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Are You Financially Ready?
Are You Financially Ready?

Are You Financially Ready?

How can you tell if you are financially ready to take the next big step to becoming a homeowner?

This step will help you figure out your current financial situation by using some simple calculations.  With this guide, you will be able to set the maximum price that you should consider for your home.

How Much are You Spending Now?

Calculate Your Household Expenses

Evaluate your present household budget.  How much do you spend each month?  By figuring this out, you are already on your way to figuring out your financial readiness because it gives you an idea whether you can afford to be a homeowner.

To get a realistic look at your current monthly expenses, you can use the Current Household Budget worksheet or you may also use the CMHC Household Budget Calculator.

Calculate Your Monthly Debt Payments

Do you know how much debt you owe?  How much do you spend each month paying these off?  These are two of the top questions that mortgage lenders will ask from you once you’re decided to be a home owner.  The answers to these help in figuring out if you are financially ready.

Calculate Your Total Monthly Expenses

Your total monthly expenses are your household expenses plus your debt payments.
The total in the Current Household Budget as Homeowner form
+ The total in the Monthly Debt Payments form
          Total Monthly Expenses
Or simply, you may use the form below:

How Much Can You Afford?

I can’t stress out enough how important it is to know first how much you can afford to spend on owning a home.  It is the first thing you need to know before shopping for a home.  In addition to that, you’d have to make plans on the different unavoidable expenses related to homeownership.  This includes, heating system, property taxes, maintenance and other required renovations.
What is Housing Cost?  Also known as PITH — Principal, Interest, Taxes and Heating.  These are your monthly mortgage payments (principal and interest), property taxes and heating expenses. 
There are 2 simple rules to help you figure out how much you can “realistically” spend for a home.  Knowing these will help you understand if you will qualify for a mortgage.

Affordability Rule 1

Your monthly housing costs should not exceed 32% of your gross monthly income.
Gross Debt Service (GDS) Ratio – the percentage of your housing costs’ total from your gross monthly income.  Note that this should be less than 32% of your gross household monthly income in order to get approved for a mortgage.

So if you’re considering to buy a condominium or leasehold tenure

Condominium – PITH also includes half of the monthly condominium fees
Leasehold Tenure – PITH includes the entire annual site lease.

Affordability Rule 2

Your entire monthly debt load should not be more than 40% of your gross monthly income.
Total Debt Service (TDS) Ratio:
Your entire monthly debt load includes your housing costs (PITH) plus all your other debt payments (car loans or leases, credit card payments, lines of credit payments, etc.). You have calculated these on the Monthly Debt Payments form.
Fill in the tables below to determine your GDS and TDS ratios.

Your Maximum House Price

The most important factors in considering the maximum house price that you can realistically afford depend on the following:

  1. household gross monthly income
  2. your down payment
  3. the mortgage interest rate

For most people, especially the first-time home buyers, the hardest part is saving the necessary down payment.

Calculate Your Maximum House Price

To help you figure out the maximum price you can afford for your home, the maximum mortgage amount you can borrow, and your monthly mortgage payments (including principal and interest), you can use the Mortgage Affordability Calculator below.

  1. Interest is compounded semi-annually - not in advance. The interest rate is fixed for the term of the mortgage and is usually renegotiated at the end of the term of the mortgage.
  2. Minimum down payment may vary.
  3. These calculations are approximate. They do not account for the payment of CMHC Insurance Premiums, applicable sales taxes, closing costs, or other fees that may be required.

Mortgage Loan Insurance

Mortgage loan insurance helps protect you as a lender against mortgage default.  This will also help you purchase homes that have a minimum down payment of 5%— with interest rates comparable to those with a 20% down payment.

The CMHC Mortgage Loan Insurance premium is calculated as a percentage of the loan and is based on the size of your down payment. This simply means that the higher the percentage of the total house price/value that you borrow, the higher percentage you will pay in insurance premiums. The savings that you get from lower interest rates offsets the cost for Mortgage Loan Insurance premiums.

What is Your Current Financial Situation?

Do Your Calculations Look Encouraging?

With all the calculations that you’ve done so far, are you confident enough to start the home-buying process? If the numbers look good, then you're ready to proceed with homeownership.

Do Your Calculations Look Discouraging?

Then you’d have to postpone your home-buying plans a bit.  You need to step back and make some improvements. 

Did your calculations show that you might have some difficulty meeting your monthly debt payments? If that's the case, you may find it difficult to get approved for a mortgage.

Here are some ways to improve your situation:

  • Pay off some loans.
  • Save for a larger down payment.
  • Check your current household budget and decide where you can spend less.  Each penny you save should go towards a larger down payment.
  • Lower your home price — your first home is not necessarily your dream home.

Other strategies that will help you:

  • Talk to a credit counsellor. He (or she) can help you figure out how to minimize your debts.
  • Consider getting a home through a rent-to-own program. Some builders or non-profit sponsor sometimes provide these schemes.
  • Find out about programs through which you can help build your own home.
  • Ask the housing department of your municipality if any special programs exist.

What Happens Next

Get a Copy of Your Credit Report

Lenders need to see how well you pay your debts and bills in the past before approving a mortgage. To do so, they will get your credit report from a credit bureau.  A credit report will tell them about your financial history and how well you use credit.

With this in mind, it’s best to get a copy of your own credit history before looking for a mortgage lender.  There are two main credit-reporting agencies: Equifax Canada Inc. and TransUnion of Canada. You can contact any of the two companies to get a copy of your credit report for a certain fee.

Once you receive your credit report, closely examine it to make sure that all information is complete and accurate.  Remember that no detail is insignificant. 

No credit history

If you don't have a credit history yet, start building one. For starters, you can apply for a standard credit card with good interest rates and terms. Once approved for a credit card, make small purchases and make sure that you pay these as soon as the bills come in.

Poor credit history

Poor credit decreases your chances of getting a mortgage loan. Lenders will think hard before giving you any.

You will have to re-establish a good credit history by paying off debts regularly and on time. Most unfavourable credit information (including bankruptcy) drops off your credit file after seven years.

You may also consider getting credit counselling or you may talk to your lender to discuss options.

Get a Mortgage Pre-Approval

Before you start your shopping, it's a great idea to get a pre-approved mortgage as many realtors will be asking if you've been approved. To figure the amount you can afford, a lender will look into your finances. He will then give you a written confirmation or a certificate for a fixed interest rate. This will be valid for a specific period of time. Keep in mind though that this is not a guarantee of getting approved for the mortgage loan.

Even if you haven't found a home that you would want to buy, having a pre-approved mortgage amount will help keep a good range in mind.

You'll need the following the first time you meet with a lender:

  • Your personal information, including identification such as your driver's license
  • Details on your job, including confirmation of salary in the form of a letter from your employer
  • All your sources of income
  • Information and details on all bank accounts, loans and other debts
  • Proof of financial assets
  • Source and amount of down payment and deposit
  • Proof of source of funds to cover the closing costs (these are usually between 1.5% and 4% of the purchase price)

Make Your Mortgage Work for You

Your lender or broker will give you several options to help you find the mortgage that best suits your needs. Some of the most common are:

Amortization Period

Amortization is the length of time you choose to pay off your mortgage.  Usually, mortgages come in 25 or 30-year amortization periods. But these can also be as short as 15 years.  The longer the amortization, the smaller the monthly payments.  However, remember that the interest costs increases as you prolong the amortization.  Total interest costs can be reduced by making additional (lump sum) payments whenever possible. 

Payment Schedule

It’s up to you if you how often you would want to repay your mortgage.  This can be monthly, bi-monthly or even weekly.  You also have the option to accelerate your payments.  This usually means one extra monthly payment per year.

Interest Rate Type

You need to choose between "fixed", "variable" or "protected (or capped) variable".

fixed rate will not change for the term of the mortgage. Although this type carries a slightly higher rate, it provides the peace of mind knowing that interest costs will remain the same.

variable interest rate fluctuates with the rate of the market. Normally, this does not change the overall amount of your mortgage payment, but rather changes the principal repayment – the portion of your monthly payment that goes towards interest costs or paying your mortgage. If interest rates go down, you end up repaying your mortgage faster. If they go up, more of the payment will go towards the interest and less towards repaying the mortgage. You should be prepared to accept the risks and uncertainty should you take this option.

protected (or capped) variable rate is almost the same as a variable interest rate but the maximum interest rate is already set.  So, even with the fluctuating market rate, your interest payment will not go over the maximum amount set.

Mortgage Term

The Mortgage Term is the period of time for which options, such as the interest rate, are chosen and agreed upon. It can be as short as six months or as long as five years or more. When the term is up, you can then renegotiate your mortgage at the interest rate by that time and choose the same or different options.

"Open" or "Closed" Mortgage

An open mortgage lets you pay off your mortgage in part or in full at any time without any penalties.  This will also let you renegotiate the mortgage at any time.  Although this option comes with more flexibility, it has a higher interest rate.  Open mortgage is a good choice for those who plan to sell their home in the near future or for those who would want to make large additional payments.
closed mortgage typically has lower interest rate without the flexibility of an open mortgage. However, most lenders nowadays allow homeowners to make additional payments of up to certain amounts without penalty.  This is why most people would select this type of mortgage.

 

Up-front Costs

Figure Out the Up-front Costs

There are many up-front costs in home-buying. Early planning ensures that things go smoothly.

Down Payment

A down payment is the part of the home price that must come from your own money as mortgage does not cover it.  A conventional mortgage will require you to make at least 20% down payment where as you can make a minimum of 5% down payment if you have a mortgage loan insurance from CMHC.

Deposit

Once you make an Offer to Purchase, you need to pay the deposit to show that you are serious buyer.  This deposit will form part of your down payment with the remainder owing at time of closing. If you back out of the deal for any reason without having covered yourself with purchase conditions, such as financing, home inspection, etc., your deposit may no longer be refunded and you may even be sued for damages.  The deposit amount varies. Your realtor or lawyer / notary can help you decide on the amount.

Appraisal Fee

Some mortgage lenders may require you to pay for a recognized appraisal to complete a mortgage loan.  An appraisal is an estimate of the value of the home.  The cost for this service which must be paid as soon as you contract it is usually between $250 and $350.
Having a property independently appraised before you make an offer is a good idea.  Doing so will help you determine the property’s worth.  Therefore, ensure that you will not be paying too much.
The appraisal should include:

  • Assessment of the property's physical and functional characteristics
  • Analysis of recent comparable sales
  • Assessment of current market conditions affecting the property

Ask your realtor or other member of your team to help you find an appraiser.

Mortgage Loan Insurance Premium

If your down payment is less than 20%, you have a high-ratio mortgage. In this case, your lender will need mortgage loan insurance.
Mortgage loan insurance lets you buy a home with as little as 5% down payment.  This is required by most Canadian lending institutions as it protects the lender.  If you, the borrower, defaults (fails to pay) on the mortgage, the lender is paid back by the insurer. You pay a premium for mortgage loan insurance. Your lender will either add the mortgage loan insurance premium to your monthly payments, or ask you to pay it in full upon closing.

Mortgage Broker's Fee

Applicable only if you have decided to use a mortgage broker. The mortgage broker will find you a lender with the terms and rates that will best suit you.

Home Inspection Fee

CMHC recommends that you make a home inspection a condition of your Offer to Purchase.
A home inspection is done by a qualified home inspector. The home inspector will provide you with information on the homes’ condition. It generally costs about $500.  But depending on the age, size and complexity of the house and the condition that it is in, it may cost more. For example, it may be more costly to inspect a large, older home, or one in relatively poor condition or that has many pre-existing problems or concerns.

Survey or Certificate of Location Cost

Another requirement that may be asked by the mortgage lender is an up-to-date survey or certificate of location. Even if the seller has a survey, but it is more than five years old, it will probably need to be updated.
A survey or certificate of location can cost $1,000 to $2,000.  To save yourself on costs, you should ask the seller to provide an updated survey, especially if there has been a new addition, deck or fence built close to the property line. Otherwise, you’ll have to pay for it yourself.
Remember, the seller must first agree before commissioning a surveyor to inspect the property. Ask your realtor to help co-ordinate this with the owner.

Title Insurance

You may opt to get title insurance.  Your lender, lawyer, or notary may even suggest this as it will cover loss caused by defects of title to the property.

Land Registration Fees

Land Registration fee is sometimes called Land Transfer Tax, Deed Registration Fee, Tariff or Property Purchases Tax.
Some provinces and territories may require you to pay this provincial or municipal charge once the sale is closed. These fees can cost a few thousand dollars, as it is based on a certain percentage of the property’s purchase price. To get the current rate, you can search the internet or better yet, check with your lawyer (or notary) or other team member.

Water Tests

If the home has a well, you will need to have the water tested to ensure that the water supply is adequate and the water is drinkable. You can negotiate these costs with the seller and list them in your Offer to Purchase.

Septic Tank

Septic tanks should be professionally checked to make sure it is in good working order. This can also be negotiated with the vendor and listed in your Offer to Purchase.

Estoppel Certificate Fee (does not apply in Quebec)

Also called a Status Certificate.  This applies if you are buying a condominium, or strata unit. It outlines a condominium corporation's financial and legal state. Could cost up to $100.

Prepaid Property Taxes and/or Utility Bills

Property taxes are charged by the municipality where the home is located. This is based on the home’s value. If in case the seller has already paid the property tax or other expenses that apply to the time after the house passes into your hands, you need to pay back the seller for taxes and other costs (including items like filling the oil tank).

Property Insurance

The mortgage lender requires you to have property insurance because your home is security for the mortgage. This will cover the cost of replacing your home and its contents in case of loss. Property insurance must be in place on closing day.

Legal Fees

Legal fees and other related costs must be paid on closing day. The minimum cost is usually $500 (plus GST/HST). Furthermore, your lawyer or notary will also charge you direct costs to check on the legal status of the property.

Other Costs

Depending on your situation, you may have some other initial expenses to consider:

  • Moving expenses
    Whether you'll be hiring a moving company, or renting a truck and asking friends for help, there are likely to be moving expenses.
  • Renovations or repairs
    Can renovations, or repairs, be delayed, or are some necessary to do immediately?
  • Condominium Fees
    Do you have to make the initial payment for these monthly fees?
  • Service connection fees
    Telephone, gas, electricity, cable TV, satellite TV, Internet, and so on, may charge service connection fees. Some utilities may ask you to pay a deposit.
  • Appliances
    Does your new home come with appliances? Do you already have your own?
  • Gardening equipment
    Will you need to buy gardening equipment, the first summer in your new home?
  • Snow-clearing equipment
    Will you need to buy snow-clearing equipment, the first winter in your new home?
  • Window treatments
    Do blinds, or curtains come with the house?
  • Decorating materials
    Do you want to re-paint or apply wallpaper? Do the floors need to be refinished or re-carpeted? Do you have all the tools you need for redecorating?
  • Hand tools
    Do you have the basic hand tools you'll need for your new home?
  • Dehumidifier
    Will you need a dehumidifier to control moisture levels?

Use the Home Purchase Cost Estimate form to help figure out your estimated up-front costs.