Financial Considerations When Buying a Home

 

Assess your present household budget and your annual income to determine if you are eligible for a mortgage and how much you can comfortably afford.

Also check out the Mortgage Affordability Calculator at www.REALTOR.ca.

 

A mortgage is a loan, generally used to buy a property.  How much you pay depends on how much you borrow (the principal), the loan's interest rate, and how long you take to pay it back (the amortization period).

Do not be afraid to negotiate interest rates and mortgage terms with different lenders.  They are offering you a product and talking to more than one lender helps you make an informed decision.

 

When you buy a home with less than a 20% down payment, the mortgage needs to be insured against default.  This type of insurance protects the mortgage lender in case you are not able to make your mortgage payments.  It does not protect you.

 

The federal government has assistance programs to help homebuyers.  Research government program requirements to see if you are eligible.

1.  Assess Financial Readiness

What do lenders require?

Mortgage lenders use two calculations to help determine your eligibility for a mortgage - your Gross Debt Service (GDS) ratio and your Total Debt Service (TDS) ratio.

Your GDS ratio is the percentage of your gross monthly income used for mortgage payments, taxes and heating costs or - if you are buying a condominium - half of the monthly maintenance fees.  As a general rule of thumb, your GDS ratio should not be more than 32% of your gross monthly income.

Your TDS ratio is the percentage of gross monthly income required to cover monthly housing costs, plus all of your other debt payments, such as car loans or leases, credit card payments, lines of credit payments and any other debt.  Generally, your TDS ratio should not be more than 40% of your gross monthly income.

Have you been pre-approved?

Getting pre-approved for a mortgage before looking at properties gives you a more realistic expectation of what you can afford.  However, keep in mind that the pre-approved amounts can overestimate what you can actually afford to pay.

Pre-approval does not guarantee you will be approved once you actually apply if market conditions, such as interest rates, or your personal circumstances change.

Do you know your credit rating?

Order a copy of your credit report to make sure it does not contain any errors because lenders will check it before approving you for a mortgage.  A credit report is a summary of your financial history and shows whether or not you have had any problems in the past paying off debts.

The Financial Consumer Agency of Canada (FCAC), a federal government agency, has tips on how to order your credit report for free and how to improve your credit rating.  Visit FCAC's website at:  www.itpaystoknow.gc.ca.

2.  Consider Mortgage Options

What type of mortgage is best for you?

  • Fixed rate mortgages:  Your interest rate is locked in for a specified period called a term.  Your payments stay at the same for the mortgage's term so you will not pay more if interest rates increase over time.
  • Variable rate mortgages:  Rate of interest you pay may change if rates go up or down.
  • Conventional mortgages:  Require a down payment of more than 20% of the property's value.  You are not required to get mortgage default insurance with a conventional mortgage.
  • Closed mortgages:  The mortgage cannot be paid off early without paying a prepayment charge.
  • Open mortgages:  A mortgage that can be paid off at any time during the term, without having to pay a charge.  The interest rate for an open mortgage may be higher than for a closed mortgage with the same term.

What mortgage features are best for you?

  • Portable mortgages:  If you sell your existing home, you can transfer your mortgage to your new home while keeping your existing interest rate.  You may be able to avoid prepayment charges by porting your mortgage.
  • Prepayment privileges:  You can make lump-sum prepayments or increase your monthly payments without having to pay a charge.  This can help you pay off your mortgage quicker and save on interest charges.

How often can you make your payments?

  • By switching from monthly payments to accelerated weekly or biweekly payments, you can pay off your mortgage faster.  Explore your options for mortgage payments and see how much interest you could save by using FCAC's Mortgage Calculator Tool at:  www.itpaystoknow.gc.ca.

What types of mortgage charges might you have to pay?

You may have to pay charges if you prepay large portions of your mortgage due to unforeseen life changes, such as marital breakdown, death of a spouse or relocating for a job.

It is your right to know how lenders calculate prepayment charges.  Read your mortgage contract carefully and make sure you understand how charges will be calculated before you sign.

How much do you need for your down payment?

A down payment is the portion of the property's price not financed by the mortgage.  You will need a down payment of at least 5% of the purchase price of the home.  For example, to buy a home for $200,000, you will need at least $10,000 as your down payment.  If your down payment is less than 20%, you will need mortgage default insurance.

3.  Mortgage Default Insurance

Are you planning to purchase a property with less than 20% down payment?

If yes, you require mortgage default insurance which generally adds 0.5% to 3% to the cost of the mortgage depending on the total amount borrowed.

Mortgage default insurance enables you to purchase a home with a minimum down payment of 5% (10% for multi-unit dwellings) with interest rates comparable to those of a conventional mortgage.

Major providers of mortgage default insurance include Canada Mortgage and Housing Corporation (CMHC), Genworth Financial Canada, and Canada Guaranty Mortgage Insurance Company.

4.  Research Government Programs

  • First-Time Home Buyers' Tax Credit - a $5,000 non-refundable income tax credit on a qualifying home.  The credit provides up to $750 in tax relief to assist first-time buyers with purchase costs.  For more information, check the Canada Revenue Agency's (CRA) website:  www.cra-arc.gc.ca.
  • Home Buyers' Plan - a one-time withdrawal up to $25,000 from a Registered Retirement Savings Plan (RRSP) by first-time buyers to help purchase or build a home.  Generally, you have to repay all withdrawals from your RRSP within 15 years.  For more details, visit CRA's website at:  www.cra-arc.gc.ca.
  • CMHC Green Home program - when you use CMHC-insured financing to buy or build an energy-efficient home or make energy-saving renovations, you may qualify for a premium refund of 10% on your mortgage default insurance and premium refund for a longer amortization period (if applicable).  Check out CMHC's website for more information:  www.cmhc.ca.

Government programs can change over time.  For the most up-to-date information, refer to Service Canada's website:  www.servicecanada.gc.ca

This information is provided from Financial Consumer Agency of Canada and CREA (The Canadian Real Estate Association.)