This 37-year-old millennial lives with roommates and is hoping to get her own spot. With $10,000 in student debt, should she rent or buy in Toronto?
Millennial Money is a weekly submission-based series that provides financial advice to millennials in the GTA. Read the full series here.
Lola, 37, works in the pharmaceuticals industry making $87,000 a year, plus bonuses. Having spent most of her adult life living with roommates, it’s time for her to be more independent.
Though the plus side to her living situation is her rent comes in under $600 in Etobicoke, there is a downside: lack of privacy.
“I really need my own space,” she said.
She started looking into renting her own place, but found that listings started at around $1,500 to $1,600 a month. “It’s too expensive,” she said.
The high prices got her thinking: if she would be paying $1,500 a month to live alone, how different is that from monthly mortgage payments if she chooses to buy?
Though she’s earning more than ever before, she notes that her work contract is set to end in June 2022. She also has $10,000 to pay off in student debt.
Before jumping into home ownership she wants to make sure she can be financially stable in case her contract doesn’t get extended.
“I want to rent for now and maybe buy later once I get a permanent job. That makes financial sense to me now. But on the other hand I am thinking that instead of paying $1,600 in rent, I might as well pay that in mortgage. So I’m confused between these two ideas,” Lola said.
Luckily during the pandemic, Lola has been able to save around $300 monthly as she hasn’t been incurring public transit or grooming (hair and nails) expenses.
In addition, working from home has led her to have more home-cooked meals. “During pandemic times, most meals are at home, but I’ll still buy lunch at $10 to $15 per meal.”
On the weekend, Lola also saves money by spending time at home. “Before the pandemic, I used to go out to with friends around the city,” she said.
Should Lola be looking to rent or buy? How can she get organized to make that move? We asked her to share a week of spending to get a better idea of her finances.
The expert: Jason Heath, managing director at Objective Financial Partners Inc., on Lola’s living situation.
Lola is a renter who is considering buying a home. There are a few things that she should consider.
She should get pre-approved for a mortgage so she knows how much a bank will lend her. Based on some quick calculations, she may be able to buy a $400,000 condo with a $20,000 down payment. You need a five per cent down payment at least and can borrow the other 95 per cent from a bank.
It is one thing to know what the bank will give you and it is another to know what you can actually afford.
Lola’s budget of about $1,500 per month suggests she should be saving over $3,500 per month based on her income. If she is, that is great, and she could pay off her OSAP debt and build a down payment in no time.
I am wondering, though, if she has understated her spending, so she may want to do a deeper dive on her expenses. Online banking sites often have built-in tools to analyze your spending by category, and there are third party apps for the same purpose. Lola should consider building a budget to see if the cost of home ownership works for the lifestyle she wants to live.
Say the bank does approve her for a $380,000 mortgage with a $20,000 down payment, there are other closing costs like provincial and municipal land transfer tax, legal fees and moving costs to take into account. Her mortgage payment could be $1,600 to $1,700 per month assuming a mortgage rate of 2 to 2.5 per cent.
At first glance, that seems like a bad choice given she thinks she can rent for $1,600 per month. However, assuming a 2.25 per cent interest rate on a $380,000 mortgage over 25 years, about $950 per month of her mortgage payments would go toward paying down mortgage principal in the first year.
On the other hand, home ownership has other costs. If it is a condo, as would likely be the case in the Greater Toronto Area at that price, there are condo fees to consider. There are also property taxes, insurance costs and repairs. Could she rent a bigger or better place for $1,600 per month than she could buy for $400,000? The point is you cannot simply compare a mortgage payment to monthly rent to determine which is best financially.
As a rough rule of thumb, if you can pay annual rent of less than five per cent of the purchase price of a comparable home, renting may not be a bad deal. This is a very rough rule of thumb, because factors like condo fees, the condition of the home and required repairs, the price increase or decrease in the future, and other considerations can change the math. I would also think twice about buying a home that you do not think you could live in for five or more years given the transaction costs — land transfer tax and real estate commissions in particular — involved in moving.
In the short run, I think Lola should focus on paying off her remaining student debt and building a down payment fund while she considers her budget for renting or buying. She has $150 less to spend on public transit given she works from home, so hopefully that is all going toward debt repayment and saving.
If you have an expense that suddenly decreases, or you get a salary increase at work, it can be a good idea to try to save that extra cash flow if you can. As people’s incomes increase, they often suffer from lifestyle creep if their expenses simply rise with their income. If your cash flow gets a boost, for any reason, putting a little toward increasing your net worth rather than to spending more can pay off big in the long run.
Results: She spent less. Spending in week 1: $261.50 Spending in week 2: $175
How she thinks she did: Lola notes that her week-to-week spending are quite similar as she’s put together a plan that she sticks by, but this exercise has made her realize that there may be expenses she’s unaware of.
“I need a better tracking system to track my expenses, because smaller expenses can go unnoticed which might add up later,” she said.
She’s downloaded an app to help track all her costs to get a better idea.
Take-aways: “Given all the detailed calculations and advice from the expert, I think renting would be a good choice for me at this moment,” Lola said, adding that she’s unsure she’ll remain in the GTA in the next five years.
This doesn’t mean she is giving up totally on home ownership, just putting those plans on hold for now. “This advice was really helpful to make a decision. I will work toward building up my down payment and maybe I would be able to afford a bigger house at a later stage.”
On top of looking for rental spaces, she wants to change her mindset about the extra cash she has. “I will keep in mind any extra cash saved or earned will go toward paying my student loan or investing,” she said.
“A small change in perspective can make a big difference.”