Reader Mail: 24 and Clueless (Rent vs. Buy)

I didn’t come up with the title, it was the subject line of an email I got from Jenny.  Jenny is in a very common situation, she’s just about the graduate school, currently has some income, and is looking to purchase a house in the very near future.

I’m 24 years old and really concerned about my financial future, I come from rather meager upbringings and I want to be sure that I’ll be able to live/ retire comfortably.

  • I’m currently a full time student and full time employee making about 32,000 a year and am living on my own with bills to pay.
  • I currently have about 9,000 in savings (plus a small RSP savings account with Scotia Bank that pays less than 2% interest)
  • I would like to make sure that I’m on the right track, and would like to own a condo/ apartment within the next couple years, but worry that with such low funds and only 1 credit card in the way of credit I’m not going to have much luck!!
  • I’m living in BC approximately an hour outside downtown Vancouver and figure that I’ll be paying about 250,000 for a condo in my suburb.
  • As for graduation the details get a little foggy there, right now I’m fairly content with my job but am getting my bachelors degree just as an insurance policy so to speak. I figure that by the time I graduate (probably in 3 years or so) I’ll either be ready to try my hand at a new career unrelated to my education (but be able to earn a higher salary since I have it), or will have been led certain way by the courses I’m interested in/ skilled at.
  • Absolutely no debt and am not yet married.

To start, I’ve said this before, but I’m not a financial advisor so anything I say should be taken with a grain of salt.  With that out of the way, looking at the details indicated, it seems that Jenny is far from clueless.  As a young person still in school, it’s commendable to be debt free and have some savings put away even if working full time.  Lets take a look at some of the financial goals

Rent vs. Buy

Jenny’s first goal is to purchase a $250,000 condo.  Assuming a 5.5% fixed interest rate, and 5% down, the payments would be $1,450/month + property tax + condo fees.  Assuming 1%/yr property tax and $250/month in condo fees, the total housing cost of approximately $1,900/month not including utilities.  To rent in the same area, according to Jenny, it would cost around $1,200/month for a 2 bedroom apartment.

The initial problem with purchasing is qualifying for the mortgage at her current salary.  Purchasing the condo would result in a month housing expenses of at least $2,000/month with utilities.  The maximum a lender will give is a gross debt servicing (GDS) and total debt servicing (TDS) of 32% and 40% respectively.

In Jenny’s case, even if $32,000/year would result in a GDS of 75% which is way outside the qualification range.  Even if her salary got boosted to $50,000 in a couple years, it would still result in a GDS of 48%.  Jenny’s (or family) income would need to increase to $75,000/year to qualify for a mortgage on this home.  The point being is that unless Jenny’s income (or down payment) increases significantly, then purchasing a home at this price may not be an option.

The alternative, not that it’s a bad one, is renting.  Renting has always gotten a bad rap as they say that you’re paying someone elses mortgage.  While this may be true, paying lower housing costs and investing the difference between renting and mortgage payments, can put you ahead over the long term as home ownership is historically known to only keep up with inflation.  If home ownership is something that you want for yourself, then I would suggest to rent first (as cheaply as possible), save as much as possible, then consider buying when the income levels are high enough to support the housing costs after a large down payment.

In conclusion, I think that Jenny is already on the right track.  She should keep up her savings habits even while her salary increases, index her portfolio for the long term, and wait for the right time to purchase a home.

How would you improve Jenny’s financial situation?

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FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Gates VP
11 years ago

@AK: this is a great question, but it’s highly dependent on where you are and how you want to live. Instead of a direct answer, let me give you some links and reasonable quotes:
NYT: Median Home Prices vs Median Income
These are for major US cities, but the variation is pretty staggering. Canadian cities will be no different. If you look at the relatively flat periods, you’ll notice how even in 1979, cities like NY, LA & SF all carried premiums. Trading at 3.5x to 4x the median income. Expect TO and Vancouver to have a similar premium.

What you’ll notice is that the multiple hangs around 2x in periods of reasonable stability. To me, it seems clear from the charts that prices will continue to fall in many of these regions. A thought echoed by others. That last link also has a reasonable quote:
The simple truth is that median income should not exceed 3 to 5 times your bring home income (and that’s being generous).

I’m sure that many on this blog would argue that even the 3x to 5x should be one person’s income not both. 5x on two incomes is a very large financial burden.

So why am I answering your question with all of these numbers?

B/c this multiple is probably going to be the gauge of how “relatively” expensive housing is going to be. Here’s a chart for Housing Affordabiliy that lists 3x and under as the “affordable” number. The PDF report has a city-level breakdown of this multiple from Q3 2008. The report includes Canada (which is rare).

Take a look at the PDF, check out the Median Family Incomes by Province and you’ll get an idea of how expensive housing currently is. And if you’re in Canada, check out the Canadian stats as housing “boom/recession” is very different in nature than the US crisis. (and I say this as a Canadian living in the US)

What I can tell you overall is that much of Canada is still quite expensive. Even with recent drops in places like Edmonton / Calgary, the average home price is well out of reach of the average family. My personal rule of thumb is the “two-professional family”. If two late twenty-somethings with professional careers (engineer, nurse, teacher, etc.) cannot afford a house, then prices are way too expensive. If they can’t afford a home who can?

In Western Canada, that’s quite true. In fact, if you look at the previous PDF, the major Canadian city with the lowest multiple is Winnipeg (at 3.0). Regina and Saskatoon were both higher. Of course, if you start including property taxes, Winnipeg moves out of the “affordable” range. Average prop taxes are $3,600 / year which is double that of other Western cities. But Winnipeg has to pay for lots of snow removal and road work, just the way it is.

Anecdotally, I know lots of western Canadian 20-somethings who simply can’t afford a home.

So to your original question should we still wait before buying or is this a buyer’s market now.

Please take a look at the stats. In some places it may truly be a buyer’s market. And most places are suffering falling home prices so it may feel like a “buyer’s market every where”. But historically, it really isn’t. If you go over the charts, most of Canada is still above historic norms. It can feel low, but remember that we’re in a 15-year housing bubble. Most people just can’t remember what a house cost in 1993, nor can can they adequately adjust for 15 years of inflation.

Remember, it’s not like we have some type of “Canadian Space Shortage”. Winnipeg still has miles of gravel road inside its own perimeter. What we do have is an aging population that will likely want to “down-size” in the next 10 years and nowhere near enough people to fill up these old houses (here’s a population chart).

If you need a house now, they you need one now. But based on sheer numbers, I can’t believe that we’re anywhere near the rational bottom.

AK
11 years ago

so it’s been a year since this post, how is the real estate market? interest rates have dropped, should we still wait before buying or is this a buyer’s market now

The Nemesis Enforcer
12 years ago

Keep renting for now. Condo prices in Vancouver will go at least 20-25% lower based on forecasts and the current climate. Consider sub-letting your condo during the Olympics (if you’re allowed) to make a substantial amount of rent during that time. Put $5k of your 9k into a Tax Free Savings account. I’d buy a redeemable GIC (nothing locked in) at this point as there’s a good chance you may need to dip into the funds in the short term. Screw the RRSP. At your income level/current situation it’s much wiser to carry the unused portions forward to future higher income years. Best of luck to you!

Patrick
12 years ago

Rent! Here’s a gratuitous link to my own blog, where I explain my own decision on this.

Ed
12 years ago

I would make tracks to the school bursar’s office and demand a full refund. You obviously didn’t learn a damn thing and, considering that money was exchanged for this “education”, they have perpetrated a fraud. Take the bastards to court. They deserve far worse that the hassle of defending themselves.

Kurtosis
12 years ago

Rent rent rent. All data points to a demand-destruction-driven global deflationary depression over the next few years. The fact that this is even a possibly implies the prudent thing to do is to NOT go into debt right now. In deflation, cash is king, debt is a killer.

My advice to Jenny, rent for the next 2 years, by then it will be very clear how this economic mess is playing out, and you can make a more informed decision whether to buy a house at the bottom or continue renting. But we’re not at the bottom yet, we’re just now at the end of the beginning.

Peter
12 years ago

Congrats Jenny,

I am also in the lower mainland and can relate to your position. Even married with no kids and two full time jobs earning >$100K combined we are still renting. But I am completing my education as well and so it is not a good time to buy. Throw some kids in there and only one income will service the debt. Not a good idea with current prices if you still want to max RRSP and have a little bit in savings.

Good luck and keep saving for that down payment.

DAvid
12 years ago

James is also speaking of a very rare situation where an employer expects staff to move on a regular basis (eg. RCMP), and addresses some of these costs to ease the movement of staff to ensure coverage throughout the country. It does not address the issue of staff who move from an area where prices have not risen at the same rate as elsewhere.

DAvid

Gates VP
12 years ago

@James: to answer your thought, I’ll paraphrase @Scott: If it’s cheaper to rent than to pay even the lowest mortgage… then keep renting until such time the ratio reverses.

I’m not always a fan of simple rules, but whenever I crunch the numbers, the theoretical rent vs. buy curve centers around this point.

If you look at both of your clauses, neither of these situations would solve Jenny’s problem of the home simply being too expensive.

Even outside of Jenny’s situation, legal fees, closing costs, etc. are just small portion of the equation. There are also moving costs and moving time. Inevitable repairs both to sell your old house and move into a new one. You have to blow a bunch of time packing boxes and bunch more time filing paperwork as you update your address in 20 different places.

And the clause on lost home value would be quite dicey because a house is worth what it actually sells for. How would such a clause even be enforced? If I bought at $225k and my neighbour’s sold for $200k the next day do I get the money? Do I have to sell for $210k to get the money? Why am I selling? Just b/c the house dropped in value? Am I selling b/c the company closed up shop? What are the odds they honor the promise?

Point is given the details on the clauses you gave it’s impossible to really provide a much of answer. Which is why I defer to my original quote from Scott. Unless you can find a way to make the mortgage less than the rent, it’s going to be tough to justify a financial decision to purchase a home. (if you just really want one, go ahead, no sympathies if it sucks :)

Simple Life
12 years ago

hi Jenny

The best way is to compare both scenarios: renting and buying. One of them will end up with more saving, that will be the one for you should go for.

for example
expense for renting: 20k a year
expense for buying: 30k a year

it is clearly renting will make you 5k richer