Excerpted with permission from The Bank of Mom and Dad: Money, Parents, and Grown Children by Derrick Penner, Published by Self-Counsel Press.
Home ownership in North America is considered one of the central tenets of financial security. Why rent and pay someone else's mortgage when you can pay your own mortgage to wind up owning your own home? At worst, it is considered a sound way to build up savings as a mortgage loan is paid back. At best, expectations for property prices to rise over time hold the promise of increasing a young buyer's equity making his or her home a reliable investment over the long term.
However, nowhere is the financial tension between generations greater than in real estate. While parents have seen the greatest gains in property values over the last two decades, it is their children who are approaching the prospect of home ownership with higher debts and reduced spending power. In recent Canadian surveys, as many as one-third of first-time buyers reported that they needed or expected help from parents in making a purchase, and in some expensive cities, it is almost assumed that the Bank of Mom and Dad will be chipping in to the cost. In the United States, recent surveys have shown that more than a quarter of 20-something buyers relied on parents for help with a down payment.
The question is to establish whether it makes sense for parents to help their kids buy a home. For young adults just setting out on a new career, it might make more sense to rent (assuming they'll also be able to save some money) and kick-start an investment plan that would lead to home ownership later than to buy real estate before they're really ready. The magnitude of the commitment deserves taking some time to carefully consider the options.
Real estate, in investment terms, is an illiquid asset: it can't easily be converted to cash, which could hinder the ability of a 20-something owner in looking for better jobs or in accepting out-of-town promotions if he or she can't easily pick up and move. There is the risk of losing any advantage parents have given them in buying a home if they wind up having to sell just a few years later before equity gains in the property add up enough to pay back the up-front closing costs (e.g. Legal fees for conveyance, inspections, mortgage insurance premiums) that go along with buying real estate. If they sell just a short time later, they can't forget that the process will involve a hefty commission to the realtor.
The rent-versus-own calculators that most financial institutions provide among their online investment tools can be useful for the 20-somethings in figuring out the answer to this question. These tools range from simple to complex. For instance, the rent-or-buy calculator offered by Canada's Office of Consumer Affairs (OCA) asks users to input a few simple bits of data: The amount saved, current rent, and the interest rate he or she would expect to pay on a mortgage. It calculates an estimate of how much a person would be able to spend on a home.
The Canada Mortgage and Housing Corporation offers a more comprehensive calculator for young would-be buyers to test their financial readiness to purchasing a home. It includes worksheets that get users to lay out household expenses; add up all their debts, which is put into calculations against the accepted ratios for the amount of income they should be spending on housing (it shouldn't be more than 32 per cent of pretax earnings); and the total amount of their income, which shouldn't be consumed by debt (no more than 40 per cent).
In the US, the Federal National Mortgage Association, more commonly known as "Fannie Mae," also offers online resources. These are estimates, but the calculations can offer a sobering suggestion about what young adults can afford to buy versus what they want to buy, and can help start a discussion about how they can get from one to the other.
It also offers a reminder that potential buyers need to be mindful of those other costs of a home purchase people don't think about when they are looking at the listing prices of homes. Using one theoretical example, putting in a suggestion of $16,000 will produce an estimate that a person could afford a $170,000 home, with just a little more than a $10,000 down payment and that about $5,100 of that hard-won savings fund will have to go toward closing costs to buy a home. The calculation offers a reminder that a buyer will face about $420 per month in ongoing costs of ownership such as property taxes and utilities. Those figures will change depending on prevailing interest rates, and obviously the amount that a curious potential buyer has to plug in, but it is helpful to ground the person's expectations.
Other calculators, such as the one offered by Get Smarter About Money (produced by the Investor Education Fund founded by the Ontario Securities Commission) or the online calculator on the US National Association of Realtors' website, ask for more information about interests and taxes. It will calculate whether the anticipated monthly payments to own would exceed the rent prospective buyers are paying as well as run a comparison of what equity they would earn in their expected home versus investing the amount saved for a down payment (as well as socking away the difference between their current, lower rent and the monthly cost of ownership, assuming that is attainable). In the end, prospective buyers (or committed renters) won't necessarily get the comforting, definitive yes or no answer they were looking for. It will be more like, "Not now, but at some point in the future it makes sense to buy." For the right person, who knows he or she is ready to settle down in one spot indefinitely – and has put a solid financial plan in place – home ownership is a good way to build equity.
Over the last few decades (except for the period of the US housing crash), buying real estate has looked like a no-brainer as an investment with steadily rising gains. There is no guarantee that today's young adults will have that same experience over the coming decades, but done right, home ownership has been a proved way of building forced savings that will serve them well. For those who can't or don't buy, the process of reaching the decision isn't about admitting defeat that they can't afford to buy; it is about making renting work for them. As long as they use the information as a means to bolster savings and investment plans, they shouldn't wind up further behind.