Before starting your home search, it is important to evaluate your financial situation, confirm your budget, familiarize yourself with mortgage options and secure pre-approval from your lender. This will help you conduct your search with confidence and negotiate your desired home successfully.
Establish Your Budget
As a general guideline, total monthly housing costs for your primary home, including mortgage payments, taxes, maintenance fees, insurance, interest charges and utilities, should not exceed 32 per cent of your gross monthly household income.
Many financial advisors also suggest that total monthly debt, including mortgage payments, credit card and car payments, should not exceed 40 per cent of your gross monthly income.
Those purchasing a real estate investment property should consult their real estate and financial advisor to understand tax and financial implications of their purchase.
If your down payment amount is less than 20 per cent of the total purchase price, you will need to purchase mortgage loan insurance that guarantees the debt against default. In most cases this will be added to the mortgage loan.
Check Your Credit Rating
Your credit report plays an important role in your mortgage approval process and in determining the interest rate and other loan terms a lender offers you. Before meeting with a potential lender, you may wish to confirm your credit rating so you have time to resolve any issues. Contact Trans Union of Canada: 1-800-663-9980 or Equifax Credit Information Services Canada: 1-800-465-7166 for more information.
Understand Mortgage Basics
Mortgage interest rates are fixed, variable or adjustable.
- Fixed: A fixed mortgage interest rate is a locked-in rate that will not change for the term of the mortgage.
- Variable: A variable rate fluctuates pending market conditions while the mortgage payment itself remains unchanged.
- Adjustable Mortgage Interest Rate: With an adjustable rate, both the interest rate and the mortgage payment change based on market conditions.
OPEN OR CLOSED MORTGAGE
- Closed Mortgage: A closed mortgage cannot be paid off, in whole or in part, before the end of its term. A closed mortgage is a good option if you’d prefer a fixed monthly payment and wish to predict your monthly expenses. However, because there are often penalties or restrictive conditions if you pay an additional amount, a closed mortgage may be a poor choice if you decide to move before the end of the term or if a decrease in interest rates is anticipated.
- Open Mortgage: An open mortgage is flexible. You can typically pay off part of it or the entire amount at any time without penalty. This may be a good option if you plan to sell your home in the near future or if you intend to pay off a large sum of your mortgage loan. Most lenders allow open mortgages to be converted to closed mortgages at any time, though often for a small fee.
- Amortization is the length of time the entire mortgage debt will be repaid. Many mortgages are amortized over 25 years, but longer periods are available. The longer the amortization the lower your scheduled mortgage payments, but the more interest you pay in the long run.
CONVENTIONAL VS. HIGH RATIO MORTGAGES
- Conventional Mortgage: A conventional mortgage is a mortgage loan that is equal to, or less than, 80% of the lending value of the property. The lending value is the property’s purchase price or market value —whichever is less. For a conventional mortgage, the down payment is at least 20% of the purchase price or market value.
- High-ratio Mortgage: If your down payment is less than 20% of the home price, you will typically need a high-ratio mortgage. A high-ratio mortgage usually requires mortgage loan insurance. CMHC is a major provider of mortgage loan insurance. Your lender may add the mortgage loan insurance premium to your mortgage or ask you to pay it in full upon closing.
- The term is the length of time that the mortgage contract conditions, including interest rate are fixed. The term can be from six months up to ten years.
- There are generally several term options for a mortgage and it’s important to weigh the benefits and costs of each. A longer term (five years, for example) may allow you to plan ahead and protect you from interest rate increases, but may not offer you flexibility, should interest rates fall.
Optimizing Your Mortgage
Work with your lender to optimize your mortgage payment schedule for your unique situation. Many primary homeowners aim to pay off their mortgages as quickly as possible, which can be achieved with more frequent installments. Your mortgage may also be structured to allow an increase in payments as cash flow permits, and there may be anniversary lump sum payment opportunities each year to be applied directly to the principal.
If you are purchasing real estate solely for investment purposes, other considerations such as tax implications come into play. Consult your real estate and financial advisor for assistance.
Get Written Pre-Approval
In markets where there is high demand and a low volume of the type of home you wish to purchase, written pre-approval is essential and will give you the competitive edge in securing your desired home. For example, in a scenario where a seller receives two similar offers, one accompanied by a letter that confirms financing pre-approval and another other without supporting documents, the former offer is frequently considered first.
Now that you’ve mastered this step of the buying process, read about what still lies ahead in the next chapter on Secure Financing.