A starter home is a house purchased by a first-time home buyer in the hope that after living in it for a few years, they can upgrade and move on to a bigger and more expensive permanent home. This route has historically been the means by which a majority of first time buyers get their feet into the property market.
A home ownership study conducted in 2015 by Genworth Canada showed that 50% of typical first time buyers regard their first home as a starter home from which they planned to move within the decade. Starter homes are by their nature smaller houses such as small semi-detached or fully detached houses, townhouses, and condos.
A permanent home loosely defined is one you potentially see yourself living in for 10, 20, 30 years or even for life. It does not necessarily refer to the so called “dream home”. However, it is a house that has the characteristics and capacity to meet your needs for many years to come.
Some of the reasons why starter homes are popular include:
1. Affordability: A smaller house usually means a smaller mortgage and lower down-payment requirements. It is easier for a first time buyer who has not won the lottery to qualify for.
For some who would rather buy a bigger permanent house starting out, soaring house prices for example in the hot markets of Toronto and Vancouver are forcing them to reconsider and downgrade their expectations.
2. Lower home expenses: A smaller home translates into lower ongoing costs including property taxes, home insurance, utilities, renovation cost, and so on. This is advantageous to first-time home buyers who do not want to become swamped by high recurring expenses every month.
3. Easier to resell: There is a stronger demand for sales of homes in the $150k to $250k range which is where most starter homes fall. This means that it may be easier to get this houses sold and off the market should there be a need to sell them quickly.
4. Uncertainty: When people are uncertain as to how long they will live in a certain area due to maybe their job status or if they work in an industry that is unstable, they may want to hedge their bets by buying a smaller starter home.
5. Future rental plans: Some first-time home buyers plan to live in their starter home for a few years while they save up for a bigger permanent home and thereafter hope to convert the starter home into an investment by renting it out.
6. Speculation: Sometimes when people buy starter homes, they engage in it purely for speculation purposes, hoping that prices will rise in the short to medium term and they can flip it and make some money.
When buying a starter home may not be a good choice:
1. If you are planning to sell the house in 5 years or less
2. If you have an expanding family and will need to upgrade in 5 years or less
3. If you are buying a starter home because of your uncertainty as to how long you will be living in an area, for example, in a contract job, unstable job industry…
4. If you can afford a permanent home now and there are no other restricting factors
5. If what you can afford is in the price range for a ‘fixer-upper’ which would require lots of renovation work, and you are not a DIY proponent. Home renovation costs can add up…just think about a leaking basement. Phew!
All the above scenarios may cost you financially. According to Forbes and several other reliable computations out there, depending on where you live, it may take between 5 to 7 years or more to break-even on a home and cover the costs of buying, selling and owning the home. These costs include closing costs, real estate agent commissions, property taxes, lawyer fees, renovation costs, moving costs, and so on.
It is worthy to note that the first few years of mortgage payments are structured in such a way that you are paying a lot more in interest payments and a lot less in principal. So, it may surprise you to find out that you have little or no equity in the home if you sell after just a few years.
In the debate of starter home vs. permanent home, sometimes, renting is the right answer. Depending on your circumstances, renting while saving up for a permanent home may be the smart thing to do.
Personally, we chose to go the route of the permanent home for our first home purchase. We rented for a number of years, moving and changing apartments a couple of times. When it was time to go house hunting, my wife and I decided that buying a bigger house was the better option for our growing family. Barring unforeseen circumstances, we hope to live in our home for many, many years to come.