In the world of personal finance, opinions about homeownership are too narrow. Some call it the best investment you’ll ever make, while others see it as a costly financial burden. The truth? My theory is that one’s home can be an asset or it might become a liability, depending on how you approach it and whether you use it to reach your financial goals or get away from them. Let’s break it down step-by-step, using simple language and examples to make the debate clear.
So, What Makes a Home a Liability?
At first glance, buying a home might seem like a dream come true, but there are several financial responsibilities and risks involved.
1. High Initial Costs: Buying a home most often requires a significant upfront investment. In markets like the Greater Toronto Area (GTA), saving up for a down payment alone can take years unless one is fortunate enough to have access to generational wealth. Add to this the closing costs, such as legal fees, and land transfer taxes, and the total can feel overwhelming.
For example, purchasing a $1 million home in the GTA will require anywhere between $75,000 to $200,000 (or more depending on household income) plus additional fees totalling tens of thousands of dollars to cover closing costs. For many families, this cost can delay other financial goals like retirement savings, savings for children’s education, etc.
2. Illiquidity: Real estate isn’t like stocks or savings that you can cash out quickly. Selling a home can take weeks or even months, especially in a slow market. Plus, selling in a rush might mean that you sell for lesser than it’s worth. If you need funds urgently, you’re stuck unless you can tap into a Home Equity Line of Credit (HELOC) or can qualify to pull equity out via a refinance.
3. High Transaction Costs: Not only is a home highly illiquid, the costs of buying-selling a home can be quite expensive. Realtor commissions, Legal fees, and Land Transfer Taxes (double in City of Toronto) can take a significant bite out of your finances. On average, transaction costs can range between 5% and 8% of the property’s value, making real estate a less flexible investment and something that you should not get in and out of very often.
4. Ongoing Costs: Owning a home isn’t just about the mortgage. You’ll also need to budget for:
Maintenance and repairs (e.g., replacing a roof or fixing plumbing).
Property taxes, which vary by region.
Utility bills for heating, electricity, and water.
These ongoing costs can add up to thousands of dollars per year. Per Investopedia, an average homeowner spends (or should set aside) around 1% to 4% of their home’s value annually on maintenance alone.
5. Market Volatility: While real estate has historically appreciated over time, it's not immune to periodic market downturns. Economic factors, changes in neighbourhood demographics, and other unforeseen circumstances can all impact property values, potentially eroding homeowners' equity, albeit often temporarily. It would really hurt if you have to sell it during a downturn.
6. Mortgage Financing & Interest Costs: Most people can’t buy a home outright (and probably shouldn't even if you are able to... if you are curious, reach out to me!) and rely on mortgages. Until the loan is paid off, the mortgage is a liability. For Canadian homeowners, mortgage debt remains personal responsibility even if home values drop. Also, given that we often pay down the mortgage over multiple mortgage terms (usually 1 to 5 year periods), the cost of financing can change drastically from one term to another.
7. Impact of Income Tax – In Canada, mortgage interest costs on a primary residence are not tax deductible. This means homeowners must use after-tax income to pay off their mortgage, effectively increasing the true cost of homeownership. Curious about the true cost of your mortgage? Click here to learn how much its costing you! There are strategies to reduce this financial impact—feel free to reach out if you'd like to explore your options.
8. "Notional" Rent – This concept refers to the “imaginary” rent you pay yourself by living in your home instead of renting it out. For example, if a comparable property in your area rents for $3,000/month, that’s $36,000/year in notional rent you’re effectively incurring. While not an out-of-pocket expense, financially savvy homeowners consider it when evaluating their home’s overall financial impact.
So, What Makes a Home an Asset?
Despite the challenges, homeownership has its benefits, often making it a worthwhile investment for many.
1. Appreciation Potential: Real estate values generally increase over time. In Canada, the average annual property appreciation rate is around 5%, though this varies by location. In hot markets like the GTA, property values have risen even faster over the past two decades.
For instance, a home purchased for $500,000 in 2010 might be worth over $1.1 million by end of 2024. That’s a substantial return on investment, particularly if you’ve manage to paid down your mortgage.
2. Equity Building: Through mortgage payments, homeowners gradually build equity in their properties. This equity serves as a form of savings and can be tapped into through various means, such as home equity loans, additional mortgages, etc., enhancing homeownership’s asset-like qualities.
What makes this particularly powerful is that a home is a leveraged asset unlike stocks and other most financial investments. When you purchase a home, you’re typically using a mortgage to cover a large portion of the cost. As the property value appreciates, the growth is based on the total value of the home—not just your initial investment (down payment). This amplifies the rate at which equity grows over time.
For example:
If you buy a $500,000 home with a 20% down payment ($100,000) and the property appreciates by 6% annually, the increase in value ($30,000) applies to the entire home value, not just your down payment. That’s a 30% return on your original investment in one year. And this can really amplify your wealth creation over the long term.
By leveraging borrowed funds, equity builds faster compared to assets you buy outright. This makes homeownership a powerful tool for long-term wealth creation, provided the market remains stable and you manage your mortgage responsibly.
3. Stability and Security: Owning a home provides a sense of stability and security that renting often cannot match. You have control over your living space, allowing you to establish roots in a community and create a sense of belonging. This stability fosters a sense of belonging and peace of mind, regardless of market fluctuations.
4. Income Generating Potential: Many homeowners rent out parts of their homes, such as basement suites or additional rooms, to generate extra income. This rental income can offset costs like the mortgage, property taxes, or utilities.
Moreover, rental income often qualifies for tax deductions on certain expenses, like maintenance and interest on the portion of the home used for rental purposes. This income can also often help with qualifying for a mortgage.
5. Tax Advantages: One of the biggest benefits of homeownership in Canada is the Principal Residence Exemption. When you sell your primary home, you’re generally not taxed on the capital gains, making it a highly tax-efficient investment. However, if you rent out a portion of your home and claim tax deduction on expenses, this benefit might be reduced or in other words you may need to pay tax on a portion of the profit.
The Role of Notional Rent in the Debate
Notional rent is a powerful but often overlooked concept. It’s the hypothetical rent you could earn if you rented out your home instead of living in it. By occupying the property, you’re essentially paying yourself this rent, which impacts the financial assessment of homeownership.
For example:
If your home could rent for $3,000/month but you live in it, that’s $36,000/year in “lost” income.
However, this cost is offset by the fact that you’re not paying rent elsewhere, which could potentially be just as expensive, more expensive, or in some cases, maybe cheaper depending on the local rental market.
If the notional rent—the hypothetical rent your home could generate—is higher than what you would pay to rent a comparable property, it may be worth exploring ways to address this difference. Options include generating revenue from the property, such as renting out a portion of it, or leveraging the equity in your home to create additional income streams and wealth. These strategies can help balance the financial impact of owning and occupying the property (and not having to consider selling it).
By understanding notional rent, homeowners can better evaluate whether their property is serving their financial goals effectively.
How to Balance the Asset-Liability Debate
The key is to maximize the benefits from the asset side while minimizing the liabilities. Here’s how:
Choose a Home You Can Afford: Avoid overextending yourself financially. Aim to keep your total homeownership expenses under tight control, ideally not more than 30% to 35% of your monthly income. Keep an eye on that Notional Rent figure periodically.
Plan for Maintenance: Budget 1% to 4% of your home’s value annually for repairs and upkeep.
Consider Income Potential: If possible, rent out a portion of your home to offset costs.
Think Long-Term: Real estate is generally a long-term investment. Avoid buying and selling too often, and avoid selling during downturns unless absolutely necessary.
Leverage Equity Wisely: Put your home’s equity to use judiciously. Invest in other income-generating opportunities to enhance your financial standing and wealth. Be cautious about over-borrowing and the safety of those investments.
Understand Your Market: Research your local real estate trends, consult professionals and educate yourself before making key decisions.
Conclusion: Home as an Asset or Liability?
The debate over whether a home is an asset, a liability, or both is nuanced. Understanding the complexities of homeownership, including notional rent and the interplay between financial responsibilities and benefits, is crucial. Ultimately, homeowners must consider individual circumstances, financial goals, and market conditions to make informed decisions aligned with their long-term prosperity. A home is more than just a physical structure—it can be a foundation for financial stability and personal well-being, or it can become just a heavy financial burden. The key lies in understanding the dynamics of homeownership and making informed decisions that align with your goals.
Take control of your financial future today. Whether you’re a current homeowner or planning to buy, evaluate your situation carefully. Speak with professionals, explore strategies to maximize your home’s potential, and educate yourself. Ready to dive deeper?
Subscribe to our blog for more tips and insights on making smart financial choices and reach out to Neil for personalized guidance!
Comments