Buying a house is arguably one of the most significant financial decisions that you will ever make. The upfront cost to purchase and maintain a home are simply nothing to sneeze at all.
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Further, buying a house comes with a lot of emotional attachment. A home tends to be aspirational and a representation of events and things yet to come. We form many family traditions and lifelong memories with loved ones in our houses.
As such, it is crucial to be well-informed before making this life-changing purchase.
1. Is homeownership right for you?
In many people’s minds, homeownership is a measure of financial success and stability, often regarded with the same reverence as graduating from a university program or even getting married. Buying a home is perceived to a big deal, and rightly so!
However, due to this societal pressure around buying a home, many people jump into it without carefully considering the benefits and risks.
Benefits of Homeownership
- Builds equity. A portion of a mortgage payment pays down the principal of your home, and the rest goes towards interest. The principal part builds your equity. Further, the value of your home will increase over time and could be an excellent long-term investment.
Find out whether renting is throwing out money here.
- Freedom and flexibility. As a homeowner, you are free to customize your residence to suit your needs and wishes. You can renovate, paint, own pets, and change floorings to your liking without seeking permission from anyone.
- Tax benefits. You may reduce your tax burden by deducting some of the expenses related to homeownership, including mortgage interest.
Risks of Homeownership
- High upfront and ongoing costs. Depending on where you live, you may be required to come up with more than a 20% down payment to buy a house. Once you have bought your home, you are further responsible for ongoing costs such as property taxes, utilities, and maintenance.
- Limited location flexibility. It can take a long time to sell your house should you need to move to a different location. Depending on the city, it could take months to find a buyer at the right price. This lack of flexibility can tie you down. It can also cost you a lot if you have to support two residences before selling your house.
- Potential depreciation. While houses typically tend to appreciate over time, this is not guaranteed, as with any investment. As was the case during the 2008-2009 housing crisis in the United States, your home can lose its value.
Learn more about renting vs. buying a home to determine whether homeownership is right for you.
2. Are you financially ready for homeownership?
The most significant deterrent to homeownership comes down to finances for most people. Coming up with the prerequisite down payment is often no small feat. And even after successfully acquiring a mortgage, the costs associated with owning a home can be significant.
If you are a first-time homebuyer, here are some primary financial considerations.
Get a loan pre-approval
A loan pre-approval is the first step in the home buying processing.
Pre-approval is when a potential lender determines the amount they can loan to you, and the interest rate they would charge you. There is typically no fee or commitment required for a pre-approval.
Reasons why you should get a pre-approval first
- To determine the maximum amount of loan that you qualify for and look for homes within your budget.
- Allows you to lock in an interest rate for a fixed amount of time, typically 60 to 120 days. This interest rate stays secure within this time frame, even if the general rates increase.
- To determine your mortgage payments, which is essential for budgeting purposes, and to get an idea of your expenses with a mortgage in place.
A mortgage pre-approval is not a guarantee that the bank will extend a mortgage to you. Your potential lender still has to assess your house’s price and condition before granting you a mortgage.
So you may be wondering what the lenders consider when pre-approving you for a mortgage. Below are the key things that lenders will use to determine whether to extend a mortgage to you.
- Good credit score. A good credit score, 740 or higher, demonstrates to lenders that you are responsible with your credit and are likely to be a good borrower. Before requesting a pre-approval, it is a good idea to check that there are no mistakes in your credit score. Yes, there can be mistakes in your credit score reports.
- Proof of income. This proof may include two years of tax returns, pay stubs, letter of employment, etc. The lenders want to know that you have a consistent source of income.
- Bank statements. The lender may request a few months of your most recent bank statements to see the cash movements in your accounts. Bank statements will help the lender spot any irregularities such as large one-time deposits, frequent cash payments, etc.
- Cash reserves. Lenders will want to make sure that you have enough cash for the potential down payment. Additionally, the lenders will want to verify the source of your funds.
- Gross Debt Service (GDS) Ratio. This ratio refers to the amount of your monthly housing cost as a percentage of your gross monthly income. In Canada, lenders require your GDS to be less than 32%.
GDS = (Mortgage Payments + Property Taxes + Heating Expenses) / Total Monthly Income
- Total Debt Service (TDS) Ratio. This ratio refers to your whole debt load as a percentage of your gross monthly income. In Canada, lenders require that your TDS has to be less than 40%.
TDS = (Mortgage Payments + Property Taxes + Heating Expenses + Other Debt Obligations) / Total Monthly Income
A down payment is the initial upfront amount required by lenders when purchasing a house.
The minimum down payment depends on the purchase price of the house. Below is a general guideline on the minimum down payment requirements in Canada.
|Home Purchase Price||Minimum Down Payment|
|Less than $500,000||5% of the purchase price|
|$500,000 to $999,999||5% of the first $500,000
10% for the portion above $500,000
|More than $1,000,000||20% of the purchase price|
Note that your lender may require a larger down payment for various reasons, including a lower credit score, self-employment, etc.
Reasons why lenders require a down payment
- It demonstrates your commitment as a borrower. You have “skin in the game,” and therefore, less likely to walk away from the obligation.
- It protects the lender in case of a default. Should the lender foreclose on your home, they do not have to find the highest price for the house in a resale. They only need to sell the house for an amount sufficient to cover their investment.
Benefits of a larger down payment
- Avoid paying mortgage insurance. You are not required to have mortgage insurance when you make a down payment of greater than 20%.
- Obtain a lower interest rate. With a larger down payment, lenders can offer you more favourable interest rates as you are perceived to have lower risk.
- Smaller monthly mortgage payments. As you pay more upfront, you end up borrowing a smaller amount. This results in smaller monthly payments as well as lower interest expense overall.
- Future borrowing power. A more significant down payment results in a lower debt-to-equity ratio, making you more attractive to lenders in the future. Generally, carrying less debt makes you a less risky borrower.
Benefits of a smaller down payment
- A smaller amount of time is required to save. A smaller down payment will require less time to save, and you can get into the housing market sooner. Staying out of the housing market longer could put you against increasing housing prices as time goes by.
- To maintain a fully-funded emergency fund. With a smaller down payment, you can keep a healthy emergency fund in case of a rainy day down the road. When you use up all your resources for a down payment, it leaves you financially vulnerable if an emergency happens.
Types of Mortgages
There are two types of mortgage to consider:
1. Conventional Mortgage (Low Ratio): A conventional mortgage does not exceed 80% of the property value. This means that you will put down a deposit of more than 20% of your home’s value to qualify for a conventional mortgage.
2. Insured Mortgage (High Ratio): As required by law, if a lender extends a loan that exceeds 80% of the property value, the mortgage has to be insured. As such, if you put down a deposit of less than 20%, you will be required to take out mortgage insurance.
The mortgage insurance premium can be paid upfront as a lump sum or added onto your mortgage.
Other Upfront Costs (AKA Closing Costs)
First-time homebuyers often overlook closing costs. These costs range from 1.5% to 4% of the property’s value and can be quite significant. Closing costs include:
- Legal Fees: Lawyers coordinate the closing process, prepare the paperwork for title transfer, and transfer utility services to you. Legal fees vary a lot, and you may need to shop around to find the best offer. Generally, legal fees range from $1,500 to $2,000.
- Title Insurance: The lawyers will run a title search on your property and obtain title insurance to ensure you are the legal owner in the public registry. The lawyer will bill you this cost, which ranges from $100 to $300.
- Home Inspection Fees: A home inspection is not mandatory but highly recommended. The home inspectors check to make sure that everything is in proper working conditions. Home inspection is essential to avoid any unpleasant (and expensive) surprises later. Home inspection fees could range from $400 to $600.
- Tax on Mortgage Insurance: While mortgage insurance premiums do not have to be paid upfront, some jurisdictions will require tax on the insurance beforehand. For instance, the provincial sales tax (PST) in Ontario is 8%. If your mortgage insurance is $10,000, you’ll be required to pay $800 at loan closing.
- Appraisal Fee: The lender will request an appraisal of your property through a third party. The goal is to determine the property’s value and the amount that the lender will loan you. Note that the lender will not lend you more than the appraised amount (even if your offer is higher). Most of the time, the lender will cover the appraisal fee. This fee can range between $300 – $500.
3. The professionals you need when buying a home
- Real Estate professional: Getting the help of a licensed real estate professional is not mandatory but is essential for a first-time homebuyer. A real estate professional will help you to:
- Research the listings of various properties to identify the ones that suit your needs
- Obtain information on neighbourhoods that you may otherwise not know
- Plan site showings and set up appointments to fit your schedule
- Negotiate the offer and contract details
- Find other qualified professionals that you may need
- Lender: Few people can purchase a home with a 100% down plan. As such, you will most likely need to finance your home through a lender. There are many lenders in the market, so be sure to shop around for the best value. Lenders may include:
- Credit Unions
- Pension Funds
- Trust companies
- Brokers: they work with various lenders to find you the best rates
- Lawyer: You will need legal expertise when buying a home to guide you through the following aspects:
- Preparation and review of legal documents such as purchase agreements, mortgage documents, title documents, and transfer documents
- Ensuring that utility accounts and property taxes on the property are up to date
- Make arrangements with your lender for funding of the lawyer’s trust account in preparation for closing
- Insurance broker: This is often a requirement by lenders before extending a mortgage. Homeowners insurance will safeguard your new home from disasters such as fire, burst pipes, theft, etc.
- Home inspector: A home inspection is essential to find out whether everything is working correctly. The home inspection findings can influence your decision to move forward with the purchase, renegotiate the sale price, or request repairs.
4. Factors to consider when searching for your new home
Searching for your new home is the most exciting part of the entire process. Going through open houses and viewing houses for sale with your real estate agent can be thrilling.
Below are some vital aspects to keep in mind during this process.
- Location: It is arguably the most critical aspect to consider when buying any real estate. While you could modify the house’s decorative elements, you cannot change the location after the deal is closed. As such, you need to consider:
- The commute times from the house to work, school, place of worship, etc.
- Neighbourhood noise
- Street traffic at various times of the day. The street may be quiet in the mornings but busy in the afternoons.
- Property type: The right property type will depend on various factors, including your budget, family size, needs, etc. Property types for consideration may include:
- Freehold: You would outrightly own the property, including the land.
- Condominium: You own the unit you live in and jointly share the ownership of common areas with other unit owners.
- Leaseholds: You may own the property but rent or lease the land it sits own. A government body typically owns the land. Leaseholds are common for townhomes.
- Lifestyle: Your lifestyle will influence many aspects of your search. Lifestyle factors may include:
- Whether you have children or planning to start a family soon
- How you enjoy spending your spare time. Do you like to shop, eat out at restaurants, or spend time outdoors? Choose a location that supports your preferences.
5. Additional Home Costs
Beyond mortgage payments, there are additional costs that may catch a novice homebuyer off guard. These costs may include:
- Property Taxes: A property tax is based on your home’s assessed value by a local government. It is an annual fee that can be paid as a lump sum or in instalments.
- Property Insurance: Your lender will require proof of property insurance before extending a mortgage to you. Property insurance protects against risks such as theft, fire, flooding, etc.
- Condo Fees: Every condo owner pays condo fees to maintain common facilities, including pool and lawn maintenance, snow removal, window washing, etc.
- Maintenance and Repairs: As a homeowner, you are responsible for the ongoing maintenance and repairs in your home. Repairs and maintenance may include roof repair, water heater repair, foundation repair, deck repair, etc.
- Moving Costs: It can be expensive to hire professional movers and packers to ease your moving process. Even if you decided to do it yourself, moving costs could add up fast. Moving costs may include temporary lodging, eating out, packing material, moving track rental, utility connection fees, and new furnishings.
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“Perfection is not attainable, but if we chase perfection, we can catch excellence.” ~Vince Lombardi
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