You are trying to decide whether to continue renting an apartment or to buy a house. In 20 years, you plan on leaving Canada and moving to a warm tropical island and would like to have as much money as possible. You have just won $25,000 in the lottery and will be able to use that money for a down payment. At the moment, your rent is $700 a month and you expect it to increase by 1 percent a year. The long-term forecast for housing in your area is that house prices are expected to rise at a rate of 5 percent a year for the next 20 years.
With $25,000 down, you are able to obtain a 5-year, $250,000 mortgage at 7 percent, compounded monthly and amortized over 20 years (the value of the house you are considering is $275,000). Every five years you will have to renegotiate the mortgage, and you expect interest rates to increase by 50 basis points (½ a percentage point) each time. Assume zero taxes.
a. If you expect to earn 10 percent on your investments, should you buy a house or continue to rent?
b. Would your answer change if you only expected to earn 4 percent on your investments?