So what is a mortgage? Sophisticated catchphrases like: it’s good debt’ or ‘a smart use of leverage to obtain an asset’ come to mind. When translated from the Latin (see…sophisticated) it means ‘death pledge’. Either you pay it back or the loan is forgiven when you die. For most, house debt is the largest they will incur in their lifetime so it’s worth unpacking.
Over the long term, owning a house is the way to go. The usual argument is that rent and a mortgage payment are the same so why not buy? In the short sighted view yes, that’s probably true. But that scenario leaves out the real life factors of tax increases and repairs. If you rent and the furnace goes out in January, the landlord replaces it. If it’s your house well, that’s why you need an emergency fund and not a credit card or line of credit.
In priority, here’s how I recommend a house purchase take place:
- 100% cash, no debt. That’s right, save up and pay it in one shot. I know this one is a bit out there and no one does this, but if you spent a few years in the beginning of your life living super cheap, saved up and bought, how much more cash would you have each month with no housing payments? The next upgrade house would be within reach quickly as well.
- Be completely debt free, have an emergency fund then save up a down payment to the spot where your mortgage + taxes are no more than 25% of your household take home pay on a 15 year fixed rate mortgage. Having your housing costs below 25% ensures you won’t be housebroke and the maximum time in debt will be 15 years. Yes this means less house initially.
- If you’re like most, you’ve stumbled along for a decade and woke up in the middle of too much house and too much debt. Get out of debt, save up an emergency fund, start putting 15% of your gross income into retirement savings then throw everything else at your mortgage. I’m assuming that most of you reading will fall into this category. Even if your mortgage payment is a little over 25% of your take home pay, the mortgage is rarely the massive issue in your situation. Getting on the same page, a written budget and out of consumer debt as fast as possible will sort you out much faster than trying to refinance your mortgage (usually).
I can already hear some people bring up the fixed rate vs variable mortgage. Again personal finance is only 20% math. Let’s say that mortgage rates are about 3% right now. That level is the exception and not the rule over the last 50 years. It can only vary upwards. A few people will say that if they get a variable right now and attack the mortgage aggressively, it will be paid off quickly with less interest going to the banks. Fine, but almost no one does that. As discussed previously, the temptation to take one marshmallow not is too great. Keep in mind that anyone who lends you money has a vested interest in keeping you in debt for longer. They aren’t evil, it’s just something to keep in mind.
Real estate always goes up in value…most of the time. If you plan on owing a house for less than three years, rent don’t buy. After factoring all of the fees and costs associated with selling, you usually haven’t made anything. But wait, why not keep it as a rental? Rental property can be great if it’s done properly. Here’s my recommendations on rentals:
- Pay off your personal home, then save up and pay cash for rentals. Bomb dropped. If you had your home paid for and a paid for rental, how much surplus would you have each month? How much quicker could you buy the next rental? When a tenant moves out, you aren’t panicking while paying two mortgages and you can afford to spend $100 per month to keep the pipes from freezing while you do interviews for the right tenant. “But I went to a seminar by the airport to learn the true secrets of real estate for $5000 and they said to max out all my credit vehicles to put small down payments on a bunch of rentals and that if I really wanted to increase my knowledge I need to sign up for the $50,000 seminar…” Oh boy. These are scams and you know it, but might not know why. Essentially they convince you increase your credit limits with a lot of rah rah and bamboozlement. Once you’ve done that, now you can afford the more expensive step of the pyramid…I mean sophisticated top secret seminar. The typical game of using equity to put down payments on more property works in theory when it works. Once real life injects itself, things fall off the rails quickly. I have a rental and the last tenants I evicted turned out to be white supremacists and still owe me three months of rent. Lesson learned.
- Don’t own rentals you can’t drive by whenever you want. Moving every few years and having properties all over the country rarely works out. If you are the landlord, you need to be able to respond to things. Being a plane ride away is a great way to wind up in a mess with a tenant. Think of it in reverse. If you had $200,000 in the middle of your table, would you buy a rental in Edmonton if you lived in Ottawa? Probably not. Asking yourself if you would buy something again if you didn’t own it is a great decision making exercise. Property management companies can be nice, but you need to manage them and have very clear communication on repairs and costs.
- If you currently have a rental close by, pay off your own home first then the rental. If you were going to lose one, it would be the rental. If your rental can be paid off in a year or two and you really like it (would buy it again), then maybe pay off the rental first.
In summary, buy a house. Just do it the right way and make sure it fits in your overall picture. Rules have tightened up recently but be aware that lenders will approve you for more than you can afford. A lender once told me their formula for approval was the mortgage payment plus enough heat to keep the pipes from freezing. Lots of folks in ‘nice’ neighborhoods have patio furniture in their $800,000 house.
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