When you first move to Toronto, you’ll likely be renting your living space. But after renting for a few years, you’re going to ask yourself this question: is it better to rent or buy a home in Toronto?
Maybe you want to purchase your own place for emotional reasons (“my very own place!”), financial reasons (“I want to build equity”), or maybe a bit of both.
A major influence on your decision to rent or to buy may be the marketing you see from the real estate industry asking you the perpetual question: “Why rent when you can own?”.
Makes sense, right? After all, why throw away your money on rent when you can pay off a mortgage? Buying a home seems like the clear cut answer.
But is it the right answer? Let’s assume that you’re thinking about purchasing a condominium in Toronto. Whether buying your own home is the smart thing to do will depend on three discretionary factors:
- How much of a down payment can you afford to pay? If you cannot come up with at least 20% of the purchase price, you’ll need to pay an insurance premium to CMHC to qualify for a CMHC insured mortgage.
- What is the interest rate you’ll be paying on your mortgage?
- How much does it cost you to rent something similar to what you want to buy?
and three non-discretionary factors:
- The property tax rate – in Toronto, the rate currently about 1 percent of the assessed fair market value
- The land transfer tax (provincial and municipal) – you can calculate the tax you’ll pay on this website
- Maintenance fees – the average in Toronto is about $0.50 per square foot
Let’s suppose you’re currently renting a 600 square foot condo apartment in downtown Toronto for $1,700 per month. You’re thinking about buying a similar condo unit in the same building (same square footage and layout) that’s listing for $400,000, including parking and locker. Maintenance fees per square foot in your building are $0.50 per square foot.
There are three ways you can purchase the condo:
- You can take out your life savings of $20,000 and put it towards the minimum 5% down payment to qualify for a CMHC insured mortgage. Your bank tells you that you’ll qualify for a $380,000 mortgage at a 3% annual interest rate for a 5 year term, amortized over 25 years. Your banker tells you that at 3% amortized over 25 years, the interest you’ll pay on your mortgage over the next 5 years will be $53,040.99.
- You can ask your parents to help you with a down payment of $80,000. This will be equal to 20% of the purchase price, so you don’t need to pay the very expensive CMHC insurance premium to qualify for a mortgage. Your bank tells you that you’ll qualify for a $320,000 mortgage at a 3% annual interest rate for a 5 year term, amortized over 25 years. However, since your down payment is bigger and you need to borrow less money, the interest you’ll pay on your mortgage over the next 5 years will be only $44,666.09.
- You can finally agree to go out with Myron, the VP Finance at your company, who’s been pestering you for months to go out on a date with him. However, you’ll only do so on the condition that he gifts you the full $400,000 purchase price of the condo.
Click here to see a table of the results. You’ll see that whether you rent or buy will mainly depend on how much of a down payment you can afford. This will influence how much interest you’ll pay over the term of the mortgage and whether you’ll need to pay to CMHC a premium to insure your mortgage with your bank. If your down payment is less than 20% of the purchase price, you will need to purchase insurance from CMHC before a bank will give you a mortgage.
You’ll note that land transfer taxes, property taxes, maintenance fees, mortgage interest and CMHC premiums are expenses of home ownership that do nothing to increase the equity in your condo. However, just as you would be evicted by your landlord if you didn’t pay your rent, your home will be taken away from you by the City of Toronto if you don’t pay your property taxes, by the condominium corporation if you don’t pay your maintenance fees, and by the bank if you don’t pay the interest on your mortgage.
Also observe that I used a 3% mortgage rate in my example because that is the current variable rate for a 5-year term. However, mortgage rates will eventually creep up. If they increase significantly, it might not make sense to buy a home even with a 20% down payment.
Bottom line: if you can only afford the 5% minimum down payment to get a CMHC insured mortgage, you’re probably better off just renting. Only consider buying if you can afford a substantial down payment. The bigger the down payment, the less money you’ll be throwing away on mortgage interest and premium payments to the CMHC.