Getting the best mortgage financing for your first home
Most Canadians do not give this much of a thought. They go down to their local bank branch, apply, and are pleased when they are approved for a mortgage. The Canadian retail banking system is designed to make you feel safe and comfortable.
You can do better. For example, the default setting is a five-year mortgage term. This might be right for you. Or it might not be. You could belong to a large percentage of people who will need to make changes in less than five years. This could involve expensive penalties. On the other hand, you might choose a one year term. You will need to requalify for a renewal or new mortgage at the end of the year. This might not be convenient if your employment circumstances change. A standardized approach works if you live a standardized life.
Speak to a mortgage broker. This person probably has more experience than you do or the person who is waiting to greet you down at the bank branch. Usually, the mortgage broker’s service is free to you. There are many options and sources available for mortgages and it is the mortgage broker’s job to know what these are and help you choose. Typically, interest rates and mortgage features vary and are negotiable. Timing, fast or slow, can be essential in varying circumstances. The mortgage broker respects your privacy and the challenges that you are facing. There may be possibilities that you didn’t know existed.
Here are some basic things about mortgages. You should know the difference between amortization and term. Amortization is the period over which the entire mortgage loan is repaid. Choosing an amortization (15, 20, 25, or 30 years) is a trade-off. Longer amortization means lower payments. Shorter amortization means you pay off the mortgage more quickly and pay less interest.
The term of the mortgage is the length of time over which certain factors are fixed, such as the interest rate. Terms can range from three months to 10+ years. Choose carefully and get some advice based on your life circumstances and career path. Are you well-settled into a way of life and a steady career trajectory? Do you work on contract or have a permanent government position? What is your relationship status? Are you an anxious person or confident about the future?
Mortgages typically come with opportunities to pay them off more quickly, such as biweekly payments and lump-sum payments. You need to balance paying off your credit accounts with the need to keep cash on hand for emergencies and the ability to make regular payments. In normal times, we recommend a six-month emergency fund. In these uncertain times, if possible, extend this to a full year.
You are probably using all your resources, including family gifts, to purchase your first home. Your next priority needs to be restoring your savings and the goodwill of those who may have helped you. A quicker payment schedule is something to consider down the road.
Another distinction useful for first-time homebuyers is the difference between fixed-rate and closed variable-rate mortgages. With both of these, your regular payment amount stays the same. However, with the closed variable rate mortgage, the amounts applied to principal and interest change with prevailing interest rates. These variable-rate mortgages often have the advantage of lower rates. There tend to be lower penalties if you need to break the mortgage. On the other hand, you are on the hook if interest rates rise. There tend to be fewer prepayment privileges with variable-rate mortgages. Be sure to discuss fixed-rate and variable mortgages with your mortgage broker. They will be sure to have an opinion on this one. Again, there is no one-size-fits-all answer.
You can get the best financing for your first home when you are in a strong financial position. This may tempt you to wait for a day that is not coming any time soon. You do not need a million dollars in the bank and zero credit balances. A strong financial position means confidence and evidence that you can make your mortgage payments for the foreseeable future.
Financial institutions use ratios between your bills and ability to pay (debt-service), credit reports, and employment income information to determine your ability to make mortgage payments. Sometimes people fiddle with their mortgage applications to qualify. Not only is this illegal, but you are only asking for financial trouble. It is better to make a new plan than to fudge your mortgage application.
The Federal Government requires you to qualify at an interest rate that is the greater of the Bank of Canada’s five-year benchmark or their negotiated rate plus 2%. That rate today is 4.79%. This means that if rates rose to 4.79%, you could still make your mortgage payments.
You need a down payment to purchase a home. Your downpayment needs to be at least 5% of the first $500,000 in price, 10% for the portion of the price between $500,000 and $1 million. If you are so fortunate that your first home will be over $1 million, the required down payment is 20%. For a downpayment of less than 20%, you will require mortgage loan insurance from the Canada Mortgage and Housing Corporation (CMHC) or Genworth Financial Canada. The typical cost for this insurance ranges from 2.8% to 4.0% of the amount of your mortgage, and this amount can be added to your mortgage. The maximum amortization for an insured mortgage is 25 years.
This mortgage loan insurance for your financial institution is often confused with mortgage loan insurance for you. You will also want to insure your mortgage in the event you fall ill and are unable to make your payments for some time. Speak to your mortgage broker about this.
Downpayments can require some creativity! Your family can provide a gift. You can save your money. If you are a first time home buyer, you can withdraw money from your RRSP through the Home Buyer’s Plan without paying tax. You can withdraw up to $35,000 from your RRSP and apply it toward your down payment. If you have a spouse, they can also apply $35,000 of their RRSP to your down payment. Generally, the amount must be repaid over 15 years and the repayment cannot be claimed as a deduction on your tax return.
A strategy that works for many first-time homebuyers, is to use a TFSA to save their downpayment. This is easy and your withdrawals are tax-free and flexible. You can remove the funds without penalty and replenish them later. You may be able to put a lot more of your down payment in a TFSA than you can in an RRSP.
Along with the downpayment, you will need funds for your closing costs. You need funds for things like moving costs, legal fees and land transfer taxes. Your mortgage broker can help you with the calculations (1.5-4% of your purchase price).
This is an exciting time in your life and I hope this general information helps you to prepare for the purchase of your first home. If I can be of any assistance, please do not hesitate to contact me.