Homeownership comes with a wide range of financial and social benefits. Owning your own property earns you an increased sense of stability: you can renovate your space to your own tastes, make home improvements, and build stronger ties to your community. But aside the lifestyle benefits, homeownership also makes a lot of fiscal sense.
The biggest perk of buying a home is the accumulation of equity over the long run, as you gradually pay off your mortgage principal.
What exactly is equity?
Equity is the difference between the market value of the property and the debt on your mortgage. It’s the part of the house you truly own, the amount you’d walk away with if you sold your home and paid off your loan in its entirety.
With every monthly mortgage payment, you put equity into your pocket rather than your landlord’s pocket. And, unlike most things you buy, a home’s value will almost definitely appreciate in the long run, which builds even more equity year by year.
To calculate how much equity you’ve accumulated in your home, it isn’t enough to simply subtract your outstanding loan from the price you paid for your home. Your calculation needs to be based off the current market value of your property, which is determined by analyzing market trends and sales comparables in your residential district.
Let’s take a look at these two scenarios to see how home ownership grows equity over seven years. The calculations are based on an estimated 3% annual appreciation rate. In reality, some neighborhoods grow at a much faster pace, while others show a slower upward trend. Montreal has consistently demonstrated annual growth rates between 2% and 5%, according to Centris reports.
This is a condo for sale in the South West of Montreal, at $295,000. Comparable units in the building are listed for rent, at $1,500 a month.
Let’s assume you buy it with 5% down with a 25-year amortization with today’s best mortgage rate (2.38%). You can replicate these calculations using any asking price of your choice using Ratehub.ca’s mortgage calculator.
- Down payment: $14,750
- Amount borrowed:$280,250
- Mortgage payment per month: $1,283
- Principal paid over seven years: $64,829
- Amount outstanding after seven years: $215,421
- Appraised resale value with appreciation: $362,812
- Home equity gained:$362,812-$215,421= $147,391
- Equity gained after resale: $147,391
Let’s compare renting the same condo over seven years:
- Rental price: $1,500 a month
- Total amount spent over seven years: $126,000
- Equity gained: $0
It’s clear to see which outcome is more attractive. A homeowner would sell the home and leave with $147,391. A tenant would leave with nothing. Even after taking into account maintenance costs and selling fees, the difference is still astronomical.
But that’s not all.
The fiscal benefits of homeownership go beyond just building equity:
- Homeowners can create passive income by renting out a spare room in their home, or leasing out the entire property if they invest in an income property.
- For the less financially disciplined, owning a home is a forced savings plan. With each mortgage payment, you’ll be routinely putting money away towards your equity while increasing your overall net worth.
- Tax benefits. First-time buyers are eligible to make tax-free withdrawals of up to $25,000 from their RRSP to contribute towards their down payment under the Home Buyer’s Plan. Buyers of new construction or buyers undergoing substantial renovations can also be subject to GST/HST and QST rebates. And you can reap tax-free profits because any gain on the sale of your principal residence isn’t taxable.
So does that mean it’s always a better move to buy? Absolutely not.
Buying is advantageous, but only when the homeowner can comfortably afford it. Ideally, your total housing costs (including your mortgage) should only amount to 30% of your gross (before-tax) income. If your monthly paycheque is less than three times the (mortgage plus carrying) costs of any home you can find on the market, taking the plunge into homeownership is a risky move.
Moreover, equity perks only start to kick in after three to five years of having a mortgage. Because of the way principal payments are structured, most of your payments go towards the interest in the first few years of your mortgage. So if you plan to relocate in the near future, it makes more sense to hold off on homeownership.
In other cases, homeownership is a great way of building a strong financial future. A parting word of advice for anyone buying in the near future: be realistic about your costs and budgeting, be patient until you find a good deal, and have your agent do a thorough comparative market analysis before purchasing a home!
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