Being a first-time homebuyer is exciting, but it can also be overwhelming. Thankfully, we’re here to help. Through this guide, we’ll help ensure your journey from renter to homeowner goes smoothly and, as much as possible, stress-free.
We’ve gathered all the information you most need to know about buying a home, and assembled it into seven essential steps, from the moment you decide to become a homeowner to the day you close on your first property. While we intend this guide to be a good place to start for first-time buyers, we hope that you will also rely on the expert and personalized guidance of service professionals, like mortgage brokers, in order to avoid all the pitfalls on the way to owning your first home.
The Buy Decision
First, let’s take a step back and look at some of the reasons people decide to become homeowners. There are several factors to consider, so let’s take a look at the pros and cons of both renting and buying.
One advantage of renting is flexibility. If you’re unsure whether you’re going to live in the same town next month, let alone next year, renting can be a practical option. Typically all you have to do is provide your landlord with 30 days’ written notice prior to moving out of a rental unit. That being said, your landlord has flexibility as well, which means at any time you could receive notice that your rent is increasing or the property is being sold, forcing you to find a new place to live. Moving out of a home you own is a far more involved and costly process, but while you live there you enjoy the freedom of not having to answer to a landlord.
The biggest consideration, however, is likely on the financial side. Each time you make a mortgage payment, you’re gradually building up equity until one day you own a valuable asset (your home) free and clear. Real estate is one of the most reliable investments there is, and for most homeowners, the value of their home appreciates to such an extent that it eventually plays a major part in funding their retirement. In other words, you could pay rent for the next 25 years and walk away with nothing, or you could pay off a mortgage for 25 years and sell your home at a fair market price.
It’s for this reason that you’ve likely heard people say that renting is “throwing your money away” or “paying your landlord’s mortgage.” In order for a renter to come out financially ahead of a homeowner, he or she would have to take all the money that would otherwise go toward a down payment, property taxes, and other homeownership costs, and put it all in successful long-term investments.
This takes a great deal of discipline, not only to put that money away but to resist the temptation to withdraw it at the wrong time.
It’s also worth noting that the government sees homeownership as a good thing, so it offers tax incentives. There are various tax credits available and, unlike most investments, you won’t have to pay a dime in capital gains taxes when you sell your principal residence.
Step 1: Get a Credit Check
If you’ve decided you want to become a homeowner, like most buyers you’ll eventually have to qualify for a mortgage. But before a lender will finance your real estate dreams, they’re going to want to make sure you’re good for it. They need a quick, easy way to see if you’ve been good at paying back debts. That’s where your credit score comes in.
Your credit score may not be the only factor lenders consider on a mortgage application, but maintaining a good score is key to getting the mortgage you want, and therefore the home that you want, and improving that score takes time. That’s why we’ve listed it here as the first step you should take on the way to buying a home.
Apply for Your Credit Score or Credit Report
Your credit score is a 3-digit number assigned to you by the two Canadian credit bureaus, Equifax and TransUnion. The number falls between 300 and 900 and, as you may expect, the higher your credit score, the better.
This number is intended to represent your overall quality as a borrower. A good score is attractive to mortgage lenders because it suggests you pay back money that you owe, and you do it consistently.
A score of at least 680 is considered good by lenders, but to play it safe, aim for at least 700, as your score will fluctuate based on your daily credit behaviour, and you wouldn’t want it to dip below the optimal level right before you apply for a mortgage.
You are entitled to view your credit score once per year at no cost, and you can request to see your score with either bureau online (www.equifax.ca or www.transunion.ca). You’ll need to verify your identity by confirming personal data such as your SIN, address and full name.
Check for Any Major Problems
If you find that your credit score is less than optimal, it’s helpful to request a full report. This will help you identify where the problems are so that you can start altering your habits to improve your score on your way to homeownership.
Unfortunately, the credit bureaus don’t disclose exactly how they calculate credit scores, but what we do know is that there are five key factors that most impact the score you receive. Keep these factors in mind when reviewing your credit score or credit report.
Your Payment History
Lenders want to see steady payment history. In fact, of all contributing factors, your payment history has the biggest impact on your credit score.
Remember that time you forgot to pay your cellphone bill on time? It probably didn’t help your credit score. Late and partial payments on any credit cards, loans or other bills will count against you. Likewise, if any of your debts are written off or sent to collections, or if you’ve ever filed for bankruptcy, your credit score will take a serious hit.
The Length of Your Credit History
Lenders also want to see that you have a long track record of using credit responsibly. Someone who has had credit cards and other credit accounts open for 10 years have proven themselves as a borrower more than someone who signed up for a credit card last week. As such, how long you’ve had credit accounts open matters, and cancelling credit cards will lower your score.
Your Available Credit
After your credit history, the factor that matters the most is your available credit. Not to be confused with your credit limit, your available credit is how much money you can borrow at a given time.
Your available credit is calculated by taking your credit limit and subtracting any balances you’re currently carrying. For example, if you have a card with a credit limit of $4,000 and another with a limit of $6,000, your total available credit is $10,000. If you rack up more than $3,500 ($35%) worth of purchases on those cards at any given time, it will be reflected in your score.
Using less than 35% of your available credit suggests to lenders and credit bureaus that you’re a responsible borrower. For this reason, lowering your credit limits can actually hurt your score, even though it can seem like a responsible thing to do.
Number of Credit Inquiries
Another factor influencing your score is the number of times you’ve initiated credit inquiries, which are exactly what they sound like: requests to obtain information on your credit.
There are two types of credit inquiries: soft hits and hard hits. Soft hits don’t count towards your credit score. The most common example is requesting a copy of your own credit report. Hard inquiries do impact your credit score. The most common example is applying for credit, such as a mortgage or credit card. Too many hard inquiries within a short time period make lenders nervous and can lower your credit score.
Lenders don’t want to see just one type of credit; a variety helps demonstrate that you can manage all kinds of debt responsibly and that you can balance priorities. This also suggests to lenders that you’re likely to be able to manage a mortgage on top of your other expenses.
Change Your Habits
Improving your credit score isn’t easy, but here are a few tips to get you started:
- Pay off your outstanding debt.
- Start paying off bills in full and on time.
- Make at least the minimum payments on money owed.
- Use credit cautiously.
- Keep old credit cards.
- Limit the number of credit inquiries you make.
- Diversify your credit.
- Build up at least 65% available credit.
Fix Inaccuracies in Your Report
If you see any inaccuracies, you have the right to file a dispute with Equifax or TransUnion immediately to correct it. To be extra cautious, review credit reports with both bureaus, since the information they’re working with can be slightly different.
Common inaccuracies include someone else’s information on your credit report, debts that aren’t yours, debts that you’ve already fully paid off, and incomplete payment history. Mistakes like these can impact your ability to qualify for a mortgage with the best terms.
Both Equifax and TransUnion have different dispute resolution processes. You’ll typically submit a few words in writing to indicate you don’t agree with an item on your credit report. If you’re not satisfied with the resolution process or believe the information in dispute is still incorrect, you can add a special note to your file with an explanation as to why you disagree.
Step 2: Evaluate Your Buying Power
Since this is your first time buying a home, you’re probably wondering how much you can afford to spend on a property — and how much you’ll be able to borrow to do it. Now that you have an idea of your credit health, you can start evaluating your buying power. With a realistic idea of what kind of home you can afford, you’ll be well equipped to start the process of finding a home and a mortgage.
There are four main factors that lenders use to evaluate mortgage applicants, and you can use them to evaluate your own financial preparedness as well:
Income: The first factor lenders look at makes perfect sense – all else equal, the higher your income, the more you can afford to spend on a home. A good rule of thumb is to buy a home that costs about three times your annual household income (before tax), though there are varying opinions on this subject. If you don’t have a significant other, you might consider buying with a sibling, parent, or friend, as your combined income will make it easier to afford a home, especially in pricey markets like Toronto and Vancouver where the average home costs far more than triple the average household income.
Stability of income matters to lenders, too. If you’re self-employed, your job is temporary, or you job hop every six months, not only does this reflect poorly on you in the eyes of the lender, it also might not make financial sense for you to buy. If you’re concerned about your job history or stability, ask your mortgage broker to help you find a lender who can accommodate you.
Down Payment: Similar to your income, the bigger your down payment, the easier it is to qualify for a mortgage. In Canada, the minimum payment you’ll need is 5% of the purchase price of a property. For houses above $500,000, any amount above that threshold requires a 10% down payment.
For simplicity’s sake, let’s say you and your partner have a combined gross annual income of $100,000, and you want to buy a home that costs $300,000. You’d need at least $15,000 for a down payment in this case.
Although 5% is the minimum required, if you can, it’s better to aim for more. If you have at least a 20% down payment, you’ll qualify for a conventional mortgage. In simple terms, this means that lenders see you as generally less risky and you won’t have to pay mortgage default insurance (more on this later on). If you have less than 20% to put down on your new home, you’ll be required to pay that insurance cost, which gets added to your mortgage, and you’ll be burdened with bigger monthly payments. A larger down payment will also give you a buffer in case the housing market takes a tumble. Contrary to popular belief, home prices don’t always go up, and a small down payment will leave you more exposed.
Either way, once you determine the approximate down payment you’ll need to become a homeowner, look at how quickly you’re saving up to determine the earliest you could possibly buy. This step often prompts would-be buyers to adjust their budgets and spending habits.
Credit Score: As discussed, your credit score and credit report provide lenders a detailed picture of your track record in paying back money you’ve borrowed. Having a good credit score pays off – literally. It means you may qualify for a lender’s prime (best) rate, as well as other features you want on your mortgage. If your credit score is less than optimal, you may need to adjust your budget to account for the possibility you’ll be offered a higher mortgage rate or that you’ll be approved for a smaller mortgage than you want.
Debt Service Ratios (TDS/GDS): The last major consideration for lenders is debt, and how you’ll be able to manage all your current commitments in addition to the mortgage debt for which you’re applying. In order to make this assessment, lenders calculate two types of debt service ratios:
- Gross Debt Service Ratio: Your Gross Debt Service Ratio is used to determine how much of your income will have to go toward paying for your new home. Lenders (banks and other financial institutions) will approve mortgages only when the GDS ratio suggests the applicant will be able to afford the ongoing costs, without struggling to balance all other day-to-day expenses.
Specifically, when submitting a mortgage application, you need to ensure that your GDS ratio is under 32%. This means that if you add up your projected mortgage payments (including principal and interest), condo fees (if applicable), property taxes and heating costs, it should make up no more than 32% of the total gross income of the household.
- Total Debt Service Ratio: The TDS ratio casts a wider net than the GDS ratio. ‘Total debt’ refers to not only your housing costs, but also all other consumer debts – like your credit card, outstanding car loans or student loan payments. Lenders want to see that your total debt payments account for less than 40% of your gross household income. If your household income, before tax, is $5,000 per month, then your debt payments and housing costs cannot exceed $2,000 per month. If the mortgage you’re applying for puts you over that $2,000 mark, you won’t be approved.
The Interest Rate Stress Test: With a mortgage covering at least 80% of the cost of your home, you are considered to have a low loan-to-value (LTV) ratio. This means that the amount you’re borrowing (the loan), relative to the price of the home (the value), is fairly low. It used to be that the interest rate stress test did not apply to these buyers, but as of January 1st, 2018, all mortgage applicants at federally regulated lending institutions (i.e. the big banks), will be subjected to it.
So what is it? The central purpose of the test is to determine whether you could continue to afford your home if the interest rate on your mortgage increased. An assessment of your finances must show that you can afford the mortgage payments not only at the current rate of interest, but with the higher of two alternatives: The Bank of Canada’s five-year benchmark rate (typically between 4% and 5%) and your contractual rate plus 2%. For example, If you were to apply today for a mortgage at 2.94% interest rate, you’d have to prove you could afford the same house with a 5.14% interest rate.
That higher rate could be a difference of several hundred dollars per month, and if that pushes you past the threshold for debt service ratios, you fail the test. And if you fail, you don’t get approved – period.
Other Ways to Improve Buying Power
The Home Buyers’ Plan (HBP)
To encourage more Canadians to make the jump from renting to homeownership, the Federal government created the Home Buyers’ Plan, or HBP for short.
Through the program, first-time homebuyers can borrow up to $25,000 from their RRSPs to put toward a down payment on a home. If you’re buying with a partner, relative or friend, that’s a combined $50,000 you can borrow together.
Money that you contribute to your RRSP is tax-deferred, which means you don’t pay income tax on it until you withdraw it in retirement when, theoretically, you’ll be in a lower tax bracket. The HBP allows you to withdraw a portion of those funds for the purpose of buying a home, without tax or penalty.
If you do take advantage of the HBP, here are a few things to keep in mind:
- Make sure you complete the right forms. If you simply take the money out, or you withdraw funds that have been in your RRSP for under 90 days, the transaction will be treated as a normal RRSP withdrawal. Not only will you have to pay withholding taxes, you’ll lose the RRSP contribution room forever.
- Follow the repayment rules to the letter. Any amounts borrowed must be paid back over the course of 15 years, starting in the second year after you borrow the money.
- While you’re saving up your down payment, it’s often a good idea to stick to low-risk investments within your RRSP. The last thing you want is to lose a big portion of your down payment right before you’re ready to buy a home.
Gifted Down Payments
A gifted down payment, or what has become known as the ‘Bank of Mom and Dad’, has become increasingly popular as home prices soar and mortgage regulations tighten.
Some first-time buyers are using gifted money for their entire down payments, and others are using it as a way to reach the 20% mark and avoid CMHC fees. However, keep in mind that your lender will still need to know where your down payment is coming from, and may have specific rules about gifted money. Typically this money needs to come from an immediate relative, who needs to confirm that you are not expected to pay it back.
Even with a down payment covered, you’ll still need to prove that you can afford all the ongoing costs of owning a home, not to mention check all the other boxes on your mortgage application.
If your parents can’t afford to contribute financially in a substantial way, you might consider asking one of them to be a co-applicant or a guarantor on your mortgage to help you get approved.
Buying with Family or Friends
Purchasing a property with family and friends can be a good way to get into the real estate market, even if only one of the owners chooses to use the property as a primary residence. Remember that regardless of the relationship, it’s always best to keep the arrangement professional. Have your real estate lawyer draft a detailed, written agreement that includes an escape clause in case of a scenario where one person is ready to sell or runs into financial difficulty.
Pre-Budget and Adjust
Once you’ve considered the factors lenders use to assess affordability, in order to determine approximately how much money you can afford to put toward a new home in the form of a down payment and ongoing costs, you should also conduct your own stress tests – after all, it’s you who’s going to be making the mortgage payments on top of all of your other expenses, and the last thing you want is to stretch yourself financially, especially as a first-time homebuyer.
For instance, the debt service ratios that lenders use don’t consider other day-to-day costs like child care, and they don’t consider the portion of your income that goes to tax, CPP and EI before it goes into your bank account.
Here are a couple of ways to test your finances yourself:
Interest Rate Test: When calculating mortgage payments for the homes you’re considering (there are lots of calculators online that can help you do this), don’t use the posted rate — instead, use a hypothetically high interest rate, at least 2% higher than the current advertised rates. This will help ensure you’ll pass the mortgage stress test, but it will also help you plan for the possibility of unexpected costs.
Cash Flow Test: Map out a typical month of expenses and after-tax income. Then, add in every conceivable expense related to home ownership. This could include: mortgage payment (remember to use that high interest rate), property taxes, home maintenance costs, sudden repair costs, home insurance, furnishing and decoration, upgrades and renovations. Be realistic about how much income you’ll want to have left over for things like entertainment, vacations and contributing to an emergency fund.
Life Events Test: Life isn’t predictable. Take your cash flow test and try a couple possible scenarios. For instance, what happens if you were to lose your job? What if you buy a second car? What if you decide to have children or go back to school? How long would you be able to afford your housing costs in these scenarios?
Building in an affordability buffer is an important part of determining the suitability of any potential new home, to help ensure that you will not struggle with payments in the event interest rates rise or other costs emerge. Any good mortgage broker will work with you to determine an appropriate buffer, and if you have a financial advisor, he or she can provide helpful guidelines as well.
If you discover that there is a significant gap between the type of home you want and the type of home you can reasonably afford, you may benefit from speaking with a financial professional for a more detailed strategy. To start, here are some general recommendations for getting yourself financially on track:
- Pay down high-interest debt and avoid taking on new debts.
- Pay all your bills in full and on time.
- Try to maximize stability and reliability in your employment — this could mean seeking full-time work from a temporary or part-time position.
- Alter your budget and set out savings objectives each month.
- Decide whether you want to participate in the Home Buyers’ Plan and ensure you’re putting enough funds into your RRSP.
- Try to avoid major purchases that involve hard hits on your credit and significant changes to your debt ratios.
- Start Step 2 again with a lower price target for a home. Consider a different location or housing type and run your stress tests again.
Step 3: Get a Mortgage Pre-Approval
By this point, you’ve done a fair bit of homework on your own, but it’s time to start talking to mortgage professionals to get a better sense of what kind of home loan you can reasonably expect. First, there are two basic routes you can take: banks and mortgage brokers. Let’s take a look at each.
Most of us have existing relationships with banking institutions long before considering using them to finance a mortgage. It can be nice to deal with a familiar face, especially when you’re navigating unfamiliar decisions, and your bank may also be able to throw in extras, like waiving the fees on your home appraisal or offering seminars on homeownership.
Banks aren’t without their downsides, though. A bank representative can recommend only the products and rates offered by the institution. If you want to shop around for a lower mortgage rate, you can end up spending a lot of time reaching out to various institutions, not to mention potentially hurting your credit score with multiple credit checks in quick succession. Lastly, it’s not in your bank’s best interest to offer you its lowest mortgage rate right off the bat, which means you need to negotiate down to the rate you want in order to avoid paying more than you need to.
Your banker isn’t likely to tell you to go down the street to a competitor that offers a mortgage product that better suits your needs – but that’s essentially what a mortgage broker does.
A broker can help you save time and money by shopping the mortgage market on your behalf, for the type of mortgage that best meets your requirements at the lowest rate.
Because brokers aren’t tied to any one lender, and they have access to rates that aren’t available to individuals, and they can often get you a lower mortgage rate than you could otherwise obtain yourself, even if you went directly to that same lender. While there are some lending institutions that don’t deal directly with brokers, such as Tangerine, brokers still have access to the vast majority of the market and can let you know specifically which lenders they don’t work with.
Mortgage brokers also have the ability to consult with multiple institutions on your behalf without making multiple hard hits on your credit. They’re often more flexible when it comes to availability and remote communication, which makes the process more convenient for most first-time buyers.
So how much does using a mortgage broker cost? Here’s the best part – in most cases, it’s free. That’s because your broker is directly compensated by the lender once your mortgage is confirmed.
Pre-Qualified vs. Pre-Approved
Before you start looking at properties, it helps to have a general idea of how much you’ll be able to borrow from your lender. That’s why it’s a good idea to get pre-qualified or pre-approved for a mortgage, even if you’re still only considering homeownership.
Getting pre-qualified can be fairly simple. In some cases, you can do it online in less than 10 minutes. With some basic information such as your income, down payment size and debt summary, you can get an estimate for how much you may be able to borrow to buy a home – but while pre-qualification is helpful, it’s not written in stone. Your lender hasn’t yet verified the information you’ve provided at this stage, nor have they done a credit check.
If you’re at all serious about buying a home, it makes sense to skip the pre-qualification altogether get a mortgage pre-approval. Approach your lender, and they will ask you to provide some additional documentation (listed below). If it’s the institution you currently bank with, they will already have access to a portion of this information. Together with a credit check, this enables your lender to estimate the maximum amount you’ll be permitted to borrow, the conditions of the loan and the interest rate.
Typically a pre-approval also allows you to hold that interest rate for the next 90-120 days, so that if you apply for a mortgage in that time, you’ll get the interest rate quoted in your pre-approval even if rates have risen in the interim.
From here, you can determine the approximate purchase price of homes for which you can get a mortgage, and start house hunting with a more informed perspective.
However, there are a few important caveats to note about mortgage pre-approvals:
- A pre-approval involves a hard hit on your credit, so multiple applications can actually hurt your credit score. A mortgage broker can help you get the pre-approval you need without damaging your credit.
- A pre-approval doesn’t mean you’re guaranteed a mortgage. Once you’ve made a firm offer on a home, you’ll need to make a formal mortgage application and receive a mortgage commitment from your lender.
- Your pre-approval will state the maximum you could potentially borrow in the form of a mortgage, but this doesn’t necessarily mean you can afford a loan of that size in practical terms. Ensure you evaluate all relevant affordability factors before you start seriously looking for homes.
How Revolving Debt Impacts Buying Power
Revolving debt is debt you don’t have to pay off fully at one time. The most common example is a credit card.
If you’re carrying credit card debt, aim to pay it off before applying for a mortgage, because lenders want to see that you’re using less than 35% of your total available credit. For example, if your credit limit is $10,000, you should carry a balance of no more than $3,500 on your credit card at any one time. Some people lower their credit limit, hoping it will help their credit score, but this can have a negative impact if it puts you above the 35% credit utilization threshold. When you apply for your mortgage pre-approval, take a look at your credit card and line of credit balances and make sure you’re using less than 35% of the total available credit.
Forgetting the CMHC Fee
As mentioned previously, if your down payment is under 20%, your mortgage is classified as high-ratio. This also means that you’re legally required to buy mortgage default insurance through the Canadian Mortgage and Housing Corporation (CMHC). Don’t confuse this insurance with other forms of insurance, like home insurance or your bank’s mortgage insurance. This CMHC fee is intended to protect your lender, not you, in the event that you fail to repay your mortgage.
CMHC fees are added to your mortgage amount and are structured by tiers. For example, if you have a 5% down payment, you’ll pay higher fees than someone who has a 10% down payment for a property of the same price. These fees are thousands of dollars to start, and because they’re tacked on to your mortgage, you’ll end up paying much more in interest over the life of your mortgage.
Not Saving for Closing Costs
We’ll outline these costs in more detail later in this guide, but it’s essential to include estimated closing costs in your savings objectives. When you eventually want to finalize your mortgage, you need to have that cash available, and you don’t want those costs to come out of the money you intended to use as a down payment on your home.
When considering a mortgage pre-approval or approval, your lender will have a list of documents required. These can include:
- Personal identification, such as your driver’s license or passport
- Your most recent T4 slip
- Recent pay stub
- Proof of or a letter of employment
- Notices of tax assessment
- Bank statements (i.e. proof of capital for down payment and closing costs)
- Information on a gifted down payment (i.e. letter from parent stating amount will not be repaid)
- Information about other major assets, such as cars, cottages or boats
- Current rental documentation
- Debt statements, including credit cards, child or spousal support, car loans, lines of credit and student loans
Although you don’t need to provide this yourself, your lender will ask for permission to review your credit score and credit report. They will also double check all this information once you’ve made and offer on a home that’s been accepted. If everything is in line, then you’ll be able to finalize your mortgage at that point.
Step 4: Mortgage Decisions
Buying a home could be the single largest financial transaction of your lifetime, and you’re likely to carry this mortgage for many years to come, so it only makes sense to consider carefully your options for lenders, mortgage types and interest rates. Otherwise, you could be leaving hundreds if not thousands of dollars on the table in potential savings.
When you get your mortgage pre-approval, there are a number of questions you should ask your mortgage broker or lender. Now is a good time to decide what type of mortgage you want and how you want to pay it off. Not only will this help you save time and stress later on, but it will help you make more accurate calculations for the purpose of budgeting and house hunting.
Should I get a fixed or variable-Rate mortgage?
For first-time homebuyers, going with a fixed-rate mortgage can make a lot of sense, because it means that the rate of interest you’re paying on your home loan will remain the same for the entire term, even if your lender’s rates change during that period. This can make budgeting and planning a little easier and more predictable.
But that security comes at a cost. Typically, you’ll pay a higher mortgage rate than that of a variable mortgage of the same term length. For instance, a 1-year fixed-rate mortgage will have a higher mortgage rate than a 1-year variable-rate mortgage, and a 5-year fixed-rate mortgage will likely be even more expensive.
It makes sense to opt for a fixed-rate mortgage, or “lock in,” if you anticipate mortgage rates will increase in the near future — but let’s face it, none of us has a crystal ball. Many homeowners choose this option simply for the peace of mind.
With a variable-rate mortgage, you’ll typically start off with a lower mortgage rate than the corresponding fixed mortgages, but that rate can change at any time.
Your mortgage rate is based on prime rate (the interest rate lenders offer their most creditworthy customers) plus a spread. For example, if prime rate was 3.20% and the spread was 0.6% (or 60 basis points), your mortgage rate would be 2.60%.
But what if your lender changes its prime rate? Although your mortgage payment amount would stay the same, less of your money will go towards principal and more of it will go towards interest, effectively lengthening your amortization period (the length of time it takes to pay off your mortgage). This means that if you want to stay on track, you’ll need to increase your mortgage payments whenever interest rates increase. Although you can lock-in your mortgage rate at any time, you’ll typically pay a premium in a rising rate environment.
On the other hand, if prime rate goes down, more of your money will go towards principal and less of it will go towards interest, effectively speeding up the length of time until you’re mortgage free without you having to put any additional money toward your home.
For this reason, variable-rate mortgages make the most sense if you anticipate mortgage rates will stay the same or fall. If there’s the possibility that you might have to break your mortgage, variable-rate mortgages can also make sense, since the mortgage penalty fees tend to be less costly than those of fixed-rate mortgages.
What are the cost of penalties?
When signing up for a mortgage, probably the last thing on your mind is breaking it, and yet over half of Canadians with five-year fixed-rate mortgages break them before the end of term.
The reality is that you could find yourself out of work for a period of time and unable to make your mortgage payments, you could get sick (that’s why disability insurance is so key for homeowners), you could decide to sell your home earlier than planned, or you could decide to move to a different lender to get a better mortgage rate. Whatever the reason, if you need to break your mortgage you may be required to pay a mortgage penalty. Penalties for breaking your mortgage or paying it out early can add up to a significant amount, so it’s a good idea to be aware of the cost now, rather than being blindsided by it later on.
The penalty you’ll pay depends on your mortgage type. If you have a variable-rate mortgage, it’s simple – you’ll pay three months’ interest. With fixed-rate mortgages, however, you’ll pay the greater of three months’ interest and something lenders call the Interest Rate Differential. The formula is a little complicated, but essentially, lenders calculate your mortgage penalty based on current interest rates. Some lenders use the more lenient discounted rate, while others use the lofty posted rate. Find out which one it is before signing up, as the difference can be substantial.
What are my pre-payment options?
A mortgage prepayment is any amount of money you put toward your home that’s over and above your minimum required mortgage payments.
For most homeowners, it makes sense to make prepayments in order to pay down your mortgage early. However, if you have high-interest debt, such as credit card debt, it’s likely best to pay that down first, while making no more than the minimum payments on your mortgage. You may also choose to invest rather than make mortgage prepayments if you can get a higher rate of return, but many prefer to go with the guaranteed rate of return that paying down your mortgage offers.
What makes prepayments so powerful is that unlike a regular mortgage payment that’s split between interest and principal, 100% of prepayment funds go toward principal, which can help you save thousands in interest over the life of your mortgage. Also keep in mind that the more you prepay, the lower potential mortgage penalties become, the shorter your mortgage amortization period gets, and the more flexibility you have with respect to lowering monthly mortgage payments.
Most lenders let you make scheduled additional payments on your mortgage, to double up or increase the size of your monthly payments, and to contribute lump sums whenever you have the funds available. However, they will have limits on the amount you can pay as a lump sum, which is typically between 10-20%, and may have rules about when and how often you can prepay. Ask your broker or lender what your options are and go from there.
Which payment frequency should I use?
Similar to mortgage prepayments, payment frequency has an effect on how quickly you pay down your mortgage and how much total interest you pay. Typically frequencies are monthly, semi-monthly, biweekly and weekly. There are also accelerated versions of each payment frequency, which significantly change the rate at which you can pay off your home loan.
Most buyers choose to align payment frequency with their paycheck schedule (ex. if you get paid biweekly, choose to pay your mortgage biweekly as well), and many select the accelerated option in order to save on interest costs. Ask your broker or lender for more information about which option is best for you.
Is this mortgage portable?
As its name suggests, a portable mortgage is one that you can take with you should you decide to move to a new home. This means even if you decide to sell your home and move to a new one, you can keep your current interest rate, avoid paying penalties for breaking your mortgage and avoid early repayment charges.
Although most fixed-rate mortgages are portable these days, most variable-rate mortgages are not, so it’s a good idea to ask your lender ahead of time, and to find out if there are restrictions. For instance, from start to finish you’ll have somewhere between 30 and 120 days to finalize the closing of your current mortgage and the switch to your new one, though this varies.
Porting your mortgage means you’re carrying over most or all of the conditions of your current mortgage to your new one, but despite this continuity, the process is still essentially an application for a new home loan. As such, you’ll need to provide certain documentation and complete certain steps in order to prove you’ll be able to afford your new home.
If the move results in a larger loan, as it often does, many lenders will let you “blend and extend” your mortgage. This means they’ll find a middle ground between the interest rate and conditions of your current mortgage and your new one.
Should I get mortgage life insurance?
Lenders are required to offer you mortgage life insurance when signing up for a mortgage, and if you’d like to forgo this step, you’re required to sign a waiver to pass on the coverage. Now is a good time to decide whether or not you want this added cost on your mortgage.
The main purpose for this type of insurance is that if you or your spouse were to pass away suddenly, your lender will pay the remainder of what you owe on your home. They may also cover up to five years of accrued interest and any unpaid property tax amounts as part of the death benefit (if you chose to pay your property taxes through an account at your lender).
There are two main types of mortgage life insurance: (1) your lender’s mortgage creditor insurance and (2) third-party insurance. The coverage will be very similar between the two, but in most cases, there is a clear advantage to choosing a third-party insurance policy: If you ever decide to switch lenders, your mortgage life insurance coverage would come with you, whereas if you were to have your lender’s mortgage creditor insurance, you’d have to take out a new policy at your new lender.
One key benefit of mortgage life insurance is that it provides immediate coverage. If you don’t have any coverage at all, or the insurance you do have isn’t sufficient to cover the balance on your mortgage, it’s a good idea to sign up for it, and simply opt out once you’re otherwise insured.
Step 6: Find a Home
At this point, you should have a good idea of what kind of home you can comfortably afford and what kind of mortgage you’ll be able to obtain. It’s time to start house hunting, and the best way to start is to take stock of your professional network. Make sure you have the right professionals by your side, because waiting too long could push you off track at a critical time.
Enlist the Right Professionals
Real Estate Agent: Not everyone in the market for a new home hires a real estate agent or realtor, but as a first-time buyer you’ll likely find it helpful. It’s the seller who pays commission to a real estate agent, so many first-timers choose this option because they can get good advice at virtually no cost. An experienced agent may also be able to give you the inside scoop on new listings not even posted online yet.
If you do choose this route, you’ll want to hire one who is familiar with not only the property type you’d like to buy (condo, townhouse, house, etc.), but also the neighbourhood in which you want to live. Much like finding a home, in order to find a qualified realtor, ask family and friends, watch for lawn signs and open houses, stop by a neighbourhood brokerage and explore multiple options before making a decision.
Real Estate Lawyer: A lawyer is absolutely essential to the process of closing on the sale of a home. It’s best to form this professional relationship early in the house hunting process, so that you won’t be scrambling later on. It’s also best to use a professional who specializes in real estate. Search online for lawyers in your area, or get a referral from your realtor or family and friends.
Home Inspector: As we’ll discuss later on, most homebuyers include a home inspection as a condition on an offer to purchase a home. This is something you’ll have to arrange yourself if that offer is accepted, so it’s good to be prepared. Your realtor should be able to refer one or two local home inspectors that have credible track records and systematic processes for inspecting every inch of your potential new home. Ask to make sure they check for moisture and signs of mould.
Mortgage Broker or Lender: As explained in the previous section, you can go directly to a lending institution (such as a major bank) in order to apply for a mortgage, or you can enlist the help of a mortgage broker, who will deal with lenders on your behalf. Either way, you should have this relationship in place before you begin seriously looking at homes.
Your Personal Checklist
You don’t want to buy and sell homes too frequently, not least of all because of the closing costs you’ll incur, so it’s best to find a home that will suit your needs for at least five years. Creating a checklist is one of the best ways to help ensure this happens.
Begin your checklist with the most important things you’re looking for in a home. These are the qualities and features that you absolutely cannot live without, so setting them in stone will immediately narrow down your field of search — and it’ll help your real estate agent present you with suitable options.
Location, Location, Location: They say the three most important rules when buying real estate are location, location, location — and that’s no joke. Sit down with your partner and map out an area that makes sense for both of you. Consider the proximity to work, friends and family. Will you be able to get where you need to go, or will this be an ongoing problem?
Condo vs. Townhome vs. House: Choosing the right property type largely depends on two factors: your housing budget and family size. Typically the lowest-priced home type in a given area, condominiums come with less responsibility, and condo fees tend to protect you from sudden major costs. Still, some condo owners are held to strict rules, and others are faced with unexpected expenses like fee hikes or special assessments.
A townhouse is good middle ground between a condo and house, offering more privacy and space than a condo, at a lower price point than a house. Similar to a condo, certain types of townhomes have association fees that go toward maintaining the grounds. A house will offer you the most freedom of all home types, but it’s more home to maintain and more expensive to finance. You won’t have maintenance fees, but you’ll pay more in property taxes, utilities and home insurance.
New vs. Resale: A newly built home allows you can customize everything right down to the countertops, and it’ll all be brand new when you move in. However, new homes can take several years to be built and there are often delays. You may not have repair bills, but you could be faced with additional costs like fences, landscaping or customizable features. Also, a lot of builders require buyers to make down payments on a prescribed schedule — typically in installments leading up to move-in day — so keep this in mind as it may affect your plans for getting your finances in order. Newly built homes tend to be slightly more expensive on average than resales, there is little flexibility on purchase price, and you’ll need to pay GST/HST.
Likewise, resale homes have their pros and cons. While you’re likely buying in an established neighbourhood, with public transit and other conveniences at hand, you also have to accept that, for better or worse, the home has been lived in by other owners. Previous residents may have made alterations you dislike or let aspects of the property fall into disrepair. That being said, you can factor in these considerations when bidding on the property, and even include certain repairs or changes in your conditions. Resale homes offer more certainty with respect to closing dates, more flexibility on terms, and the added bonus of avoiding GST/HST.
Neighbourhood Necessities: Include in your must-have checklist elements of the neighbourhood that your lifestyle demands. Is there an elementary school within walking distance? Do you have specific health care or mobility needs that require you to have certain resources nearby?
Consider features of the surrounding area that may affect your ability to sell your home later on. If there’s a highway, railway or airport nearby, you may be able to get a good price today, but you could have a hard time finding buyers down the road, especially if you happen to be selling in a slow market. Even features that you think of as positive could end up driving the price down if you eventually decide to move — so just because you like living beside a golf course, doesn’t mean other potential buyers will.
What about the people who could end up being your neighbours. Is it mostly single-family homes, or high-density rental units? Does it seem quiet or lively? While you’re at the home for a viewing or open house, you may want to talk directly to one of the neighbours. Most people are willing to answer a question or two, and to let you know of any notable issues. Ask your realtor about other considerations in this respect.
Secondary Suite: Renting out a room or a full apartment in your home can be a great way to pay down your mortgage sooner — when it’s done right. Some homes have been built or augmented to have a secondary suite in one segment of the home. Others require a bit more work, such as installing a kitchen or bathroom. Figure out if you’re cut out to be a landlord and budget for any renovations you’ll need to make the home attractive for tenants. Also, do your homework and find out the regulations surrounding rentals in your community. Deciding to rent out part of your home will significantly affect your financial parameters, so make this choice early on and put it on your must-have list.
Number of Bedrooms: This is often the first or second feature highlighted in the description of a home for sale. Decide on a minimum number of bedrooms, and try to ensure this will accommodate you for at least a few years. If you’re planning on making your family bigger, it may not be a good idea to buy a one-bedroom, because the costs of starting this process all over again in a couple of years could negate any financial gain you think you’ve made.
These are the features you want in a home, but don’t necessarily require. Be flexible – this part of your checklist will help guide you as you search for homes, but if you’re looking for a property that meets every single one of your specifications, you could be looking for a very long time. There are countless items that could appear on a nice-to-have list, but here are a few to get you started.
- Parking situation
- Age of home
- Specific upgrades
- Lot size
- Deck or patio
- Sun exposure
- Proximity to major road
- Open-concept design
- Flooring type
- Garage entry
- Finished basement
- Street type
House Hunting Resources
With your checklist in hand, it’s time to start looking. If you’re working with a real estate agent, he or she will send you listings that meet your must-haves, arrange viewings and keep an ear to the ground. Otherwise, there are lots of other ways you can stay informed as to what’s coming on the market.
MLS: MLS is short for Multiple Listing Services. Your agent should set up a search on the MLS website for properties that meet your needs, but it doesn’t hurt to browse the website on your own as well. This is also a good way to get a sense of what’s on the market without having to go to each listed home in person.
Family and friends: If you’re thinking of buying a home, tell everyone you know: your family, friends, coworkers – so that if someone near you is putting their home on the market, you can be the first to know, and could have a leg up on others who may consider putting in an offer.
Lawn signs: Keep your eyes peeled for properties with “for sale” signs on their lawn. If you see a property that you like, you can inquire about it further with your agent and schedule a showing or drop in to an open house. This is also one of the few ways you’ll come across For Sale by Owner properties, which aren’t listed on the MLS website.
Builders: Builders can let you know about projects nearing completion and those in the pipeline. They advertise new developments that, once available, are sold on a first-come-first-serve basis, so search online, watch for signs in your neighbourhood and call up known builders directly to learn about upcoming projects.
Social media: Facebook isn’t just for socializing with your friends. Follow agents who operate in the neighbourhood in which you’re looking to buy, and you might just come across a home that has everything on your checklist.
Step 6: Make an Offer
Once you find a home you’d like to call your own, it’s time to make an offer. Chances are you aren’t the only one who’s interested, so you need to put careful consideration into this step.
Setting the Right Price for Your Offer
The price is the first decision you’ll have to make. Your realtor can help you settle on an initial offer price, but you’ll likely consider factors like recent sales in the area, list price, potential renovations required, and (as best you can tell) how much interest there seems to be in the property.
Setting an appropriate price also depends on the current market, as there are three general types: buyers’, balanced and sellers’. In a buyers’ market, sellers outnumber buyers. As such, buyers have more negotiating power. They’re able to include more conditions and offer lower prices. In a balanced market, sellers and buyers are on relatively even footing. Home prices tend to increase at the rate of inflation, and buyers and sellers are equally able to negotiate a fair price.
In a seller’s market, buyers outnumber sellers. As such, home sellers call the shot. Since there are many buyers competing for a limited number of homes, multiple offers are a lot more common. This puts pressure on home prices, which typically increase well above the rate of inflation. In situations like this, make your best offer first, because a lowball offer could cost you the home you want.
When you submit an offer, you’ll also have to decide which conditions (if any) you’re going to include. Common conditions are home inspection, financing, and urgent repairs, although you can include a condition for just about anything.
The main purpose of conditions is to protect you, the buyer. For example, if you do a home inspection and find something major like termites or structural issues, it lets you work with the seller to attempt to remedy them – and in a worst case scenario, it gives you an out so that you can walk away from the deal.
A condition of financing is also worthwhile to include, especially for first-time homebuyers. Once you make an offer, your lender does an appraisal to confirm its value. If the appraisal comes in under your purchase price, you’ll need to make up the difference. If you don’t have the money and decide to walk away from the deal, not only do you risk losing your deposit, you could get sued by the seller and his or her realtor. This condition also helps protect you in the event you aren’t approved for a mortgage.
Although not conditions, it’s common to ask for multiple walk-throughs of the property, and for the home to be in broom-swept condition upon closing.
In bidding wars, it’s common for buyers to make subject-free or clean offers. A clean offer is one that doesn’t have any conditions — even financing or home inspection. While this may make your offer more attractive to the seller, it exposes you to the risk of being committed to a home without having the proper financing in place, or buying a home with problems like mold or infestations, that an inspection would have brought to light.
Another benefit of working with a realtor is that he or she will help you put this offer together and will present it to the sellers.
If you’re buying a newly built home, the offer process is slightly different. You’ll make an offer directly to the builder. Although there isn’t likely to be a bidding war on a new home, there also isn’t much room for negotiation as there would be with a resale property.
Once Your Offer is Accepted
You’ve made an offer and it’s been accepted — that’s a big step, but you’re not out of the woods yet. Here are the main items that need to be cleared up between the day your offer is accepted and the day you close on the property.
Pay Deposit: When the seller decides to accept your offer, you’ll both have to sign the sale contract and you’ll be required to pay a deposit to show your commitment to the deal. The amount can vary greatly, anywhere from a few hundred dollars to 5% of the purchase price of the home, but in any case, this money will go toward your down payment when the deal closes — it’s not an added cost in that sense. The details of the deposit will be outlined in the sale contract, but buyers often have 24 hours to pay.
Complete Home Inspection: If you included any conditions in your offer, get them cleared up as quickly as possible. You’ll want to contact your home inspector and schedule an inspection right away (it’s a good idea to have a backup home inspector in case your first choice is out of town). If they discover any significant problems, you’ll have to work with the seller to determine an appropriate course of action.
Finalize Mortgage: If you’ve made your offer conditional on financing, you’ll want to clear that up as well. If you were smart and got a mortgage pre-approval, it’s time to finalize the deal with your lender.
Your lender will order an appraisal to confirm the purchase price of the home is in line with its market value. If it comes in the same, you can breathe a sigh of relief. If it comes in less, you’ll have to make up the shortfall; this often happens when buyers get carried away in a bidding war. Although some lenders pay for the appraisal, you’ll more than likely have to pay for it out of pocket.
Your lender will also want to make sure nothing has changed with your finances since you were pre-approved. They will verify your income and down payment to make sure you’re still employed and still have the funds needed to purchase the property. They may also request a fresh credit check to make sure nothing major has changed (hint: try to avoid making any big purchases on your credit card, such as furniture for your new home, before the deal closes. This could affect your credit score, debt ratios and savings to an extent that your mortgage approval is jeopardized).
Contact Real Estate Lawyer: Once your lender approves your mortgage, you’ll want to contact your real estate lawyer, who does a lot of the important work behind the scenes to ensure your deal goes smoothly. Your lawyer will make sure your home’s title is clear from defects and liens, purchase title insurance, register the home in your name, prepare the statement of adjustments, calculate the land transfer taxes, prepare the mortgage paperwork and, last but not least, give you the keys to your new home. If you’re buying a condo, you’ll want to have your real estate lawyer review the status certificate to make sure the finances of the condo are on the level.
Walk-Throughs: As mentioned earlier, it’s a good idea ask for multiple walk-throughs when you make your offer. You can use these to do things like take measurements for furniture or show the home to close friends and family, but make sure you save your final walk-through for a couple days before your move-in date. That way you can see if any damage has been done to the property, or changes made that will affect the terms and conditions of the deal.
Schedule Move-in Day: If you have the flexibility, you may choose to schedule your move-in date one or two days after your closing date. Often deals aren’t fully closed until the end of the day, and you don’t want to be paying movers to stand in your driveway.
Step 7: Close on Your Property
The final hurdle to becoming a homeowner is the closing process. You’ll want to make sure everything goes smoothly at closing, because if one important step is missed, you may not be able to take possession of your home.
Paying Closing Costs (And Don’t Forget to Budget for Them)
Closing costs are often thought of as the hidden costs of real estate. While many buyers give little thought to them when preparing their finances, they are much more than a drop in the bucket. It’s important to put money aside to cover them, because the responsibility is yours and it can’t be negotiated away.
In case you’re not familiar with the term, as its name alludes, closing costs are the fees and disbursements paid to close a real estate deal. How much you’ll pay largely depends on where you’re buying, but the good news is that property virgins catch a break on some of these expenses.
Let’s take a look at some of the more common closing costs buyers face.
Home Inspection: The cost of an inspection usually depends on a number of factors, such as how many square feet the home is and the property type, but the average cost is around $500.
Real Estate Lawyer Fees: The amount of your real estate lawyer fees depends on the type of deal (ex. resale vs. new build) and whether you’re dealing with one of the big banks or a non-bank lender. To be on the safe side, budget at least a couple thousand dollars for legal fees.
Land Transfer Taxes: The land transfer tax is the fee you pay to your province to purchase a property. The amount depends on where you’re buying. For example, if you’re in the city of Toronto, you’ll have to pay a double land transfer tax – provincial and municipal. Luckily, as a first-time homebuyer, in most cases you’re entitled to a refund on most or all of this cost. Search for an online calculator to estimate what your land transfer taxes will be.
Here’s a summary of other common closing costs.
- Title insurance
- Appraisal fee
- CMHC insurance
- Adjustments in property taxes and utilities
- Development and education levies
- Utility hookups
Planning the Move
Your first major decision about your new home will be whether to move on your own or hire professionals. Generally, it’s worth it to hire movers only if you have a lot of belongings and don’t have many friends or family available to lend a helping hand. In that case, do you homework and ask for references to make sure you enlist a reputable company. If you decide to move on your own, it can be as inexpensive as renting or borrowing a truck and ordering pizza for everyone.
In the weeks preceding your moving day, you’ll want to get rid of as much clutter as you can. Anything you don’t want, consider selling it at a garage sale or online on eBay, Craigslist or Kijiji. Anything you’re not able to sell, donate to charity. This will make moving day much easier.
Take some time to plan your move, because there are always last-minute details that will occupy your time leading up to closing day. Pack one room at a time and make sure you’re well prepared. Be sure to get boxes, tape and other materials you’ll need for your move.
The typical home takes about 30 to 90 days to close. This will be specified in your offer. About a week before your closing date, you’ll have one final meeting with your lawyers to finalize the deal and sign your mortgage paperwork. Make sure you read everything you’re signing carefully. If there are any mistakes, you’ll want to speak up now (for example, you could have chosen biweekly mortgage payments, but they’re set up as monthly).
In order for your real estate deal to close, you’ll need to deliver a certified cheque to your lawyer for the remainder of the down payment (i.e. your full down payment, minus the deposit you’ve already made). Once the home is registered in your name, you’ll receive a call from your lawyer letting you know the deal went through and you’ll drop by to pick up the keys to your new home. When you first enter the home, take another look around to ensure there is no undisclosed damage or other issues — if there are any, you’ll want to draw attention to them right away.
If not, now you can really celebrate. You’re officially a homeowner!
Taken one step at a time, becoming a homeowner is a surmountable goal for anyone determined to achieve it.
By setting yourself savings goals, taking advantage of government programs like the Home Buyers’ Plan, and making key decisions with respect to your mortgage, you could get there even sooner than you thought possible.
As our final piece of advice for those looking to buy: we can’t emphasize enough the importance of working with the right professionals at every step — a realtor, real estate lawyer, home inspector and an experienced mortgage broker. Taking the time to find suitable experts will not only help you expedite the process of buying a home, but it will also help ensure you experience all the benefits that made you want to buy a home in the first place.
Remember that buying property isn’t just an event; it’s the beginning of an important era in your life. Once you become a homeowner, you’re likely to stay one for a very long time — if you start out with a good mortgage broker, you’re setting yourself up to save thousands and thousands of dollars over the course of many years.
We warmly invite you to reach out to us for clarification on any aspect of this guide. We’d love to hear about your particular situation and to help set you off on the right path.