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It is exciting to buy a home-the independence, the space, the white picket fence-but it is also usually the biggest financial undertaking you’ll ever make.
Low mortgage rates are inspiring first time buyers to flock to the housing market during the pandemic, but Canadians do need to handle their money carefully owing to an unpredictable economy and stringent new mortgage laws.
And let’s not forget about insurance for the car, utility bills, student loans and other costs that are too easy to push to the back of your mind in the excitement of trying to buy a home.
Confused now? Here’s how to decide if you really have the cash for your dream home.
How much money have you got?
Your down payment is the first factor in the calculation. In Canada, if the home costs $500,000 or less, homebuyers must be able to provide at least 5 percent of the purchase price of a home upfront. Tack on another 10 percent of the excess if the home costs more than $500,000. You need to put down 20 percent if the place costs more than $1 million.
If you don’t have enough savings to put 20 percent down, regardless of the price of the home, you’re branded a risky “high-ratio” buyer. To ensure that in case you go bankrupt and stop paying, your lender is required to purchase mortgage default insurance that will cover them. In the form of higher mortgage payments, the burden of the insurance premium will be passed on to you.
You’re out of luck if you’re thinking of using a loan or credit card to make a down payment. Canada Mortgage and Housing Corporation (CMHC) regulations that came into force on July 1, 2020 state that “non-traditional down payment sources that increase indebtedness” are no longer OK.
First-time buyers can lean on the federal Home Buyers’ Plan, which allows you to borrow from a registered retirement savings plan (RRSP). You can borrow up to $35,000 (or $70,000 for couples) to purchase your first home.
Don’t forget to budget for closing costs once you’ve got your down payment ready. A lot goes into finalizing a home buying transaction, including legal fees, land transfer taxes, and title insurance. Figure on about 1.5 to 4 percent of the price of your house. That means you would need an additional $20,000 in the bank for a $500,000 home.
Even after all that, you still need money to eat and enough cash to weather an unforeseen expense or job loss. You may need to save up for quite a while, even though you’re making good money, before your first home is truly a viable option.
How much money are you earning?
Your overall monthly mortgage payments are the second component of this calculation.
If you need your mortgage protected by the CMHC, you’ll face strict restrictions here, but you probably want to adhere to these limits regardless. You can forget about saving for retirement, paying for your car or going on a holiday if you’re ‘home poor’ and up to your ears in debt.
The two numbers that you need to understand here are your ratios of Gross Debt Service (GDS) and Total Debt Service (TDS).
Your GDS is the portion of your gross income, including mortgage payments, utilities, condo fees and property taxes, that you spend on housing. The CMHC limits your GDS to 35 percent, meaning you can not use any more than a third of your income for your housing expenses.
Your TDS covers your expenses for housing but also all of your other loans, such as credit card and vehicle payments. If your TDS reaches 42 percent of your taxable revenue, the CMHC will refuse to insure your mortgage.
Even if you are not bound by CMHC regulations, when you start to decide for yourself whether a home is affordable, keep these limits in mind.
How do lenders decide what they are going to give me?
Lenders look closely at your financial status and history when determining how much money to lend you and at what interest rate when considering you for a mortgage loan. Is it realistic to trust you to pay the debt?
Expect lenders to look at your credit score and your credit report as well. The CMHC asks those in need of default insurance for a minimum credit score of 680, but lenders want to be impressed. The higher your score, the more trustworthy you appear, so check your score and take steps to boost it as high as you can before you apply for a mortgage of any kind.
In order to see if you are taking on more than you can afford financially, they will also look at your annual income and debts (i.e. your GDS and TDS). In their opinion, an ideal borrower is not a self-employed freelancer, but an employee who has worked for more than two years for the same company. Lenders often prize stability. Yes, freelancers can still get a mortgage, but the reality is it will be harder.
A decent rule of thumb is that you should expect a lender who likes you to give up to four times your gross annual income to provide a mortgage. So, if you make $75,000 a year, you might get up to $300,000 in loans.
Remember, there’s a difference between “How high a mortgage can I get? “and “How much mortgage can I afford?”Just because a lender is going to give you a big bag of cash doesn’t mean you can afford to take it all.
How a mortgage can be made more affordable
Your new mortgage can be a serious drain on your finances, no matter how great you look as a borrower. To keep costs down, you’ll want to explore every avenue:
If you have the cash, offer a larger down payment. You will have a smaller debt to pay off and therefore lower monthly costs if you pay more now. And you will not have to worry about mortgage default insurance or CMHC limits if you put down 20 percent.
Consider the Incentive for First-Time Home Buyer Scheme .
In exchange for funds to go into your down payment fund, this initiative gives the federal government a cut of your home. However, not everyone finds it a good deal.
Extend the duration of amortization.
You will not have to pay nearly as much per month if you allow yourself more time to pay off your mortgage. You will end up paying a lot of interest in the long term, but as you deal with other expenses, like student loans, the payments will be more manageable.
For a better deal, go a-hunting.
Don’t just go to the nearest bank and accept whatever interest rate they’re giving you. Shop around and get quotes from several lenders, because month after month, even a fraction of a percentage point will potentially save you buckets of money.