Buying your First Home: 101
Buying your first home is a milestone. On the one hand, it reflects how far you've come. On the other, it is an investment in your future. It is also likely the biggest investment you will ever make. Yet as exciting as it is, it can be overwhelming. When you're ready to start house hunting, keeping your finances in check should be at the top of your priorities and wish list. A little preparation will give you the best of everything–a home that is the right fit for you, your family, your future and your financial goals.
Here's a five-step guide to preparing your finances to buy your first home.
This will give you a good idea of what you can afford and what housing options are open to you. It will also help your realtor search out properties for you. The rule of thumb is that the total amount you borrow should not equal more than 2.5 times your annual gross income. It's important to keep in mind you don't need to use the full amount you've been approved for. Just because you can spend it, doesn't mean you should. You need to decide on the price you feel comfortable with.
- Understand the recurring costs aside from your mortgage.
There are many expenses involved in owning a home. Be sure to include property tax, condo fees and property insurance when you're setting your monthly budget. And don't forget that expenses for utilities may be higher than you're used to. Your monthly housing costs (mortgage payments, property tax, heating, condo fees) should not exceed 32% of your monthly gross income, and your total debt payments (housing costs plus payments on credit cards, loans, leases, credit lines) should not exceed 40% of your gross income. Keep this in mind when you're deciding what to spend on a home.
- Budget for ongoing home maintenance
Maintaining your home is key to preserving the value of your investment. As a general rule, 1-3% of the purchase price is a reasonable target for annual home maintenance.
- Investigate insurance costs associated with your decision.
A mortgage is likely the biggest debt you'll ever have. Is your existing life insurance coverage enough to make sure your loved ones will be able to afford the repayment if something happens to you? If you need more coverage, that's another expense you'll have to factor into your budget.
- Calculate your projected purchase costs.
Often referred to as "closing costs," there are many initial costs that you have to budget for, including legal fees, land transfer taxes, home inspection fees and title insurance.
To obtain a conventional mortgage you will need to make a down payment of 20% of the purchase price of the house from your own savings. If you don't have those funds and need to finance more than 80% of the cost, you'll need to purchase mortgage default insurance from the Canada Mortgage and Housing Corporation (CMHC), which typically adds 1% to 3% to the cost of the mortgage.
- Save in an RRSP
Thanks to the RRSP Home Buyers' Plan, if you're a first time home buyer, you can withdraw up to $25,000 tax free from your RRSP so long as you pay it back over the next 15 years. If you and your spouse or partner each have an RRSP, the Home Buyers' Plan can help you access up to $50,000, as long as you both qualify.
- Save in a TFSA
If you prefer to leave your retirement savings intact, consider saving in a TFSA instead. Any withdrawals you make from a TFSA are completely tax-free and can be replaced in the future when finances permit.
With mortgage rates at historic lows, it's easy to over-estimate what you can afford. A home is a long-term investment and costs for utilities, repairs, taxes and more can creep up over time. You must also remember, whether you have a fixed or variable mortgage interest rate, your interest rate may increase and when it is time to renew your mortgage, your monthly payments may also increase. Leave some room in your budget to allow for a rate increase of about 2%. Our Mortgage Rates and Tools can help you decide on the right amount.
- Fixed or Variable Rate Mortgage
Research shows that the overall cost of a variable rate mortgage has been lower than that of a fixed rate mortgage most of the time1. However, interest rates today are at historic lows and have little room to go lower. You may not be comfortable with changing interest rates and feel more comfortable with a fixed rate mortgage. You'll need to consider the trade-off between possible financial savings and peace of mind.
- Open or Closed Mortgage
Open mortgages carry higher interest rates, but they give you greater flexibility to make extra payments or to pay the mortgage off in full without penalty. Closed mortgages have lower interest rates, but are more restrictive. Check the fine print though, as you can generally pre-pay up to 20% of the principal each year without penalty. While most people prefer closed mortgages, an open mortgage can be a better choice if there's a chance that you might relocate in the near future or have additional funds to make the pre-payments.
- Amortization Period of the Mortgage
This is the total length of time it will take to pay the debt in full. The shorter the amortization, the less you'll pay in total interest costs. The longer the amortization, the lower your monthly payment, but the more expensive the mortgage will be over the long term. Consider the numbers: A $350,000 mortgage at 4% amortized over 25 years will cost $202,321 in total interest charges. The same mortgage amortized over 20 years will cost $157,567 in total interest charges.
Of course, there are many, many decisions that go into purchasing your first home. You'll need to think through all the considerations—large and small—so you can make an informed and confident decision. This is a big step. And emotion plays a big role. Education and preparation can help you stay focused on all your goals so that you buy a home that fits into your overall plan. Click here now to start researching how much you can afford.
Let's talk. Call a BMO Financial Planner* today at1-888-389-8030
1 Porter, Douglas, and Benjamin Reltzes. "Variable Rate Rollercoaster Still Hard to Beat." Economic Research, BMO Capital Markets (2011): 6-8. Print.
* BMO financial planner refers to Financial Planners, Investment and Retirement Planning that are representatives of BMO Investments Inc., a financial services firm and separate entity from Bank of Montreal.