If buying a home is a goal of yours I’d like to give you some food for thought on the whole getting approved for a mortgage and deciding on a home topic. Whether you’re looking to buy soon, or if this is a longer term goal for you, I have a list of some smaller pieces that you can work on to get you there while setting you up for huge success in having a strong financial foundation. Choosing to become a homeowner for the first time isn’t the kind of thing you decide on impulse. Mortgages aren’t as easy to get as they once were. Banks are looking for certain things when deciding if or how much to lend you for a home. There are many things that you can do to help the approval process long before you decide to pull the trigger.
1. Mind your credit score. If you don’t know what your credit history or score look like, it’s time to find that out. Equifax and Transunion both have free options on their website to apply for your credit report and have it mailed out to you. This will be a list of all the places you hold/ have held credit along with a score representing how good of a credit customer you are, ie. how likely are you to repay your loans on time every time. Having a high credit score makes you much more likely to get approved for a loan and will give you access to much better interest rates. The interest rate you pay on your mortgage can add up to tens of thousands of dollars over the life of the loan, so this is no small consideration. I will do an entire piece on credit scores on their own, but the most important pieces to consider for now are:
a) Are there any inaccuracies on that report that need to be cleaned up or major issues that need fixing? The first time I did my credit report there was a $20 dollar amount in collections from Bell that I had no idea I even owed from when I switched phone companies years before. By doing the credit report I was able to easily call and look after that stupid little amount that was dragging down my score. There was also a loan that I had paid out years earlier that was still showing as having a balance. I was able to send in proof that it was paid to the credit bureaus and get those things fixed really easily.
b) Are you making your payments on time every time? This is the most weighty piece in the calculation of your credit score.
c) The amount of your current available credit that is used. So if you have a credit card with a $5000 limit and it’s always at close to a $5000 balance, that is dragging down your score too. It’s important to a bank to know that you are capable of having available credit and not running it to the limit.
2. Debt level. The second thing banks use to decide how much mortgage you are capable of handling is what’s called a debt service ratio . Basically the calculation represents what percent of your income is going to repaying your current debt along with the new loan you’re looking to take on. There are a couple of different calculations that take into account different things like other housing costs, but this little number is very important in deciding if and how much mortgage you will be approved for. Another reason to get those debts paid off before diving into home ownership!
3. Savings. It is required to have a down payment of 5% of the cost of your home. While it may be tempting to try and get around this by borrowing the down payment under a different heading, bear in mind the debt service ratio. By trying this you may inadvertently take yourself out of the consideration for a mortgage at all by adding more ‘other’ debt to that calculation. If you’re serious about home ownership you need to get serious about saving some money too. It can be good practice to act as though you already have the extra costs of home ownership. If your normal housing costs now are $700 a month and you estimate your housing costs to increase to $1000 a month, practice living as though you already have those extra expenses. You will be better prepared for the transition all while socking away $300 each month to get you closer to the goal to boot.
I should also note that the 5% required down payment is mandated by the government of Canada. If your credit score is lacking or if you have more inconsistent income, the banks may require a higher down payment than that. 5% is the minimum. The more savings you have the better you look to the banks. If you have a down payment of more than 20% you get an added bonus of not needing to pay extra for CMHC.
There is also a program the government has called the home buyers plan. Basically this program allows you to borrow money from your RRSP savings to use as a down payment without the penalties of withdrawing your RRSP’s. So if you have money in an RRSP already you may be ahead of the races. If you don’t, that could be a great vehicle to use. You get to accumulate savings while enjoying a break on your taxes (that you can also throw in savings). More information on the program can be found here https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/what-home-buyers-plan.html
4. Income. Banks look to see if you have consistent and reliable income. If you are self-employed it is common for them to require 3 years of business history. There are banks that can work around this a little more if all the rest of your financial picture looks really good, but it’s something to keep in mind if you regularly switch jobs or have large periods of unemployment.
So those are some of the things a bank considers when deciding if or how much mortgage you could qualify for. If it’s a long term goal for you there are lots of pieces there to dig in and work on, each of which are important for a healthy financial picture anyway.
If purchasing a home is closer on the horizon for you and you’ve got all your ducks in a row with the above, congrats! I highly suggest using a mortgage broker to help you with applying for a mortgage. They take your information and shop you around to different banks and lenders to find a product that best matches your situation. Some banks are more open to self-employed people for instance, some view income sources such as child support and child tax benefit more favorably than others. An experienced broker can help you get the best possible mortgage for you and will help you get the best interest rate. They can also help you run the numbers on some of the above too and give you some more tailored advice on what areas need work or how much you need to lower debt by, etc.
I think it’s really important when choosing a home to decide the budget for it first. Don’t take what the bank pre-approves you for and go buy a home for that amount. That is the maximum they will lend you, that takes into account none of the other priorities you have for your life and your money. For most people home costs represent the largest portion of their monthly spending (35% is the recommended amount of your income) This also represents the biggest opportunity to drastically lower your fixed costs and leave more room for debt repayment, goals, fun, travel.. the good stuff. So make sure you run your own numbers on what you are comfortable as having as fixed housing costs before you go looking at houses.
When trying to come up with a purchase amount you’re comfortable with make sure you consider the extra expenses that come along with home ownership. Things like extra heating costs, property tax, lawn and snow care, repairs and maintenance (This one isn’t a maybe. Your home will need repairs and maintenance no matter how old, so put it in the budget.)
It’s also important to consider the length of your mortgage. It can be tempting to opt for a 30 year mortgage to make the numbers work, but think about where you’ll be in the 30 years. You don’t want to be still paying on a mortgage when you’re 75 and long over the whole working phase of your life. You will also pay significantly more in interest by opting for a longer term mortgage. 25 years is the standard, but that doesn’t mean you have to choose 25 years either. We do what we want around here.
So with a realistic, whole-life considering number in mind for what you want to spend, then go about talking with a real estate agent and deciding must haves and nice to haves for your home. Don’t be afraid to think outside the box either. Tiny homes are all the rage now for a reason. People are realizing the massive chains a huge house and huge mortgage can be and opting for smaller spaces instead. Maybe a house with an apartment could be a good option for you. Maybe semi-detached or a condo. Maybe a home further outside the city. I chose to build to cut costs. It’s a shit tonne of extra work and whole lot more time, but I have a lot of great contacts in the trades and heaps of experience with the process of building too. For me it was well worth the extra stress, and time now to have the ability to have a super small mortgage and have that flexibility in how much I need to earn and how I get to spend. Get creative and keep the big picture goals and lifestyle in mind. While having an extra bedroom for your once a year overnight guest might be really nice, is it worth the extra costs and sacrifices in lifestyle and goals?
Last piece of advice.. don’t watch any of those HGTV home shows! You don’t want keeping up with those Joneses with their high end kitchens and sweeping open concept entertaining spaces influencing your expectations and budget. There is nothing wrong with wanting a nice home, but keep in mind the big picture of your life and how you want to lead it too.
Lots of love
Dawn
Tax Wise 