If You Read One Article About Mortgages Read This One

I may receive a lot of heat for discussing this topic, but hey, the point of this blog is to challenge pre-existing beliefs, and offer another perspective, that way, you are armed with knowledge prior to your decision making.(PS. I enjoy a healthy and informative debate, so hit me up if you have any questions about this topic).  It is important to note that I am not saying, do not buy a house, all that I am doing is providing you with a different perspective for appropriate financial decision making. Now that all the disclaimers are out of the way… you may begin reading.  

For most of us, a house will be the single largest expense in our lives. For people in my generation (I'm a young buck), boy will we have it rough when we want to buy our homes (If you haven’t already). Housing prices in some parts of the country are extremely high, while income levels continue to stagnate. For more information on this, the Globe and Mail gotchu.

We all dream of being homeowners. Well, at least most us. The unfortunate truth is that, majority of us will not have enough cash to pay for a house in full. Enter, the mortgage. But what is a mortgage, really?

A mortgage is a loan secured by the collateral of a specified real estate property, which obliges the borrower to make a predetermined series of payments over a time period (amortization). The mortgage gives the lender the right of foreclosure on the loan if the borrower defaults.

So how does it work? You make a partial payment towards the purchase price of your house, this is known as a down payment, which could range from 20% to 40% of the value of your home. For example, assume you want to buy a $200,000 house. Your down payment is 20%, which is $20,000 (20% of $200,000) and your mortgage value is $180,000 ($200,000 – 20% of $200,000). It is important to note, that a down payment less than a 20% of the home’s purchase price, - or, in mortgage lingo, the mortgage’s loan-to-value ratio is in excess of 80%, the lender would require the home buyer to have private mortgage insurance (PMI).  Investopedia has a great and in-depth explanation on PMI. 

There are a few reasons as to why we would get a mortgage, which are as follows:

• We may not have enough cash to cover the full cost of the house.
  
• We want to stay liquid, that is, have more cash on hand for other purposes such as spending and investing . Otherwise, why would Queen B and Jay get a $52 million dollar mortgage?

Most of us believe our houses/primary residences are an asset because we tend to mis understate how much our home is costing us annually and look at things through rose coloured glasses. But is your primary residence really an asset? Truly, the answer is Yes and No. Read on for more 411 on this juicy topic.

What is An Asset? (Shout out to Investopedia for the image below)

An asset in Financial Accounting (throwback!) is defined as any resource owned by a business. For the purposes of this topic, I will borrow the author of Rich Dad Poor Dad - Robert T. Kiyosaki’s definition. An asset is an investment that provides positive cash flow to you, or simply, puts more money in your pocket and a liability is an item that results in a cash outflow, or simply, takes money out of your pocket. By virtue of this definition, your primary residence is not an asset.

Why you may ask? Well, homeownership comes with a lot of annual expenses, some quarterly and others monthly. And what is an expense? Ding Ding Ding! A cash outflow, something that takes money out of your pocket, a liability. Expenses associated with home ownership include, your mortgage payment (if you have one), which is part principal and part interest, property taxes, insurance; if you have any, home maintenance and renovations (don’t we all want to live in a nice place) and let’s not forget unexpected expenses such as the furnace breaking down during these brutal winter months or the odd painting touch ups etc. These unexpected expenses can be easily taken care of if you are a DIY expert (Sometimes). There are a lot that I have not mentioned, so if you want to improve your home expense lingo, head over to Forbes. 

Right now, you are probably thinking, “This guy is high on drugs, my house is an asset, I’m sitting on $100,000 of equity right now. Pssht, get outta here!”

Assuming that your house value has increased since purchase, (which is likely the case, but not always a guarantee, remember the Oakville ordeal due to an introduction of a foreign buyers tax not too longer ago?) then I’d say, true, you are sitting on a pile of cash. That’s wonderful. However, it is an unrealized gain. For you to take advantage of this increase in home equity, you could: 

• Sell your property (more on this later)
  

• Get a home equity line of credit or HELOC. This is more like opening a credit card with your house as collateral.  This article has more information on HELOCs. 

• Refinance, which is essentially getting a new loan with better terms. More on this here. 

Selling Your Property 

This would be the best thing to do (in my opinion, does not have to be yours) as you get your cold hard dollar bills back, no strings attached. However, there are costs associated with this. Let’s assume $100,000 is your capital gain on the sale of your home. From this amount comes realtors commission, which is approximately 5% to 6% of the sale price, home repairs; if any, staging the home (you need a buyer don’t you?), the mortgage payoff, closing costs and additional fees such as attorney fees, brokerage fees etc. Some of these expenses are negotiable, and it is unlikely that you will be responsible for all of them, but still, it helps to know that you could be liable for them.

After you get all your money back from the sale of your property, your $100,000 might not be looking so hot, net of all expenses. What’s next? Probably a new home, which MAY be cheaper than your first, because you need somewhere to live and this comes with other additional costs. So when will you get to use your realized gain for anything other than getting a new home? Isn’t the whole point of an investment to make more money to supplement your current income?

What if you were to take your down payment and invest in an income producing asset such as rental property, dividend paying stocks, peer to peer lending, which MAY provide a higher yield than the appreciation rate of real estate in your area and it also paid you monthly? Would that be a wiser investment? Food for thought.

When Your Home Can Be an Asset

Assume that, as opposed to living in your home, you opt to rent it out (now it really is not a "home", but a rental property). You will still incur a lot the expenses mentioned earlier, however, they will be covered by the rental payments that you will be receiving. What are these payments to you? INCOME! Cashflow to you, an asset. It supplements your current income.  The assumption here though, is that you are receiving positive cashflow.  If your cash flow is negative, don’t fret. This provides tax advantages for you. Read this website for more deets. 

The alternative to home ownership is renting (obviously!). This decision, however, is entirely dependent on your present situation, needs and desires as there are clear advantages and disadvantages to both renting and owning. In whatever you choose to do, go in with eyes wide open. 

I strongly urge you all to watch this video by Robert Kiyosaki, elaborating on the differences between assets and liabilities to learn more. Mr. Wonderful a.k.a Kevin O’Leary, co-founder of O'Leary Funds and Softkey and one of the "sharks" on Shark Tank,  has a few words to say on mortgages. There are a ton of high profile influencers with varying opinions on this topic, it is up to you to decide whom you resonate with best. 

To Financial Literacy,