Should You Buy or Rent? A Quick Formula to See – The Price to Rent Ratio

First Time Home Buyer Mohsen Ravankhah 16 Jan

Canada’s housing market is in turmoil. With a severe housing shortage, skyrocketing demand, and soaring interest rates, the dream of homeownership seems further away than ever. It’s a common belief, often passed down from generation to generation, that owning a home is a crucial step in wealth building. But in today’s economic climate, is this still the case? Amid the housing crisis debates, a pivotal question arises: financially, is it better to buy a house or to rent? While there’s no one-size-fits-all answer, a handy tool known as the price-to-rent ratio offers valuable insights.

Understanding the Price-to-Rent Ratio

The price-to-rent ratio is a simple yet effective way to gauge whether buying or renting is more financially sensible in the long run. To calculate this, divide the purchase price of a home by the annual cost of renting a similar property. Here’s what the results indicate:

  • The ratio of 17 or lower: buying might be more beneficial.
  • Around 20: It’s a toss-up.
  • Above 23: Renting is likely the wiser choice.

This ratio compares the cost of owning a home versus renting, indirectly suggesting which option allows for better financial investment opportunities.

Case Study: Canadian Housing Market

Let’s apply this to a real-world scenario. Consider the average Canadian home, valued at $650,000, and a typical rental unit costing $2,178 per month, or $26,136 annually. This gives us a ratio of about 25, leaning towards renting. However, if rental costs increase to $2,800 monthly ($33,600 annually), the ratio drops to 19, making buying a more attractive option, assuming the purchase price remains constant.

The Investment Factor

A crucial consideration in this equation is investment. The financial advantage of renting only holds if the savings (including the would-be down payment) are invested wisely. Simply put, if you’re renting but splurging your savings on luxuries like high-end vehicles or extravagant dining, the benefits diminish.

Other Variables to Consider

Other factors can sway the rent vs. buy decision even with diligent investing. These include fluctuating interest rates, maintenance costs of owning a home, and potential appreciation in home value. For instance, if a $650,000 home appreciates at a rate higher than the assumed 3.3%, buying could emerge as the more profitable choice. That’s why experimenting with various rent-vs.-buying calculators and considering different scenarios is vital.

The Final Verdict

The decision to buy or rent is inherently personal and complex. While the price-to-rent ratio offers a guideline, it’s not an infallible predictor of wealth accumulation. No formula can guarantee the best financial outcome in every situation. This uncertainty underscores the importance of diversifying your investments to safeguard against risks. Ultimately, whether you choose to buy a home or continue renting, a strategic and well-rounded approach to your finances is crucial.

Maximizing Your Home Purchase Savings with Canada’s First Home Savings Account (FHSA)

First Time Home Buyer Mohsen Ravankhah 8 Jan

Introduction

The Canadian government has introduced an innovative savings tool for first-time home buyers, the First Home Savings Account (FHSA). This account combines the benefits of tax-free savings accounts (TFSA) and registered retirement savings plans (RRSP) to aid prospective homeowners in their journey to owning their first home​.

The FHSA Mechanics

The FHSA allows individuals to save up to $40,000 over time, with an annual contribution limit that can fluctuate. In the first year, you can contribute up to $8,000, and any unused amount carries over to subsequent years. This setup makes the FHSA a flexible and potent savings vehicle for future homeowners​.

Eligibility Criteria

To be eligible for an FHSA, you must be a resident of Canada, at least 18 years old, and a first-time home buyer. Additionally, you must be younger than 71 in the year you open the account. A first-time home buyer is defined as someone who has not owned a home in which they lived during the calendar year before opening the FHSA or in any of the four preceding calendar years​​.

Investment and Withdrawal Options

The FHSA allows for investment in various products like mutual funds, stocks, bonds, and guaranteed investment certificates. The beauty of the FHSA lies in its tax treatment—the gains from these investments are not taxed. Withdrawals for home purchases are also tax-free, provided you meet specific criteria, such as having a written agreement to buy or build a home in Canada before a set deadline and intending to use the home as your primary residence within a year of purchasing or building it​​.

Contribution Rules and Tax Benefits

An important aspect of the FHSA is its contribution timeline, which is based on the calendar year. If you don’t hit your annual limit, the unused amount carries over to the next year, allowing for greater flexibility. The FHSA’s tax advantages are significant, as they can help divert funds from income taxes to home purchase savings. This potential tax savings on investment gains can supplement your future home purchase funds​​.

Comparison with the Home Buyers’ Plan

The FHSA offers several advantages over the Home Buyers’ Plan (HBP). Unlike the HBP, which requires repayments, the FHSA does not mandate repayments for the amount withdrawn for a home purchase. Additionally, the FHSA’s contribution limit is higher than the HBP’s. However, the FHSA’s modest contribution limit means it might not cover more than deposits or closing costs in most markets. Furthermore, rapid increases in housing prices could outpace the tax-saving benefits of the FHSA over time​​.

Conclusion

The First Home Savings Account represents a significant opportunity for Canadian first-time home buyers. Its unique blend of tax benefits, flexible contribution and withdrawal rules, and investment options make it an attractive tool for those looking to enter the housing market. While it may not fully cover the costs of a home in high-priced markets, it certainly provides a solid foundation for accumulating a down payment and easing the financial burden of purchasing a first home.