We use the term “chasing the market” in several different situations, but today I want to talk about saving for a higher down payment, and continuing to hold off on buying a property in an increasing market.
There is no right or wrong here – let’s make that clear. To each, their own, is another saying that would appropriately apply.
But I figured going through a real example, with complex mathematical equations including calculus, trigonometry, and advanced functions, might help to clear things up a bit…
It’s all so damn easy, right?
The Toronto real estate market has increased, every year, for almost two decades. So the “right” time to buy is always NOW!
But there are other factors than just market appreciation at play when you’re a young, first-time buyer, and it doesn’t always mean the best time to jump into the market is as soon as you can write a cheque.
I have a client who is looking to purchase a 1-bedroom unit with parking, which on the east side of Yonge, in the downtown core, is going to cost anywhere from $310,000 to $380,000.
Wow, that’s a big spread, right?
But that’s the true price range we’re looking at, and it makes a huge impact on her affordability, and thus her decision.
The 1-bed units with parking that cost $310,000 are probably not the type of unit I’d want to sell to her, and I’d be shocked if she pulled the trigger on one. This represents the lowest-end of that market, or the “bottom-barrel” if you want to get descriptive, and negative.
But at the other end of the price spectrum, it’s also not necessary for her to go as high as $380,000. There are some great 1-bed units with parking available in King East for $350,000.
So while the actual purchase price of the unit is going to impact her decision, believe it or not, it’s not at the top of the list.
Her issue stems from the down payment, the CMHC premium, and the timing of the purchase.
Any buyer who makes a down payment of less than 20% pays an insurance premium to CMHC, according to the following sliding scale:
These premiums were increased on June 1st, 2015, by approximately 15%.
The premium is calculated on the loan amount, not the purchase amount.
So if you had enough money to buy a condo with a 5% down payment, but not a 10% down payment, your CMHC premium is going to be higher.
This is where a would-be, first-time buyer would have a decision.
Let’s say you’re purchasing that coveted 1-bedroom condo with a parking space, for $350,000.
If you have saved enough money to make a 5% down payment, or $17,500, then the balance of $332,500 will be mortgaged, and you’ll pay an $11,970 fee to CMHC, amortized over 25 years, at $39.90 per month.
And keep in mind that while the premium is amortized (ie. repaid) over 25 years, if you sold the condo next year, you still have to pay out that entire amount. Once you purchase, that CMHC fee is payable in full.
Now if you have a 6%, 7%, 8%, or 9% down payment, you still may as well only make a 5% down payment, because until you reach that 10% threshold, you’re still paying the same CMHC fee.
If you did have 10% down, or in this case, $35,000, the mortgage amount of $315,000 would come with a CMHC fee of $7,560.
And lastly, at 15% down, or $52,500, the $297,500 mortgage amount would come with a CMHC fee of $5,355.
To some people, these might seem like nominal costs.
You’re paying $1,825 in land transfer tax on this $350,000 purchase, which would be $6,950 without the first-time buyer rebate.
You’re paying upwards of $2,000 in legal fees to close the transaction.
And you’re probably going to spend $5,000 furnishing your condo, but that’s up for debate.
To other people, these CMHC premiums are outlandish, and they might suggest that a buyer do everything in his or her power to avoid them.
In my opinion, there’s no right or wrong answer here. It all depends on the buyer.
Let’s say that the buyer with 5% down, looking at an $11,970 CMHC insurance premium, wanted to save up enough money to pay only $7,560, by hitting that 10% threshold.
That would save the buyer $4,410.
In order to hit that 10% threshold, the buyer would have to come up with, in the example of a $350,000 condo, another $17,500 for the down payment.
So how long does it take a buyer to save that much money?
That is the burning question!
Let’s say that a buyer makes a $55,000 per year salary. His or her after-tax income would be approximately $42,674 or $3,556 per month. I won’t complicate things by getting into CPP and all that. Let’s just keep it simple.
That buyer is probably renting right now, with a roommate, at a cost of $1,100 per month.
I have to think that food, and other necessities of life, are costing $500 per month.
So even if that buyer was a hermit who didn’t spend a penny of his or her disposable income on discretionary purchases, that leaves $1,956 per month in savings.
So according to these very conservative estimates, it would take 8.95 months to save $17,500.
Now what does the real estate market do in 8.95 months?
Here’s where you can really, truly, make numbers say anything you want.
Toronto’s “average home price” was up 12.3% from June of 2014 to June of 2015.
And through April, May, and June, we saw double-digit increases across the board for just about everything.
But again, let’s be conservative, and recognizing that we’re talking about a $350,000 condo, let’s use a very modest 6%.
That equates to a $21,000 yearly increase, or in our example above, over 8.95 months (let’s round up to nine), that’s $15,750.
So for the would-be, first-time buyer, looking at a $350,000, 1-bed with parking, waiting nine months to save the additional $17,500 for a down payment to go from a 5% down payment to a 10% down payment, and save $4,410 in CMHC premiums, the property in question will cost $15,750 more.
$4,410 versus $15,750.
It doesn’t make financial sense, does it?
If you were to look at the difference between 10% and 15%, where the premiums are $7,560 and $5,355 respectively, it makes even less sense, given that gap is only $2,205, compared to the $4,410 difference between 5% and 10%.
Suffice it to say, it makes even less sense to “wait” to save money and go from a 10% down payment to a 15% down payment.
There are other factors at play here, of course.
The young buyer could be “waiting” until he or she gets a big bonus, and thus it might not take 8.95 months to save.
The young buyer could be locked into a one-year lease.
We could be looking at interest rates going down, and thus waiting could result in a lower monthly mortgage payment.
But in lieu of all these maybe’s and might’s, the always-appreciating Toronto real estate market provides tax-free capital gains that typically trump any other caveat.
I certainly don’t want to sound like a naive, cheerleading, market bull, so I’m not going to suggest that in 100.00% of cases, “the right time to buy is now.”
But I do believe that buyers can get caught “chasing the market” if they’re trying to save money.
The market appreciates at a far greater rate than a buyer might save on CMHC fees, or a modest drop in interest rates.
Take a would-be home-buyer who said in 2012, “We’re saving for a larger down-payment,” and the $600,000 house in 2012 is $725,000. That’s a $125,000 tax-free, capital gain, that the would-be buyer can never get back, and the “higher down payment” only served to lower an already-low monthly interest cost.
No, this market isn’t going to go up forever.
But it’s going up today, and it’s going up tomorrow.
And buyers who continue to chase the market might want to run their own numbers, and see if it makes sense to get in…