You just saw your dream home on realtor.ca – and you want it – now! You call up the listing realtor only to be told it’s already sold conditionally to another buyer. How did they act so fast? That buyer already had a plan in place, and were likely shopping many months before you were – key steps such as building a savings and securing a mortgage take time and effort; and it can be years before you’re ready to buy. In a hot real estate market, it’s tempting to jump right in and start shopping, but without a plan in place, you’ll end up disappointed.
Home buying is beyond looking at window coverings and wrap around porches – it’s a dollars and cents procedure driven by what the bank or mortgage company will allow you to spend (or what you’re comfortable paying monthly). It’s an investment that hopefully will set you up for many years to come.
Your goal is to have adequate savings and get a mortgage preapproval that outlines your house price BEFORE you start shopping, that way when you do see your dream home you can put in an offer, safely knowing you have funds behind you.
Step 1 – save, save, save, and then save some more.
To buy a home you need money, and lots of it. To buy a secure a mortgage and buy a home, you need a down payment (consider it collateral against a loan). For a down payment under Canada’s new guidelines, you need minimum of 5 percent of your purchase price, plus closing costs. A standard down payment is 20 percent. Buyers are also expected to pass a financial ‘stress test’ to demonstrate the ability to afford their mortgage in the face of rising interest rates (i.e. you need to be able to pay your monthly mortgage payment even when calculated at a higher interest rate).
Borrowers with low down payments will require insurance on their loan. High risk borrowers can expect to require a significantly higher down payment, and higher interest charges (if they qualify for a mortgage at all).
One key point on securing a mortgage is a calculation called PITH (the sum of monthly Principal, Interest, Property Taxes, and Heating costs), which also include annual site lease and 50 percent of available condo fees, if applicable. To demonstrate you can afford a mortgage, PITH should not represent more than 32 percent of your gross household income. The more money you put down, the lower your monthly mortgage payments, and the lower your total loan costs, and the more likely you can actually afford your new dream home.
To breakdown numbers, for a 20 percent down payment for a $300 000 home, you will need $60 000 available cash as a down payment. For closing costs, factor in an additional 1 to 4 percent (up to $12 000), depending on your lender, lawyer, any prepaid taxes and utilities, and if you’re eligible for property tax rebates.
I’ll give you a moment to get up off the floor.
Instead of waiting for an inheritance or benevolent handout, some strategies for saving this kind of cash include working a second job (see my post about a side hustle over here), and for two income families, living off one pay cheque and banking the rest, or everybody in the household working some kind of side gig and generally going crazy, but raking in the dough.
What to do with this money:
Rather throwing all your hard earned cash into a basic savings account and earning very little interest, consider using a TFSA (Tax Free Savings Account) keeping in mind government rules around maximum contribution and withdrawals per tax year) or an RRSP. Putting your money into an RRSP allows growth with exposure to the stock market and access to your money through the First Time Home Buyer’s Plan (be sure to tell your financial planner your intent to withdraw the funds to purchase a home, this will enable them to select a portfolio with reduced risk given the shorter investment period), and help you set up accessing your funds for purchase using the Home Buyer’s Plan. The only caution is the money NEEDS to be in your RRSP for at least 90 days before withdrawing it, so time your purchase accordingly.
Although there’s some tricky rules and regulations around RRSP/TSFA use for home purchase, they offer more flexibility than GICs (which have fixed maturation dates, meaning you cannot access your money before the investment term is up; a strategy that stops you from spending, but limits your options when you need money to buy your dream house – now!)
Where does all this money go? Not to directly the seller, and aside from a small amount (a couple thousand) to the real estate company to be held as a deposit, but into your lawyer’s hands, to facilitate the purchase of the home. The lawyer then purchases the house on your behalf, and transfers the funds to the seller.
A final thought on all this saving is to set up a bank account at an actual bricks and mortar bank (meaning real life), to be the account to which money from RRSPs, TFSAs, and any other savings will be deposited. In this era of exclusively online banking, there’s sometimes a delay in banks generating a certified draft or money order of your funds to put toward closing costs and down payment. With tight timelines, you don’t want to mess around.
A real life bank can process this kind of transaction in minutes as part of their regular teller services – not so with internet banking. You don’t want any additional stress or possible delay on the biggest purchase of your life, it’s nice to have a real life person face to face helping you with this transaction.
Step 2 – pay down your debt, build up you credit
Want a mortgage? You need good credit. Banks and other lenders won’t be able to offer you a mortgage or if they do, they will charge a significantly higher interest rates.
There are two companies that track and report your credit scores, Equifax and Transunion. Each uses slightly different criteria to evaluate your credit history, and may have different aspects of your credit history reported, and lenders may use either of them, so it’s in your both interest to check both.
Considering buying a house in the next year or so? Now’s the time to take a hard look at your credit report, and clear up any errors or omissions, and make sure your credit score is the best it can be. Pay bills on time, ensure you make the minimum payment on all debts, and that total credit card balances are less than half of maximum credit available.
Credit Canada is a fantastic source for information on credit, advice on improving your credit score, and will offer free counselling to help you improve your credit profile. Unlike other business to ‘help you improve your credit’ (aka loan companies masquerading as credit advisors) they are non-profit, and truly great people offering free, unbiased, and practical advice. Credit Canada will work in your best interest, not so for other ‘credit specialists’.
In terms of qualifying for a mortgage, your total debt load (Total Debt Service or TDS) should not exceed more than 40 percent of your gross household income – AND THIS INCLUDES PITH as 32 percent of your gross income already, leaving you with a meager EIGHT PERCENT (8%!!!) of your gross annual income for debt payments.
The breakdown for Total Debt Service is PITH + any annual site lease and condo fees + payments on all other debt. Canadian Mortgage Housing Corporation (CMHC) has some handy forms for calculating, and your mortgage specialist can guide you further, but the bottom line is PAY DOWN as much debt as possible, and DO NOT take on new major purchases, loans, or other forms of debt in the couple years or so before you want to purchase a home. No new vehicles, no lines of credit, no personal loans. Nothing. Just pay it down, and build up your credit.
Step 3 – assemble your team. Ask around for referrals to mortgage brokers, real estate specialists, financial advisors, and lawyers you’d like to work with. Consider even moving companies – in the rapid and stressful throes of buying a house and moving, it’s nice to know you have good people on your side.
Considering a move or relocation? Question? Comments? Concerns? I’d love to chat. Drop me at line firstname.lastname@example.org