By Ron Friesen
When a commodity does not offer added value in terms of location, shelter or otherwise, but the amount of currency required to obtain ownership has increased we would say it is more expensive, not more valuable.
Let’s look at the relationship between purchase price and currency valuation. There are a number of explanations for the recent rapid rise in the cost of homeownership in Vancouver. While it may be difficult to appreciate and discuss all the dynamics of the rising values some see real estate as the leading indicator of the real value of our currency. The value of currency is essentially a measure of its purchasing power.
In the simplest form, when a relatively unchanged real estate property purchased ten years ago for $500,000 sells today for $750,000, then the real estate market demonstrates the isolated value of currency has dropped by fifty percent over ten years, in this instance.
Recommendations vary, but let’s assume the first-time home purchase should result in personal debt servicing amounting to no greater than twenty-five percent of the buyer’s annual net income. We can easily see where the effect of currency devaluation (or increasing cost of residential real estate) is having a significant effect on middle-class people just getting started.
Does refinancing the family home to help purchase another make sense?
While retirement savings and personal savings plans are said to be excellent ways to secure good quality of life in our personal futures, reducing personal debt appears to receive less encouragement in Canada. Particularly in jurisdictions like Vancouver where the heated real estate market makes it more difficult to keep up with the cost of living.
Conventional wisdom suggests we should be debt-free by age fifty. Why then do so many parents believe it a good idea to re-finance their primary residence to help their children make the hefty down payment to purchase their otherwise unaffordable first home? In a heated housing market like Vancouver becoming debt free by age fifty is a serious challenge for middle class, not only for first-time home buyers but also for any parents who want to help by re-mortgaging their own homes.
This strategy gets complicated pretty fast. It may seem like a good idea to help our children finance their entry into home ownership. What about the parents, now close to or over fifty taking on new debt and payments? It will likely affect the parents’ ability to contribute to their own retirement savings as they service this new debt. All is good, we say. The family now owns another real estate property. Yes, they do. But at what cost to the family’s overall wealth? Is the sum of the family’s estate more valuable?
Let’s not go into the risk of a real estate market stumble and interest rate increases at this point. Let’s just ask other important questions such as, who will finance the costs of aging parents in retirement? The children? What is the point of the strategy if they need to sell or re-mortgage their house in twenty years? Even if the children enjoy greater future earnings, even as the equity in their home increases, sacrifices still need to be made in order to cover the increasing costs since the parents’ retirement savings were diminished to enable the children to purchase their first home.
Pay now or pay later. True wealth management requires a plan where the objective is to grow personal wealth and reduce dependence on personal income, not to postpone retirement and refinance. It is complicated. And each case should be considered individually with the help of a trusted financial advisor.
Informed planning helps make first-time homeownership possible.
There are many sources of sound advice to help determine if there are financial advantages to owning a home and under what circumstances. When it is determined the goal is to purchase a home, for whatever reason, then it is time to develop a strategy and begin the struggle. These four strategy suggestions resonate with me:
Improve your savings to cost-of-living ratio. As early as possible in adult life make sacrifices and treat savings as a necessary monthly contribution. Delay purchases unless they are a tangible contribution to increased earnings. Spend less and save more.
Adjust the perception of what we can live without and still enjoy an acceptable quality of life. This is different for each of us. But I can say, there is a certain high-quality enjoyment comes from working, earning and enjoying simple, less-expensive pleasures in the name of a greater degree of early financial independence.
Those who are not aggressively endeavoring to build wealth are certain to avoid it. Of course, but like everything in this life, individual attitudes and abilities towards wealth building vary by degrees. Adjust to realities and aim high.
Reduce, and when possible eliminate all debt. Do not carry unnecessary debt balances. Pay down any existing debt balances to zero as soon as possible and keep them there. Avoid paying interest and fees. Again, sacrifice select pleasures and conveniences to do this.
Reduce your expectations. Other than increasing our income, this is likely the most significant behavior towards making a contribution to our future wealth. Spend less initially in order to spend less on debt servicing in order to improve contributions to personal savings.
When it is time to purchase a first home, plan to live in less-than ideal conditions. Considerably less if necessary. Purchase what we can afford. Smaller, located further out, fewer amenities. This will help us get into homeownership sooner, build equity and up-size in steps towards the dream home as personal finances can bear the cost. Enjoy the steps along the way and don’t let setbacks erode our determination.
Plan, carry on and stay strong. It is important within any investment scenario to avoid becoming a deer in the headlights. Standing still more often results in getting run over from behind. In the interest of not standing still, always consider how important it is to not transfer debt. Whether it is transferring it from one credit source to another, or from one generation to another, do nothing to jeopardize your future independent retirement and comfort. Life is precious and should be enjoyed throughout and to the end.