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November 20, 2007 – Comments (3)

It is natural for older people to teach younger people about how they got ahead and to look and evaluate how people who have accumulated wealth did so.

Home ownership has historically been a provider of wealth.  Certainly where I own a home, in Vancouver, the home balance sheets for anyone in the housing market even two years look pretty good.  But, I am willing to bet the home balance sheet possibly looks better for someone that got into the Vancouver housing market 6 years ago over someone who got in around the last top in our housing market around 93 to 95.

If I simply look at one of my former homes, well, it was about $300k at that peak in 95.  A responsible mortgage, with 25% down and say a rate of 6.5% would have the home owner paying $1500 per month in mortgage, another $300 per month for taxes and strata fees, total $1800 per month.  At the end of 13 years the mortgage would be around $155k.

Six years ago that home was a discomforting $260k. With the same payment, in six years the mortgage would be about $155k, yet the down payment was $65k instead of $75k.  Additionally, in 1995 you could have rented my home for about $1400 per month, so there is about an extra $5k per year in housing costs from being in the housing market rather than renting.

But, in 95 interest rates were more like 8% and here six years ago they were more like 5%.  Also, what would the return on equity for that $75k for the 7 year difference be?

People gloss over this enormous after tax extra cost by saying in the long run you are always better off owning a home.

If you took both examples with $75k in 95, add $3k per year to savings from reduced housing cost and say $3k from interest (I assumed an increasing rent as well and increasing interest here), well, by 2002 you'd have $111k for downpayment, and then with the same payment, and the mortgage would be down to about $90k.  The household balance sheet would be in the range of $65k better regardless of today's selling price.

I simply know that the high cost of home ownership from 95 for myself has stiffled disposible income.  Read my post http://makingsenseofmyworld.blogspot.com/2007/05/low-interest-rates-as-destructive-as.html.  The ability to get out debt by increasing payments is grossly stiffled when interest rates are low.  When interest rates were high you could save enormously on your mortgage simply by making modest increases on your payments.  With low interest rates what you are paying back is mostly principal and there is no way to avoid that.

Few have factored in how the economy is increasingly being stiffled by the inability of people to free up disposible income by making modest prudent choices of the past.  They only see the defaults on mortgages and the losses from those defaults, but completely fail to see that those who will be able to pay their mortgage will have essentially become indentured servants to their debt.

3 Comments – Post Your Own

#1) On November 20, 2007 at 11:13 AM, TMFEldrehad (99.99) wrote:

I don't pretend to know what the tax laws are in Canada, but south of the border, the tax advantages of owning a home vs. renting one help tilt the scales toward owning in no small way.

That said, I completely agree with your main premise, that owning is not always superior, financially, to renting.

-Russell (TMFEldrehad)

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#2) On November 20, 2007 at 12:44 PM, dwot (66.58) wrote:

The only tax advantage in Canada is you do not pay capital gains on home appreciation for your principal home.

Canadian do get to deduct mortgage interest.

Certainly when you factor that in, the relative price that stiffles disposable income is different, however, I think price relative to wages has increased in most places, and indeed, the US tax policy of deducting interest may have actually encouraged a higher level of debt for tax purposes.  My prediction is that this will prove to be an incredible form of mal-investment.

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#3) On November 20, 2007 at 1:45 PM, GS751 (27.36) wrote:

I like your analysis.  I think that home ownership in America is overrated.  Most people do not pay attention to the things that a lot of the TMF people do.  I mean how many Americans are paying off credit card debt at 22% interest?  How many people took out ARM loans? Most people neglect the financial aspects of their lives.

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