Lower income home owners pay more to purchase a home than higher income home owners. (This post focuses only on buying a home and excludes the option to rent.)
For comparison purposes, given the same type of property, a lower income home owner will pay $151,940 for a home; whereas a higher income home owner will pay only $106,544, which is extremely unfair. Also, a lower income home owner will likely sell their property for less than a higher income home owner. Here's why:
- Lower Income Home Owners:
- Smaller Down Payments:
- With less money, they often opt for the minimum required down payment. The smaller the down payment, the greater the mortgage loan. The greater the loan, the greater the interest on the life of the mortgage and the greater the monthly payments.
- Longer Amortization Periods:
- They often prefer longer amortization periods because this lowers the monthly payments; however, longer amortization periods results in higher interest on the life of the mortgage.
- No Additional Payments:
- With less money, they often can't afford additional payments, which means they can't afford to pay off their loan sooner.
- Limited Renovations And Repairs/Maintenance:
- With less money, they often can't afford home renovations or home repairs/maintenance, which decreases the resale value of the home.
- Undesirable Locations:
- With a limited price range, they're often restricted to less desirable locations and neighbourhoods, because generally speaking, the homes are cheaper. This affects their quality of life and the resale value of the home.
- Calculations:
- Here's an example. (For simplicity's sake, Realtor fees, condo fees, taxes, inflation, insurance and other expenses have been excluded. Additional payments has also been excluded. Also, the interest rate remains constant over the life of the mortgage.)
- Home Price: $100,000
- Down Payment: $10,000 (A lower down payment)
- Mortgage: $90,000 (A higher mortgage)
- Amortization: 20 Years (A longer amortization period)
- Interest: 5%
- Monthly Payments: $591.41 (Lower monthly payments)
- Interest Over The Life Of The Mortgage: $51,940 [1]
- Total Cost of Home: $10,000+$90,000+$51,940=$151,940
- Lack Of Diversification:
- With less money, they often can't afford other investments. Their home becomes their primary and only investment, resulting in higher risk due to lack of diversification. [2] God forbid, if the housing market collapses, they'll be greatly affected.
- Higher Income Home Owners:
- Higher Down Payments:
- With more money, they can afford a greater down payment. The greater the down payment, the lower the mortgage loan. The lower the loan, the lower the interest on the life of the mortgage and the lower the monthly payments.
- Shorter Amortization Periods:
- They can afford higher monthly payments and therefore shorter amortization periods, which results in lower interest on the life of the mortgage.
- Additional Payments:
- With more money, they can afford to make additional payments and pay off their loan sooner. The sooner a loan is paid off, the more money they have to invest in other things.
- Renovations And Repairs/Maintenance:
- With more money, they can afford home renovations and home repairs/maintenance, which increases the resale value of the home. Some strategically plan to flip [3] their homes in order to make a profit.
- Desirable Locations:
- With a greater price range, they can afford to buy in more desirable neighbourhoods, potentially increasing their quality of life and the resale value of the home.
- Lucrative Clients:
- Higher income home owners are lucrative clients and banks may be eager to secure their business, hoping for future additional loans and other investments. As such, banks may be willing to negotiate better mortgage terms (lower interest rates etc.) in order to secure their business.
- Calculations:
- For comparison purposes, let's assume the higher income home owner is buying the same type of home as the lower income home owner. We're not taking into account that the higher income home owner can afford a more expensive home or, as a lucrative client, may be able to negotiate better mortgage terms. (For simplicity's sake, Realtor fees, condo fees, taxes, inflation, insurance and other expenses have been excluded. Additional payments has also been excluded. Also, the interest rate remains constant over the life of the mortgage.)
- Home Price: $100,000
- Down Payment: $50,000 (A higher down payment)
- Mortgage: $50,000 (A lower mortgage)
- Amortization: 5 Years (A shorter amortization period)
- Interest: 5%
- Monthly Payments: $942.39 (Higher monthly payments)
- Interest Over The Life Of The Mortgage: $6,544 [1]
- Total Cost of Home: $50,000+$50,000+$6,544=$106,544
- Diversified Portfolio:
- Higher income home owners have other options as well, for example, they can offset their debt with other investments, diversifying their portfolio to decrease risk.
- Instead of putting $50,000 on the down payment, let's assume the higher income home owner chooses to diversify her investments by putting $10,000 on the down payment and investing the other $40,000 elsewhere. For comparison purposes, let's assume all variables are equal to the lower income home owner:
- Home Investment:
- Home Price: $100,000
- Down Payment: $10,000
- Mortgage: $90,000
- Amortization: 20 Years
- Interest: 5%
- Monthly Payments: $591.41
- Interest Over The Life Of The Mortgage: $51,940 [1]
- Total Cost of Home: $10,000+$90,000+51,940=$151,940
- Other Investment: (Assuming no pay outs or dividends. Inflation has been excluded.)
- Initial Investment: $40,000
- Number of Years Invested: 20 Years
- Annual Rate Of Return: 2%
- Interest Earned Over The Life Of The Investment: $19,438 [4]
- Total Future Value of Investment: $40,000+$19,438=$59,438
- Total cost of the home is $151,940, minus the income from the investment $59,438 = $92,502 paid out over 20 years, which is considerably lower than the $151,940 paid out by the lower income home owner over the same period of time.
Another issue is that banks aren't interested in helping home owners, they're only interested in making money:
- Mortgage Penalties:
- Banks penalize home owners for overpaying on mortgages or for breaking mortgages and the penalties can be surprisingly expensive, potentially running into the tens of thousands of dollars.
- Complicated Contractual Documents:
- Mortgage documents are written in legalese that the average home owner doesn't easily understand, which is how banks are able to incorporate penalty charges without explicitly disclosing the costs.
- Banks Own The Home:
- A home belongs to the bank until the mortgage is fully paid off. If the home goes into foreclosure, the home owner may lose everything, regardless of how much equity they've already invested in the property.
- False Sense Of Home Security:
- Using predatory banking practices, banks sometimes issue mortgages to people who can barely afford to buy a home. If the home owner's financial situation changes, or if interest rates rise, they wouldn't be able to make their mortgage payments and the home would enter foreclosure. This can be a devastating experience for people who were excited to own a home.
- Empty Houses:
- When the economy is bad, foreclosures tend to be high and many people lose their homes. The houses may remain empty because people can't afford to buy houses. It's sad to think that there are so many empty houses when so many people don't have a place to live.
Round tables need to be established to find a fair, equitable and ethical way of providing affordable and dignified housing for everyone on earth.
In everything we do, we should seek to benefit others instead of ourselves.
________References:
- Mortgage Payment Calculator. www.cmhc-schl.gc.ca. Canada Mortgage and Housing Corporation (CMHC). Retrieved Oct 18, 2014.
- Diversification (finance). www.en.wikipedia.org. Retrieved Oct 18, 2014.
- Flipping. www.investopedia.com. Retrieved Oct 22, 2014.
- Investment Calculator. www.bankofcanada.ca. Retrieved Oct 18, 2014.
