Millennial Housing: Do the Math!

Late last year, we were interviewed for by the Toronto Star for an article about millennial housing and how we impact and affect the market in Toronto. When the article came out this past weekend, we found The Star stating we had “done the math.”

I have previously shared the motivation behind our decision to remain in our small space. Today, I’ll draw the curtains to show you the numbers. On a side note, math is awesome.

The Background

We have the capacity to clear the mortgage in its entirety right now, but it would require us to liquidate all of our investments; let’s not get into the whole mortgage repayment versus investment debate right now.

As article indicated, we purchased our condo over 7 years ago for $280,000. Definitely not a small sum of money even back in 2008. Our friend purchased a much bigger house in Minnesota for a third of the price; he continues to poke fun of our expensive tiny box of a home. Considering that housing prices began to skyrocket at a record-breaking pace in 2009, a two bedroom condo for over a quarter of a million seems like a steal nowadays.

We made mortgage reduction a huge priority in the first few years as homeowners (well, after clearing Daniel’s $30K school loan first). We increased our monthly payments whenever our income increased and all of our annual savings went into the mortgage as lump sum payments. The amortization period on the condo was reduced to 15 years from 25 years.

As we better educated ourselves on personal finance and investing, we re-allocated our annual savings to low cost index investments but kept an accelerated bi-weekly mortgage payment schedule. An equilibrium between debt repayment and investing was formed; we are paying off the mortgage and saving at rates that will accelerate the end date for full home ownership and retirement. We have the capacity to clear the mortgage in its entirety right now, but it would require us to liquidate all of our investments; let’s not get into the whole mortgage repayment versus investment debate right now.

As of January 2016, we have paid off $146,000 of the principle, leaving a remaining mortgage of around $133,000. Without making any changes to our current monthly mortgage payments or savings rates, the mortgage for our condo will be paid off in seven years.

Hypothetical Purchase of a New Home

We would have 25% downpayment for a $850,000 home. Our new mortgage would now be mind boggling $637,500.

Let’s say we decide to upgrade right now and find a home in Leslieville, a neighbourhood we once seriously considered. The average home in Leslieville, as of November 2015, was approximately $800,000; after skimming through MLS, I found a semi-detach I liked for $850,000.

We would take the proceeds from the sale of condo (less closing costs) and use it as a downpayment for the new place. Based on current market prices of a two bedroom condo in our neighbourhood, that would roughly amount to a $213,000 down payment, or 25% of the purchase price of my bigger yuppie house. Our new mortgage would now be mind boggling $637,500. With an amortization of 25 years and an interest rate of 2.49%, our monthly mortgage payment would be $2,850, an increase of $1,100.

[table]
“”, Current (Condo), Hypothetical (House)
Mortgage Remaining, “$133,000”, “$637,500”
Years Remaining, 7, 25
Monthly Mortgage Payment, “$1,750”, “$2,850”
Difference, “”, “$1,100”
[/table]

What are the implications of $1,100 a month?

• $13,200 a year, for starters. In five years, which is the minimum duration we intend to stay at the condo, we will have saved $66,500.
• If we stay at the condo longer- say seven years-  we will have bumped up our savings to $92,400. Investing $13,200 a year for seven years, with a rate of return of 6% would grow to $110,799. We would also be mortgage free. That, to me, seems like a better place to be than in a bigger home.
• If we purchase the hypothetical $850,000 house- in seven years- we will have paid $98,200 in interest. And that’s assuming an interest rate of 2.49% through the entire duration. That is a lot of my hard earned money paying the bank! The outstanding mortgage would have a balance of $496,500, with another 18 years to go.
• Let’s not forget the cost of discretionary renovations. Many of these gems for sale have “good bones” and are just waiting to be gutted- working kitchens or not.

But Real Estate is an Investment!

I do not deny that real estate can be an investment, especially a house. The rate of return for a home in Leslieville would certainly surpass the rate of appreciation on the condo. Keeping that in mind, I compared the overall state of our finances between the two scenarios: staying in our condo and buying that house. The comparison was based on the following assumptions:

• Interest rates remain at 2.49 percent for seven years. Note, this is unlikely, and since interest rates are at a historic low, there is a bigger chance of interest rates increasing.
• The value of the condo is calculated with a yearly appreciation of 7%. This is based the value assessment of our home in 2014 and the purchase price in 2008.
• The value of the Leslieville house is calculated with a growth rate of 9.5%. This is based on the average house value in neighbourhood in 2008 and 2014
• The rate of return for investments is 6%.

[table]
In 7 Years , Condo, House
Remaining Mortgage, $0, “$497,000”
Estimated Home Value, “$679,000”, “$1,607,00”
“Investment Returns ($30K over 7 years + $1,100/month over years)”, “$1,750”, “$2,850”
Net Worth (from housing), “$835,000”, “$1,067,000″[/table]

In seven years (so 2023), buying the house in Leslieville could make me a millionaire. Not bad,but I would still have half a million in debt with all my assets tied to the house, leaving me house rich and cash poor. The difference in net worth between House me and Condo me would be $232,000. That is a tidy sum, but I would have to sell (and lose) the house to reap the benefit. On the other hand, Condo me would be cash rich having accumulated $156,000 in liquid assets. Unless we sell, real estate, however much it’s worth, will not generate the necessary income for retirement; a high net worth where assets are tied down in real estate does not bring financial freedom.

Leaving $156,000 invested for another 27 years, until I reach the retirement age of 65 years old, my liquid assets will have grown to $752,286- without adding anything else to that investment fund. However, that would be unlikely as Condo me would also be mortgage free with an “extra” $1,750 to save each month.

Related: The Great Debate: Condo versus House

Other Considerations

Other aspects of our finances would be affected by a higher mortgage, like our ability to travel or splurge on a big purchase or even to renovate. Our current housing expenses (which include mortgage, maintenance, property tax, and insurance) account for 24% of our monthly budget; an increase in mortgage payments and property taxes would raise that percentage, diminishing our current standard of living (less fun, less travel) and ability to save. In the case of an emergency, we’d risk not having sufficient cash flow to cover the unexpected expenses; in the case of reduced income, we’d risk not meeting mortgage payment obligations. And of course, if interest rates go up, so will the monthly payments.

Our Finances, Our Values, Our Priorities

After running the numbers, we decided to stay in the condo. It is a decision specific to our family and based on our values. While we could “afford” a house, acquiring a bigger mortgage does not align with our current priorities. For example, one of our financial goals is to retire at a much younger age than the average Canadian at 65 years of age. A bigger mortgage would hinder our ability to reach accelerated financial freedom.

Everyone’s situation is different. Financially speaking, some have higher incomes, bigger retirement funds, larger down payments or opt to borrow from the bank of mom and dad. Value wise, some people do not care for early retirement or place greater importance in the benefits of living in a house in particular neighourbood. They are trade-offs to every financial decision; only you can determine what you are willing to give up or live for.

Last Word

When considering taking on a mortgage, it is important to review the following questions:

• How will the monthly payments affect your current standard of living and will you be okay with the changes?
• Will you be able to maintain mortgage payments if your salary is reduced, like in the case of unemployment?
• If so, will maintaining mortgage affect put a strain on finances and keep you up at night?
• Will you be able to maintain the mortgage if interest rates go up?
• Will you be able to save for retirement and reach financial freedom at desired age with your mortgage?

The only way to answer these questions is to do the math.

You’ve heard it here many times before, and now again from The Star: we’re staying put. For how long, I can’t say. We intend on staying for 5 years, but it could longer or shorter. Maybe the housing market will crash. Maybe we will win a million dollars (from lottery tickets we don’t buy). Maybe the kids will outgrow our space sooner than we plan. Or maybe we will live mortgage free for a few years before deciding to move. Whatever the case, when our situation changes, you can be sure we’ll do the math first.

Sources

• Toronto Star Article: Millennials set to drive change in real estate market
• http://www.ratehub.ca/
• https://www.realtor.ca/
• http://news.morningstar.com/index/indexReturn.html
• http://www1.toronto.ca/wps/portal/contentonly?vgnextoid=6245ff0e43db1410VgnVCM10000071d60f89RCRD
• http://juliekinnear.com/toronto-neighbourhoods/leslieville-real-estate/house-prices

Have you done the math?