.99% of the time they upgrade. They want a bigger place, in a better neighborhood, near a better school, etc. So suddenly, that $1,500 a month in rent becomes $3,000 a month in mortgage payments. And of course, maintaining that new house will cost a lot more than the rented place. See the true picture now? If everyone buys the same place they rent, then it would make perfect sense to own. But this is not how people function.
If you’re renting, don’t feel bad when people tell you that it’s just throwing your money away – unless the place you’re renting really is the place you want to own. Then you are throwing money away!
Dot Com Mortgage Tips
Being a Dot Com that makes all their income online presents an interesting exercise when getting a mortgage. This is the same for anyone who doesn’t have T4 or employment income. Banks will want to see proof of income in the form of a Notice of Assessment from the Canada Revenue Agency. The problem is many business owners tends to overstate or pad their expenses to show less taxable income. The bank has to base your mortgage on this Notice of Assessment and if the taxable income shown is say $33,000, they may wonder why you’re asking for a $1 million mortgage. Banks based how much mortgage you can afford on your income as stated from the Notice of Assessment. So if you make $33,000 a year you can afford $663 a month in mortgage payment. Based on 6.6% interest, it would mean you qualify for a $98,000 mortgage.
If you’re in a situation where your total income is a lot higher than your taxable income, it doesn’t have to prevent you from getting a big mortgage. All you need to do is make it so your bank doesn’t need to know how much you make. How do you do that? Put down 35% down payment. At 35% down, a bank can give you a mortgage based solely on your FICO credit score. If the score is high enough (680 or above) the bank can lend you the 65% without asking any additional questions – and they will give you their lowest interest rate as well. So if your credit is high enough and you really want that million dollar house and only have Notice of Assessment income of $33,000, just put down $350,000 and the bank will lend you $650,000 without asking a single question!
Now if you don’t have 35% but still want to get that big place you can go for what is known as a “low doc” or “I declare” mortgage. These are done through a mortgage broker. Your approval is based on your credit score. You can always get a free copy of your credit report from any of the three major reporting agnecies, like Equifax. You will still need to show your Notice of Assessment but it doesn’t matter what amount is stated there – it can even say zero. The down payment can be as low a 5% and there are even programs available with nothing down.
The disadvantage of these programs is higher cost. Because of the higher risk to the lenders, they will charge a higher interest rate. Also if you put down less than 25%, there will be insurance as well as application fees and other costs. These costs can range from 1% to 5% of the mortgage amount – not a small figure when you’re dealing in hundreds of thousands of dollars.
My recommendation would be to stick with the banks and go for 35% down. At this level the banks loves you! Their risk is very low because of the amount you have committed. They will waive all fees and even pay your closing cost. If you can’t do 35% then the next best bet is to do 25%. At this level the bank can still give you the same deal as at 35% but they will base your mortgage on your Notice of Assessment. If that notice doesn’t show enough to get the mortgage you need then get a mortgage broker to find you a low doc mortgage. You won’t want to go below 25% down because the insurance costs and fees on a low doc mortgage can be very high – they are all waived at 25% down.
Pay Your Mortgage Off ASAP
Most lenders shows mortgage payments based on a 25 year amortization. My recommendation is to never take a mortgage longer than 15 years. Say you have a $100,000 mortgage for 25 years at 6.6% interest. Your payments will be $676 a month and over the life of the mortgage, you will pay $102,800 in interest. If you shorten the term to 15 years, your payment will increase by just $196 a month but you will save $45,840 in interest.
Here’s another good reason to pay your mortgage off fast – Unlike the US, mortgage interest on a principle residence is not tax deductible. Because of this, your interest payments are made with after tax dollars. So that 6.6% interest can be as high as 13.2% after tax. It’s pretty hard to find a 100% safe investment that will give that kind of after tax return, but paying off your mortgage (or high interest credit cards) can. Remember, good debts are debts where the interest is tax deductible. Bad debts are debts where interest can’t be deducted. A mortgage on your primary home is bad debt and should be dumped ASAP!
There are ways to make the interest on a principal resident mortgage tax deductible. However, the maneuver requires a person with a lot of assets outside of his home. I’ll post about that in the future because this little post is no longer little.