Thinking about Becoming a Home Owner?

 

 

 

Becoming a home owner may sound glorious; however owning a home comes with a cost. Quickly jumping into the deal simply because it seems like “the RIGHT thing to do” does not necessarily mean it is.  If you buy prematurely and discover the costs are overwhelming, you may not be able to sell and recoup your investment.  One way to be certain you are ready to become a home owner is to do your homework.    

The best information and worksheets are found at the Canadian Mortgage and Housing Corporation website.  Because a home is one of the biggest purchases you will make in a lifetime, taking time to research and understand the steps will be worth the effort.   CMHC’s booklet, “Home Buying Step by Step” is easily obtained in both print or download format.  Click here to receive a copy.

Knowing the different types of costs and expenses associated with owning a home is important.  There’s more to swapping a rent expense for a mortgage payment. Categorizing the costs into three separate compartments will help you determine the money required to finance the major purchase.  First are the upfront costs, the money required to secure the purchase.  Second will be the ongoing mortgage payments and utilities expenses.  Lastly, the cost of regular maintenance and the “renovations” which will turn the home into your dream castle need to be considered.   Using The Home Purchase Cost Estimate worksheet will safeguard you from excluding any important items.  

Another valuable tool is the word glossary to familiarize you with the terminology. Understanding the industry’s language maximizes your understanding of all aspects of your purchase.  Whether it is the difference between the mortgage term and amortization period or between a closed and open mortgage, the word glossary helps eliminate any confusion encountered in your research. Speaking from experience, getting tripped-up by terminology is easy.  You may think mortgage life insurance and mortgage loan insurance are one and the same but they’re not.  In your conversations with any professional, always ask for clarification if you are ever in doubt. 

When contemplating your home purchase, you will be working with experts from “start to finish”.  Another useful worksheet, Your Team of Professionals, will be invaluable.  Your team will consist of a lawyer, realtor, mortgage specialist, property insurance agent, life insurance broker and perhaps even a home inspector or appraiser.  Creating and maintaining an updated contact list will be convenient for you.   

In last week’s blog the discussion was about the benefits of a larger down payment. This week the focus now takes a peek at the big picture.  The concept of budgeting is always a part of the discussion when people are considering a home purchase. The final decision, whether to buy or not to buy, will depend on what you can afford in both the purchase price and mortgage payment.  Once the payment is known then the rest is in the math.  First, the payment calculation must align with the industry’s guidelines as explained in the blog, Borrowing Money is like Jumping Hurdles.   Second, a compromise may be required to determine which lifestyle expenses you are willing to give-up in order to take-on a mortgage payment. CMHC offers two specific worksheets, Current Household Budget and Household Budget As Homeowner to analyze your present and future spending.   Tallying the costs will answer the question of whether or not you can afford to buy a home at this time.

The recommendation I quite often make to clients is to “play house” to determine whether they can manage all the costs.   As children, we always loved to pretend.  You might like to pretend you are home owners before you assume the actual role.  Deposit the difference between your current household budget and the anticipated homeowner household budget into a separate savings account.   Since you will incur these expenses as a home owner, you are both practicing and preparing for the change.  If you are managing your finances effectively and avoiding any shortfall, you will have the proof needed to support your decision.  Becoming a home owner will then be a rewarding experience because you have adequately done your homework.    



Should I Use my RRSP Savings for the Down Payment?

 

 

One “hot” topic drawing various opinions is whether to withdraw RRSP savings for the down payment towards the purchase of a home.    Some lead you to believe when you do, you are robbing your retirement fund.  I believe the focus should be to find the most effective way to owning your dream home.  If “effectiveness” is the optimal strategy, what does that mean in terms of cost?

Whether you are in the lowest or highest tax bracket, don’t ignore the fact that the Home Buyer’s Plan can save you money in interest costs.  Money deposited to an RRSP can be withdrawn under the Home Buyer’s Plan without any immediate tax consequences.  Because RRSP contributions reduce your taxable income, you receive a tax refund when you file a tax return.  Whether your marginal tax rate is 26% or 44%, you have an opportunity to receive extra cash simply because you paid taxes.    

The Home Buyer’s Plan is designed so that RRSPs withdrawn using this plan must be repaid over 15 years. You may be swayed into believing you cannot afford to have an additional payment.   Seeing the math may prove otherwise.  The maximum amount withdrawn under the Home Buyer’s Plan is $25,000. This translates into an annual payment of $1,667 (or $139 per month).  The worst case scenario is if the amount isn’t repaid it’s declared as income for that year.  Using a marginal tax rate of 26%, the tax would be $433.  Whatever your reason for a cash shortfall in any particular year, coming up with $433 for taxes may be easier than $1,667. Everyone’s circumstances are different.  If yours are entirely opposite and you have the ability to repay more to Home Buyer's Plan, you are not penalized.

The significant benefit for having a greater down payment is to lower your mortgage payments.  This means you pay less interest over the life of the mortgage.  The ripple effect is you will have more money for other “things”.  When you become a home owner a new list of expenses is born: property taxes, home insurance, power, heating, water and sewer. Some of these expenses existed when you rented an apartment or a home but now there are more.  They all contribute to the cost of being a homeowner. 

Another important benefit for having a greater down payment is less reliance on CMHC (Canada Mortgage and Housing Corporation) to insure your mortgage.  These insurance premiums are calculated on the amount you borrow and are then added to the principal of your mortgage.  This link provides specific information on the cost of CMHC Mortgage Insurance to show the more you have invested into the property the lower the premium on the total loan.  Ideally, you would want to strive to save 20% for your down payment to avoid incurring CMHC fees.

The disadvantage with having only saved 5% for your down payment is the high CMHC insurance premium of 3.60%.  Basically, if you have saved only the minimum 5%, you have lost your down payment. This illustration shows how this is true for a home priced at $300,000. 

Scenario #1:

Purchase Price     $   300,000
Down Payment     $     15,000 ($300,000 x 5%)      
Mortgage              $    285,000
CMHC fees           $     10,260  ($285,000 x 3.60%)
New Mortgage      $    295,260

Scenario #2:

Purchase Price      $  300,000
Down Payment      $    60,000 ($300,000 x 20%)   
Mortgage               $  240,000

If it is important to you to become a homeowner immediately, the cost of $10,260 may not appear significant. However, if you are in the positon where you can wait and save using an RRSP (Registered Retirement Savings) and TFSA (Tax Free Savings Account), you will achieve your goal of creating a tax saving, having a larger down payment and avoiding CMHC fees.  Imagine two couples with exactly the same incomes buying homes for the same price.  One couple has a down payment of 20% while the other has a down payment of 5%.  Which couple would you rather be?

Mortgage specialists and realtors are anxious to get you into a home.  Many will use the convincing statement, “Why rent when you can own?”  Patiently saving for your down payment may not be easy but using this mortgage calculator will help you see why doing so is worth the wait.   When you compare payment amounts using an interest rate of 2.85%, the mortgage for $240,000 will have a payment of $1,117.40/monthly compared to the mortgage for $295,260 with a payment of $1,374.68/monthly.   The difference can be used towards repaying the Home Buyer’s Plan or utility bills.  However, the true significance is the interest saving over an amortization period of 25 years.  

Whatever your situation, look at all the angles to determine whether using the Home Buyer’s Plan helps fund your down payment.  I know this talk will cause a great deal of controversy. I read articles saying “Don’t use your RRSP for a down payment.  The money should be saved for your retirement.”  My philosophy is “If the shoes fits, wear it.”  You are looking for the most effective strategy.  If building equity in your home with RRSP savings works, then do it.  You will have a jump start on your mortgage by lowering your payment and interest costs.  In the end, “you can have your cake and eat it, too!”