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How to finance the purchase of a home

Posted by BONE Living on January 8, 2015
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It’s time! The decision has been made. You won’t be a tenant anymore; you will be the owner of your home. But before becoming an owner, you need to be able to finance the purchase of a home, whether it’s a house or a condominium.

Unless you have a considerable amount of money to pay for your desired home in cash, which not many people have, you will need to do business with a lending institution. Before diving into the financing process, here are a few tips that could help you better plan the purchase of your new home.

Assess your needs

The first thing to do is to carefully assess your needs. Start by making a list of the disadvantages of your current home. Is it too dark? Does it lack storage space? Is the kitchen too small? Don’t forget that everyone who moves wants to improve their living conditions.

Then, try to anticipate your immediate or future needs. Will you need one room or two? What about a home office, a basement workshop or a parking space? Don’t forget to think about external factors. Will your home be in town or in the countryside? Will it be near a highway or public transportation? Will there be services nearby or not?

This exercise will help you determine the essential features of your new home. Unfortunately, as we can rarely get everything we want, you will most likely have to compromise. But at least you will be able to identify the elements that you consider essential.

Assess your financial capacity

The second exercise is to assess your financial capacity. In order to do this, you first need to determine your monthly expenses. Once you know that amount, you will need to deduct it from your gross monthly income to see if you have financial room. As a general rule, the amount of occupancy expenses for your home, including heating, should not exceed 32% of your gross income. The amount for paying back debts (loans and credit card payments) should not exceed 40% of your gross income. All the main financial institutions now offer tools to calculate these expenses on their website. In any case, these calculations will be redone by the mortgage representative that you will eventually consult. It is also advisable that you check your credit history at Equifax Canada and TransUnion Canada. If there are any errors, you will need to have them corrected, because the lending institution will base its decision on the credit history given by Equifax or TransUnion.

Investment and mortgage loan insurance

Financing the purchase of a home requires the financial interest of the buyer. That is the investment. In Canada, the law requires an investment of at least 5% of the purchase price of the property. This investment could come from your liquid assets, a donation or an inheritance. It could also come from your savings (often an RRSP) through the Home Buyer’s Plan (HBP).

Usually, lending institutions require an investment equal to or greater than 20% of the property’s purchase price. If the percentage is lower, you will need to get mortgage loan insurance. The Canada Mortgage and Housing Corporation (CMHC) offers this insurance. The insurance premium amount varies according to the amount of the investment. For example, for an investment of 5% of the purchase price, the premium is 3.15% of the amount of the mortgage loan. Thus, for a mortgage loan of $200,000, the total premium is $6,300. The amount of the insurance premium can be included in the amount of the mortgage loan granted.

Where can you find your mortgage loan?

Where can you find your mortgage loan? If you have a good business relationship and a good credit history with your current financial institution, you can start by asking them what they can offer you. Additionally, you can shop for your mortgage loan at multiple financial institutions, compare the offers and choose the one that suits you best. You can also use the services of a mortgage broker, who will shop for you at collaborating financial institutions. This service is free because the lending institution providing the loan covers the broker’s fees.

The amortization period of a mortgage loan corresponds to the amount of time it will take you to repay your loan. In Canada, the maximum period allowed is 25 years, since 2011. You can choose a shorter period, in which case your monthly payments will be higher. The term of your mortgage loan refers to the period of time during which the specific conditions of the approved mortgage loan apply. The term varies between 6 months and 5 years. Once the term is completed, you will need to negotiate a new one.

What type of mortgage loan should you choose?

Now, what kind of mortgage loan should you choose? There are three kinds. A fixed-rate mortgage offers a fixed interest rate for the duration of the term. In this case, the interest rate is slightly higher, but you will not be affected by market fluctuations. An adjustable-rate mortgage offers an interest rate that varies according to the market. If the interest rates decrease, you will profit, but if they increase, you will need financial wiggle room to absorb the increase. The third type of mortgage loan has an interest rate cap. In this case, the interest rate varies according to market fluctuations, but a maximum interest rate (called the “ceiling”) is fixed in advance.

A mortgage loan can be open or closed. If it’s open, you will have more leeway and will be able to negotiate the terms or repay a portion or the totality of the loan when you can. However, it has a higher interest rate. A closed mortgage loan offers a lower interest rate, but you do not have the same flexibility. As a general rule, most people choose a closed mortgage loan.

Don’t forget the other fees!

The purchase price of a property is not the only cost you need to factor in when you finance the purchase of a home. You first have to pay the fees of the professionals you are dealing with, such as lawyers or notaries, real estate brokers, appraisers, and inspectors. You must not forget the infamous “welcome tax” required by many municipalities. You also need to watch out for your moving and renovating expenses. A new home often requires the purchase of new drapes, light fixtures, furniture, etc., and it is also the best opportunity to update your household appliances.

In conclusion

Buying and financing a home is a good deal from a financial perspective. Even if you buy the property with the leverage given by your credit, which requires you to pay interest expenses, you will end up with assets that have appreciated over the years. However, buying and financing a home could become a real nightmare if you are not careful. On the one hand, you always need financial headroom in case of an unforeseen event, so it’s important to respect the 32% rule. The cost of paying back the loan, heating, and municipal and school taxes should never exceed 32% of your gross income. On the other hand, you must buy a home that corresponds to your actual needs and avoid buying one that is too luxurious for your financial situation. One way of avoiding this trap is to obtain a preauthorized mortgage. In this way, you’ll know the maximum amount that you can borrow, and you will be able to direct your search towards properties that correspond to your means. And you don’t have to borrow the maximum amount allowed by the lending institution. Be modest. When it comes to buying and financing a home, erring on the side of caution is always the best advice.