Owning a house is a lifetime goal for many people. This comes with good reason. There are several reasons why owning a home is important and one of the most significant reasons is that it is the gateway to long-term financial success. Homeownership can help build your personal wealth through home equity from either market gains or renovations in the property.
Mortgages: the baseline
Most people do not have all the cash-on-hand that it takes to buy a house outright. This is where mortgages come into the equation. The ability to obtain money through a mortgage combined with a down payment increases our buying power, which makes purchasing a property one of the largest financial transactions a person will experience in their lifetime and for many a long-term investment.
Because purchasing a property is a very large financial transaction, it is important to make an informed decision. A mortgage advisor is a great source of information and should be consulted before you begin your search for your starter home, second home or investment property. Understanding what you can afford and becoming pre-approved is the first step in your property purchasing journey.
As a guideline, financial professionals in Canada recommend that your monthly mortgage payments, heat, strata fees (if applicable) and property tax costs should not be more than 32% of your gross income. This is to ensure new property purchasers will be able to afford monthly housing costs but also to make sure you have additional funds remaining to continue to enjoy your life as well as to save for a long-term need.
To determine what you may be able to afford, you can input your info into a mortgage affordability calculator.
You may want to try several scenarios using this calculator to understand what you will be able to afford but also to understand the dollar value of the property you’ll be able to purchase as well as what you can expect the monthly payments to approximately be. Some monthly payments to consider include strata fees and property taxes. As an added tool, you can calculate your estimated property tax using this calculator.
It’s also important to use the qualifying rate (which is the 5-year Bank of Canada rate) when using the calculator tool as this is what financial institutions will use to approve your mortgage once you get to that stage. Remember, this is just a qualifying rate and not your final rate.
In addition to planning for your expected monthly expenses there is another important item to consider: your down payment. Saving for a down payment can feel like the most overwhelming part of buying a house – there are rules and guidelines that can be hard to comprehend. Here’s what you need to know:
Minimum down payment requirements:
- For homes that are $500,000 or less, the minimum down payment is 5%
- For homes that cost between $500,000 and $1 million, the minimum is 5% for the first half million and then 10% for the remainder
- Homes that are $1 million or more requires a minimum 20% down payment
For any down payment that is less than 20% home buyers must purchase mortgage default insurance.
When starting to save for a down payment make simple changes in your budget or explore other financing options to help reduce the amount of mortgage you are going to need. The more down payment you have to put against the cost of the house, the less mortgage amount you will have to carry, and ultimately less interest you’ll have to pay in the long run.
Many first-time homebuyers leverage at least some of their down payment in the form of a gift from family or friends. In some cases, lenders may require proof of the gifted funds. The most important part of receiving money as a gift is that it cannot be structured as a loan; the person gifting the money does not expect it back.
If you have been saving regularly, you may be able to loan yourself dollars from your RRSPs through the Home Buyers’ Plan (up to $35,000 with a 15-year repayment period).
When considering any of these options look at how each fit into your life and how they may affect your long-term plan. A financial advisor can help you decide which down payment route is best for your financial future.
What types of mortgages and interest rates are there?
For conventional mortgages (the mortgages that most people use) interest is offered at fixed or variable rates.
You will pay the same percentage in interest each month for the term agreed to because the rate is locked. Your interest rate will not fluctuate for the agreed upon period. This type of rate is beneficial for people who prefer there to be no change to the amount of payment being used towards paying down the mortgage versus paying interest. It is also suitable for people who enjoy the predictability that comes from knowing your rate will not change for the duration of the term. It is for this reason, that fixed rates are often higher than a variable rate.
The amount of interest charged on the outstanding principal fluctuates depending on the benchmark rate of the lender. This means that if the benchmark rate of the lender changes, then so will your variable rate.
Interest and what it means for your mortgage payments
Interest is the fee the borrower pays to receive funds from a financial institution. In other words, it is the cost of borrowing money.
When you start to repay your mortgage, your payments are blended because they combine repayment of the principal and the interest on your mortgage. It is also worth noting that in the beginning of your mortgage journey, more of your initial payment will go towards paying interest versus principle. This will shift over time, as the amount you pay towards your principal increases while the amount you pay in interest decreases.
The key to saving money on your mortgage is to pay off the principal as fast as possible. This is why taking advantage of accelerated payments (paying on a bi-weekly, every 14 days schedule) and lump sum payments against your mortgage can go a long way in paying down your mortgage sooner.
Obtaining a mortgage pre-approval to begin your property purchase journey
If you’re at the stage where you’re considering purchasing a property within the next year, connect with a realtor to help you with your search. Connect also with an advisor at your financial institution to discuss your options and to become pre-approved for a mortgage amount. Determining your pre-approved dollar amount provides you and your realtor the ability to narrow your property search. It’s important to stay connected with your financial institution throughout your search by providing the documents necessary so when you find your perfect property, you can confidently place an offer.