** Special to The Just Word Blog from Enoch Omololu, a personal finance blogger at SavvyNewCanadians.com**
Becoming a first-time home buyer can be exciting as well as daunting. Exciting because you are about to have a place you can call your own, and daunting because there are so many moving parts to the homeownership process.
Following are 8 important factors to consider to make your home shopping and purchase experience a rewarding and delightful one.
1. To Rent or To Buy?
A good question to ask yourself before embarking on this journey is whether or not homeownership is for you.
Are you able to bear the potential increase in your monthly housing costs? Do you really need the extra space? How soon are you likely to move from the area?
The rent vs. buy conundrum is more than just a financial one. Many other factors come into play.
Some of the advantages of renting are:
- You can choose to change locations easily if your circumstances change e.g. if you get laid off from work.
- The monthly cost of a rental is fixed, and may be cheaper than your monthly mortgage costs when you factor in other variable expenses like maintenance and repairs, property taxes, home insurance and more.
- A cheaper rent leaves you with some extra cash that you can put towards savings and investing.
- Your landlord is often responsible for organizing repairs when they’re required and footing the bill.
Some of the advantages of buying a home are:
- You are building equity in your home every time you make a mortgage payment. This is why some use homeownership as a way to save money and build wealth over time..
- The growth in the value of your primary residence is tax-free, which can significantly boost your retirement nest if you downsize in the future.
- Pride of ownership. It’s mostly psychological, but a benefit nonetheless. You are a king/queen in your own castle.
- As a homeowner, you can choose to rent all or a part of your home and earn rental income.
If you have considered your situation and believe that purchasing a home is the right decision, follow on with the next steps.
2. Conduct a Financial Checkup
The basic question at this stage is “what kind of house can you afford?”
Compare your income and expenses to determine how much money you are able to set aside monthly for housing-related costs.
The conventional wisdom is that you should spend no more than 30% of your gross income on housing.
Use a home affordability calculator like this one by Canada Mortgage and Housing Corporation (CMHC) to calculate how much you can borrow, your monthly obligations, and how it fits into your budget.
The Canadian government has two ratios that lenders look at to determine how much they can borrow you:
A. Gross Debt Service (GDS) Ratio
This ratio looks at your monthly housing costs: mortgage payments (principal and interest), taxes, and heating expenses (PITH) and compares them to your gross monthly income. As per CMHC, it should not exceed 35%.
GDS = P.I.T.H / Gross Income ≤ 35%.
B. Total Debt Service (TDS) Ratio
This ratio looks at your total monthly debt. It adds up your housing costs, credit card payments, car payments and other applicable expenses and compares them to your gross monthly income. As per CMHC, it should not exceed 42%.
TDS = (housing expenses + credit card payments + student loans + car loan payments + other expenses) / Gross Income ≤ 42%.
In some cases, lenders will allow you to exceed these limits, however, they are a good rule to follow.
Take a look at your credit score and report. Are they in good standing?
When you approach the bank for a mortgage, they will pull your credit file. You’ll want to ensure that your credit score is in the very good to excellent range. If it is not, start working on improving your credit profile.
3. Decide on the Details
Before approaching a lender to seek pre-approval on a mortgage loan, you need to make a decision on the type of home you want to purchase.
What is your preferred neighbourhood? What type of home? Condo? New or resale? Fixer Upper? Square footage?
The type of home you prefer will determine how much you need to borrow and how much your minimum down payment is going to be.
Take a look at what your desired home is selling for. Can you afford it?
4. Save for a Down Payment
Typically, a minimum down payment of 5% is required when you buy a home in Canada. This is an out-of-pocket cost and in some cases is higher depending on the purchase price of the home. For example, a minimum 10% down payment is required on any amounts exceeding $500,000 up to $1 million.
Note that in order to qualify for a mortgage loan, you may also need to pass a mortgage stress test. Basically, you should be able to show the lender that you can still afford to make your monthly payments if rates rise.
Federally-regulated financial institutions use the higher interest rate of either the Bank of Canada’s five-year benchmark rate or the mortgage rate the lender is offering to you plus 2%.
Provincially-regulated lenders e..g. most credit unions are not required to administer a stress test.
Here are some ways to save up for your down payment:
Use your TFSA
Every year, the government gives you a TFSA contribution limit to save or invest money tax-free. For 2019, the limit is $6,000 and if you have been eligible for the program since it was introduced in 2009, your total contribution room is at $63,500.
Some excellent tools for growing your TFSA down payment savings are a high-interest savings account and/or a more conservative-oriented investment portfolio that focuses on preserving capital.
Use the Home Buyers’ Plan (HBP)
If you have an RRSP, you can withdraw up to $35,000 (or $70,000 for a couple) tax-free and put it towards your down payment.
You have up to 15 years to re-contribute the funds you withdrew, with the first payment starting in the calendar year following the year you made a withdrawal.
The Canada Revenue Agency will send you a HBP statement of account each year that shows how much you have repaid and the minimum amount you must contribute for the year. You can choose to contribute more than the minimum or even pay off your entire outstanding HBP balance early without penalty.
Use the First-Time Home Buyer Incentive
Starting in September 2019, new home buyers can apply for the first-time homebuyer incentive program and have the federal government chip in 5%-10% of the purchase price of a home. This loan must be repaid within 25 years.
Overall, the higher the down payment you can make up front, the lower the overall interest payments you will make over time.
5. Don’t Forget Closing Costs
While planning for your down payment amount, do not forget about the other costs involved with buying a home aka closing costs.
Closing costs add up and can be anywhere from 2% to 5% of the purchase price and include things like:
- Home inspection fees
- Property appraisal fees
- Land transfer tax
- Prepaid property taxes and utilities
- Legal fees
- Estoppel certificate fee
- Moving costs
6. Shop Around For a Mortgage
Don’t let loyalty to your bank cost you thousands of dollars in unnecessary interest fees. Shop around for competitive mortgage rates that can save you money in lower interest payments over time.
See what your current bank is willing to offer you and compare their rate with what is being offered by credit unions and online-only banks.
Better still, try a mortgage broker or one of the online mortgage rate comparison sites that post rates from multiple lenders.
When you find a competitive rate, ask for a pre-approval.
A mortgage pre-approval is a key step where a lender requests your financial documentation and offers to lock-in a mortgage rate for 3-4 months against any increases.
If the mortgage rates fall within this period, you automatically get the lower rate.
A mortgage pre-approval also gives you an idea about how much mortgage loan you can qualify for.
7. Find a Realtor
It’s time to go house hunting and you can either use a realtor or choose to go solo.
First-time homebuyers can benefit from using the services of a real estate agent. They help you with finding listings, arranging home viewings, negotiating the price and providing answers to your questions about the housing market.
In addition to a realtor, you may also need a lawyer to help with handling all the paperwork that changes hands between you and the seller, as well as with the lender.
8. Don’t Skimp on a Home Inspection
Home inspections are extremely important!
You may think you have found your dream home and want to make an offer quickly… but don’t forget to make your offer contingent on a positive home inspection report.
If the report states that some repairs are warranted, weigh your options and decide whether to go ahead, re-negotiate with the seller, or continue your search for a home.
Enoch Omololu is a personal finance blogger at SavvyNewCanadians.com. His writing has been featured or quoted in The Globe and Mail, Toronto Star, MSN Money, Rockstar Finance, Financial Post and many other personal finance publications.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of Justwealth, or its employees. The content of the article is provided solely for information purposes only and should not be construed as advice of any kind.