September 23, 2020

A reality check for millennials aiming to buy a house

The Globe and Mail

Mortgage rates may seem low now, but you’ll be lucky if that 2.5-per-cent mortgage only goes up to 4 per cent in 25 years. (Darren Calabrese/THE CANADIAN PRESS)

It took just six words for a financial planner who thinks millennials are maxxed out on debt to demolish one young man’s plan to buy a house.

“He’s dreaming,” Kurt Rosentreter said. “He can’t afford it.”

When this young reader e-mailed to ask if his house-buying idea made sense, I immediately thought of Kurt Rosentreter, chartered accountant, certified financial planner (CFP) and author a few years back of a newsletter article that ran with the headline: “Canadian 30 Year Olds are Screwed”.

Mr. Rosentreter argued that young people are carrying too much debt, most of it mortgages. In his words, “thirtysomethings are leveraged to the hilt.” So be forewarned – I took this young man’s case to a guy who thinks debt levels are way too high and won’t hesitate to say so.

We’ll call the young man who e-mailed me Sam. He’s a public servant in his late 20s who makes an impressive $70,000 a year and works in a city not far from Toronto.

His plan: Buy a $500,000 home on his own with the minimum 5-per-cent down payment of $25,000 and rent out the basement for $800 a month. His only current debt is a car loan that he should have paid off in the next year or two.

Mr. Rosentreter started his dissection of this plan by computing Sam’s mortgage payments over the long term using a rate of 4 per cent.

“As much as you can get a mortgage for 2.5 per cent today, we all know that over 25 years, rates are not going to stay at 4 per cent.”

The 4-per-cent rate produces monthly payments of $2,577 per month, with mortgage insurance premiums added to the principal. Over a year, that’s close to $31,000. Add utilities and property taxes to the analysis and you end up with housing-related costs of up to $40,000 a year.

Next, Mr. Rosentreter turned to Sam’s salary. Usually, someone at his income level should expect to take home $55,000 after taxes. But as a civil servant, Sam is making big contributions to a defined benefit pension plan that in retirement will produce income for life at levels based on his years of service and career salary levels. If pension contributions are included, Mr. Rosentreter expects Sam to take home closer to $50,000.

Now for some simple math: $50,000 after taxes minus housing costs of as much as $40,000 leaves as little as $10,000 to cover all life’s other costs. Mr. Rosentreter said these numbers don’t compute, and that means Sam’s plan to rent the basement of his house becomes pivotal (you’ll notice we haven’t even included Sam’s car payments here).

Mr. Rosentreter believes mortgage costs should account for no more than one-third of your take-home pay, which in Sam’s case would be $16,500 a year or $1,375 a month. That’s a little more than half of his projected payments in buying that $500,000 home with 5-per-cent down.

Sam’s plan is to generate $800 a month in rent, which would reduce his payments to $1,777 monthly and $21,324 a year. This would improve his cash flow a lot, but still leave him well offside on Mr. Rosentreter’s one-third rule.

Sam actually had two questions for me, the first being whether he can afford to buy a house on his own.

The answer is no, and it’s not just Mr. Rosentreter and me talking here.

Canada Mortgage and Housing Corp.’s online affordability calculator suggested a maximum purchase price of about $340,000 based on a $25,000 down payment, $80,000 in income from his job and rent, and a 4-per-cent mortgage rate (car loan included as well).

Sam’s other question was about retirement saving. Given that he’s a member of a DB pension plan, does he need to put money in a registered retirement savings plan?

This is an important matter because young people who buy houses may not have enough money to save for retirement.

“For a guy like this, I say: Do not put any money in registered saving,” Mr. Rosentreter said. “Focus on your mortgage, and be in a bit of a race to get it down so that if mortgage rates double or triple, you won’t be bankrupted. And next comes your children’s savings. That could come into play into the next 10 years.”

Sam’s finances appear to be strong. If he saves a bigger down payment, he’s ideal home ownership material.

But now is not the time for him to buy, even if interest rates remain at historically low levels and prices, at least in the Toronto area, Calgary and Vancouver, keep rising.

Save up, Sam. Don’t be one of those 30-year-olds Mr. Rosentreter wrote about.

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