In a recent meeting with Dave and Linda, they mentioned their daughter, Julie, was still living at home. Julie would love to have her own place. However she works downtown and rents start at $1,300 plus utilities per month. As well, the average utility costs for most of the units Julie is considering are over $200 per month – a total expense of $1,500 per month.
Can Julie afford to move out? She earns $45,000 per year. After taxes and deductions, her biweekly income is $1,212. It is immediately apparent that more than 50 per cent of Julie’s net income would go to rent and utilities.
We know from mortgage lending practices that a mortgage and property taxes should not be greater than 30 per cent of your monthly GROSS income. Julie’s gross income (before taxes and deductions) is $3,750, so she should not be spending more than $1,125 per month for accommodation. Based on this, Julie should stay at home until her income reaches $50,000.
Not a very satisfying result for Julie or her parents. Dave and Linda are approaching retirement. Even with Julie’s help, they’re finding the maintenance expensive. Mechanicals, appliances, kitchen and bathroom all need to be updated. Most recently, they replaced the furnace at a cost of $5,000. Their dream is to sell their home and buy a smaller, newer home up north by the water. With the profits from selling their home, they are considering giving Julie a down payment of $50,000 to buy her own home.
Based on the earlier analysis, we know Julie can afford a monthly mortgage payment including property taxes of $1,125 per month.
Let’s assume annual property taxes are $3,000. Julie is considering a mortgage interest rate of 3.65 per cent for a three year term with an amortization period of 25 years. The maximum mortgage she will qualify for is $172,000. If the rate is higher, the mortgage amount will be less. Conversely, lower interest rates mean Julie would qualify for a larger mortgage.
Including a down payment of $50,000 and a mortgage of $172,000, Julie can afford a home of $222,000. She will have to consider a condominium, or a freehold townhouse on the outskirts.
Julie will have to decide whether she would be willing to travel by GO train to work daily or pay a condominium fee to live in the core. A GO pass or parking plus gas will cost $200 to $500 per month. Condominium fees will be at least $300 to $600 per month. In addition, the condo fee will be included in the mortgage qualification calculation, significantly lowering the mortgage amount she can qualify for.
Considering all the factors, Julie doesn’t think she can afford a home on her own. Is there an alternative?
Julie has a long term friend who would also like to buy a home. Currently her friend is renting over a store at Broadview and Danforth. While the location is great, the living conditions are less than ideal.
Both Julie and her friend earn $45,000 per year. Their total gross income is $90,000. Using the same property taxes, interest rate and terms, they would qualify for a mortgage of approximately $400,000. With a down payment of $50,000, the total purchase price they would qualify for is $450,000.
Julie and her friend found a great house located in the one of their chosen neighbourhoods for $429,900. The house is semi-detached with two bathrooms and two kitchens as well – one each on the main and upper floors. Essentially the house is two apartments which is an ideal arrangement for their circumstances.
Julie’s friend just finished paying off her student loan. She has had no opportunity to save for a down payment.
How should the arrangement be structured to ensure each person is treated fairly? Should Julie and her friend contemplate buying a home together? What if one of them wants to move? What if one of them loses their job? What if they don’t get along?
Julie and her friend decided to approach the arrangement as a business investment.
Stayed tuned for the Nov. 19 edition to learn more about how the two friends approach this joint real estate investment.
J. McPherson 416-738-1555