Information & Advice > Financing
1) Financing Options
2) What can you afford?
3) Closing Costs
4) Pay off your Mortgage
5) Own vs. Rent
Here are five financial options worth consideration:
RRSP Home Buyers Plan
You can use up to $20,000 of your RRSPs to buy a home. If you are purchasing a home as a couple, this can mean up to $40,000. The amount is paid back over a 15 year period, and your first repayment is due within 2 years of withdrawal of funds. The plan has been highly successful and has been used by many Canadians. The plan has been extended into the current year, however certain conditions apply. For instance, RRSPs locked into company pension plans may not be applicable. Call your RRSP Centre if you have any questions about your own particular situation.
5-25% down Payment
Canada Mortgage and Housing Corporation ( CMHC) may insure first mortgages with minimum 5% down for buyers. This plan is intended for Canadians who wish to purchase a home, and have the financial ability to both manage and sustain a large mortgage debt. The borrower(s) must qualify by having a GDS (Gross Debt Servicing) of no more than 35% and a TDS (Total Debt Servicing) of no more than 42%. The CMHC insurance premium varies according to the amount of mortgage.
* In the case of those who have suffered financial hardships these ratios may be lower (GDS - 32% and TDS - 40%).
Get Someone to Help Pay Your Mortgage
Have you ever thought of buying a property with an in-law suite, and renting it out to help pay the mortgage? Now that basement apartments are legal, as long as they conform to the
and Fire Code, why not consciously buy your home with a built-in possibility of income to help pay off the mortgage sooner? This way you will be able to move more rapidly into your second home with more equity in your pocket. An apartment might bring in anywhere from $500 to $800 or more a month. That's quite a help when you're first starting out. Imagine someone giving you an extra $8,400 a year towards your mortgage payments? That pays 50% of your monthly mortgage cost of $1,400. It's worth considering.
Vendor Take Back Mortgage (VTB)
Some vendor's may be prepared to take back a mortgage to assist the buyer. The interest rate is usually lower than current market rates. The vendor may either hold the mortgage or sell it at a discount to a mortgage lender.
Prepaying a Portion of Interest or Pay downs
Back when interest rates were quite high and buyers could not afford to qualify for the high interest rates on the mortgages, the sellers sometimes were prepared to pre-pay a portion of the interest rate on a mortgage arranged by the purchaser or blend and increase an existing mortgage that carried an unattractive rate. This brings about a lower effective rate of interest and lower monthly payments.
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How Much Can You Afford?
How Large a Mortgage will you be allowed to carry?
When you go to a financial institution to apply for a mortgage they will have two main areas of concern:
- Do you have the ability to pay the loan every month?
- Will there be enough value in the property for them to recover their money should you default on the loan?
Two terms that will be used by financial people are GDS (Gross Debt Service Ratio) and TDS (Total Debt Service Ratio). These ratios are used by the financial institution to gauge both your ability to carry the mortgage and to make your payments consistently.
To determine if the property will have enough value to secure the mortgage, the financial lending institution will require an appraisal of the property. As long as the appraised value comes in at the purchase price or higher, there are no problems. However, if the appraisal comes in lower than the purchase price then you have to either:
renegotiate the deal and/or the mortgage
increase your down payment
Calculating your Gross Debt Service Ratio (GDS)
For most lenders the GDS must fall in the range of 28-30% of your Gross Family Income.
To calculate your Gross Family Income you can include:
- your gross pay (pay before deductions)
- your spouse's gross pay
- any investment income
For example if your gross family income is $50,000 annually, ($4166.66 per month) you could carry:
GDS x Gross Monthly Income = Maximum Allowable Principal, Interest & Taxes Monthly
30% x $4166.66 = $1250.00
Determine what the monthly taxes are on the property that you are interested in and subtract from the $1250.00. This will give you the maximum amount of principal and interest that you will be able to carry.
For our example, assume that the monthly taxes are $150.00. You would then be able to carry $1100.00 principal and interest.
By using the following amortization chart you can determine how much mortgage you can have:
Amortization Chart - Monthly Payment per $1000
(At 9% interest and a 25 year amortization)
$1100.00. 8.28 (from chart) = $132,850.24 (mortgage amount)
Calculating your Monthly Payment
Find the figure under the mortgage interest rate (%) that corresponds to the number of years you want to pay off the loan.
If your interest rate is 9% and the term of the mortgage is 25 years, then you need to pay $8.28 per month for each $1,000.00 of mortgage. Therefore, if your mortgage amount is $132,000.00 your monthly payment will be:
$8.28 X 132 = $1092.96
Calculating your Total Debt Service Ratio (TDS)
Most institutions require that your TDS Ratio be 35 - 37% of your Gross Family Income.
To determine the Total Debt Service, add ALL of your monthly debt expenses; credit cards, car loans, child support, other mortgages, etc.
For our example let’s assume monthly payments of $250.00
TDS x Gross Monthly Income = Maximum Allowable PIT & Debt (principal/interest/taxes)
37% x $4166.66 = $1541.66
Your allowable monthly expenses would be $1541.66, with PIT of $1250.00 and a debt of $250.00 per month. You would still be able to carry the $132,000.00 mortgage.
If your TDS is too high you may have to pay off some of your debt, consolidate debts to give you lower monthly payments.
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How Much Should You Set Aside For Closing?
A quick approach to closing costs would be to set aside 2 - 3% of your purchase price. Closing costs vary according to circumstances of each individual sale. They include:
Here is a closing costs estimator chart you can use to calculate the cash you will require when the time comes. Overestimate rather than underestimate. Make sure you have enough.
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Pay off Your Mortgage Faster
The second most important choice you will make in purchasing your home is what kind of mortgage (if needed) you will choose.
A mortgage covers the difference between the purchase price and your down payment. The larger the down payment, the less you have to borrow, the smaller your monthly payment, and the lower your cost of interest over the term of the mortgage.
The first step towards establishing a maximum mortgage limit is to calculate a monthly payment you can afford. Financial institutions do this by calculating your
debt service ratio by listing all loans (car, personal loans, monthly credit card balances). The sum of these loan payments and your mortgage payment (including principal, interest and taxes) should not exceed approximately 40% of your gross income. The mortgage payment and taxes should not exceed approximately 30% of your gross income.
The size of the mortgage you can arrange, based on payments you can afford, depends on interest rates. The lower the rates, the larger the possible mortgage and the more affordable housing are.
It is important to get a mortgage that allows you the most flexibility. An open mortgage gives you the most flexibility of all, (you can pay off any extra amount at any time without penalty), but it is also the most expensive in terms of interest rate.
You will most likely choose a conventional (closed) first mortgage. However there are a number of items you can negotiate in order to have flexibility later on when you need it.
Here are some of the things you should be sure to include:
● Negotiate the highest annual prepayment that you can. Even if you don't think you can afford it now, the time will come when you can, and you don't want to miss the benefit. The payments are a little heavier up front, but the interest saved is enormous. If you can bear it, do it.
● Make sure you can prepay "at any given time" since you never know when excess money will be available to you and the payback is enormous over the term of the mortgage. Prepayments can be made i) at any time, ii) only at designated times and iii) on the anniversary date of the mortgage.
● Make sure you have the option to increase your monthly payments if you wish.
● Try to make your payments weekly or bi-weekly rather than monthly.*
● Keep your amortization period as short as possible .**
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Why Own Your Own Home Instead of Renting?
The financial benefits of owning your own home were recently confirmed in a survey conducted by Clayton Research Associates for the Canadian Home Builders Association. The company studied a number of different scenarios in 11 Canadian cities and arrived at some convincing statistics.
If you purchased a home 30 years ago with a 10% down payment, your net worth in 1995 would be from $101,000 to $396,000 higher than if you had rented and invested your money in stocks and mutual funds over the same period. Over the last 20 years, the difference worked out from $75,000 (worst case scenario) up to $283,000. Most Canadians upgrade every 7 - 10 years. Proof shows that in most cases, moving up to a bigger or better house generates even greater profits.
Here's How It All Works:
Owning a home costs more in the short term:
- You incur more incidental expenses
- Maintenance costs, utilities, and taxes all have to be paid
- Your mortgage may well start off being more than the rent you pay initially
However , after a while the equity in your property starts to grow. The rent you were paying increases annually, while your mortgage remains the same (subject to interest fluctuations at term end).
When you rent you are helping your landlord purchase his or her property and realize the future profits.
When you own you pay the entire mortgage and the costs, but you get to keep all of the profits for yourself.
As an owner, there will come a time when your mortgage is paid off in full, and you will be living rent-free and mortgage-free. Tenants cannot look forward to this situation in later years.
If you rent and invest, you are taxed on all the profits you make. However, if you own a principal residence, any profits you earn when you come to sell it are tax-free - with no limit!
- Ownership makes future profits for you
- If you own, there will come a time when you are mortgage-free
- If you own, your profits on a principle residence are tax free with no limit
- Rent makes future profits for your landlord
- If you rent, you will never be rent- free
- If you rent and invest, your profits are taxed
Studies show home ownership makes more financial sense than renting
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