Understanding Your Finances

Getting up close and personal

When you decide to enter the world of home ownership, it’s time to take a cold, hard look at your finances.  Budgeting may be something that you’re well acquainted with – or it may be the area of your life in which you subscribe to the old saying “ignorance is bliss”.  Armed with a clear and honest picture of your financial situation, you’re ready to look at more specific costs associated with buying a home.

The branch network

For some consumers, the oldest channel is where they go to do all their banking, including getting a mortgage.  For them, this is the most convenient, and they probably have a good relationship with one of the branch representatives.  If you have a good relationship with your branch and have a good history of doing business with them, you can leverage that relationship into discounted rate on your mortgage.

In the eyes of the big corporate bank, each branch operates as an individual profit center.  Branch staff are trained and motivated to make the branch as profitable as possible.  This directly affects the bonuses handed out to the staff at the end of the year.  So don’t expect anyone to be overly generous when it comes to discounting your rate or advising you on any mortgage terms and strategies that will cost them money.  You should keep this in mind.

Each lender also has their specific lending requirements that your loan application will fall under.

Mortgage broker channel

Getting favourable rates and terms is just one advantage for using a mortgage broker.  As an independent unbiased representative working on your behalf, a mortgage broker has access to over thirty lenders in Canada, giving you the greatest number of choices with the least amount of effort.  Only your mortgage broker can speak openly to you about what every lender has to offer.  The number one goal is to put you into a mortgage that best suits your individual needs.  Which lender you are placed with is of secondary importance.

Prequalified vs. pre approved

Prequalified:

  • You’ve talked to a lender on the phone, in person, or filled out an internet qualifying worksheet.  Based on the information, you’re told how much home you can afford.

Pre approved:

  • You’ve met with a lender and filled out an application.
  • Credit and income has been verified.
  • That you have the down payment and closing costs needed has been verified.
  • You know exactly how much home you can afford.
  • The lender has submitted your loan package to underwriting and gotten written approval up to your qualifying limit.
Pre-approved mortgage

Being pre-approved for a mortgage is a critically important step in the process of buying a home.  Getting a pre-approved mortgage costs nothing except the time you spend obtaining one.  One added advantage is the protected interest rate of up to 120 days that comes with your pre-approval.  That gives you a lot of time to shop around and no risk or having to re-qualify at a higher interest rate if rates jump.  You should request a copy of your written commitment from your lender/broker to have for your personal files.  Then you know your application has been secured.  With your pre-approved mortgage, you will know exactly how much you can afford.

Having a pre-approved mortgage will strengthen your bargaining position with the seller of the home you wish to buy.  Especially in a seller’s market!

Paperwork lenders need to get started

  • Full name, social insurance number, Birthday, current address and how long you’ve lived there, and a letter from your landlord.
  • Most recent pay stub that shows year to date earnings.
  • Notice of Assessment for the past two years.
  • Current employer, along with name, address, and phone numbers of employers for the past two years.
  • Your checking, savings, and other account balances and account numbers.  Also any stocks, bonds, RRSP’s, insurance policies and other paper assets.
  • Your hard assets such as cars, RV’s, etc.
  • A breakdown of money you owe, such as auto loans, student loans, credit cards and other debt.
  • If you are self-employed or on commission, you’ll  need tax forms from the past two years, plus a year to date profit and loss statement.
  • If you are separated or divorced, include a copy of the divorce decree or separation agreement.

How much are you spending now

The first thing you need to figure out is how much you are spending now.  To figure this out you’ll need to calculate:

  • Your monthly household expenses
  • Your monthly debt payment

(there are detailed worksheet pdf’s available on this site for your personal use)

Affordability rule 1

The first rule is that your monthly housing costs shouldn’t be more than 32% of your gross monthly income.  Housing costs include your monthly mortgage payments (principal and interest), property taxes and heating expenses.  This is known as “PITH” for short – Principal, Interest, Taxes and Heating.

If you are thinking of buying a condominium you should know that:  For a condominium, PITH also includes half of the monthly condominium fee.

Lenders add up your housing costs and figure out what percentage they are of your gross monthly income.  This is called you Gross Debt Service (GDS) ratio.  To be considered for a mortgage, your GDS must be 32% or less of your gross household monthly income.

Affordability Rule 2

The second rule is that your entire monthly debt load should not be more than 40% of your gross monthly income.  Your entire monthly debt load includes your housing costs (PITH) plus all your other debt payments (car loans or leases, credit card payments, lines of credit payments etc.).  This figure is called your Total Debt Service (TDS) ratio.

Your maximum home price

The maximum home price that you can realistically afford depends on a number of factors.  The most important factors are your household gross monthly income, your down payment and the mortgage interest rate.  For many people, the hardest part of buying a home – especially their first one – is saving the necessary down payment.

Mortgage Loan Insurance

Mortgage loan insurance helps protect lenders against mortgage default, and enables consumers to purchase a home with a minimum down payment of 5% – with interest rates comparable to those with a 20% down payment.

CMHC Mortgage Loan Insurance

Is calculated as a percentage of the loan and is based on the size of your down payment.  The higher the percentage of the total house price/value that you borrow, the higher percentage you will pay in insurance premiums.  The cost for mortgage loan insurance premiums is usually offset by the savings you get from lower interest rates.

Do your calculations look…

Encouraging?

  • What is your current financial situation?  After doing the calculations, do you feel fairly confident about beginning the home-buying process?  You’re ready to proceed with home ownership!

Discouraging?

You may need to step back and make some improvements.  Did your calculations show that you might have trouble meeting monthly debt payments?  If that’s the case, you may find it difficult to get approved for a mortgage.  Here are some things you can do to improve your situation:

  • Pay off some loans first.
  • Save for a larger down payment.
  • Take another look at your current household budget to see where you can spend less.  The money you save can o towards a larger down payment.
  • Lower your home price – remember that your first home is not necessarily your dream home.
  • Meet with a credit card counselor to figure out how to minimize your debt.

Anticipating the closing costs

The last hurdle in the home-buying process is closing – when you complete all the paperwork and sign off on all the documents needed to purchase your new home.  At this time, you also finalize all the details that need to be covered when you buy a house.

Each one of the closing day items outlined cost you money:

  • Deposits and down payments – you are required to pay a deposit of at least 5% of the purchase price of the house, and you may pay it in stages or all at once.
  • Finance fees – If you use the services of a mortgage broker, the lender will probably pay the brokerage fee.  However, if you have a past financial difficulties, you may be required to pay this fee yourself.  It will likely be as much as 2% of the total mortgage.  If you are breaking one mortgage – or blending a mortgage – you may face some penalties.
  • Insurance fees – If you have a high-ratio mortgage, you must obtain mortgage loan insurance ranging between 1% and 4.75% of your total mortgage amount.  For convenience, you can incorporate your CMHC fee into your monthly mortgage payments.

Legal fees and disbursements – You need a lawyer to review the offer to purchase, perform a title search, draw up mortgage documents and tend to the closing details.  How much all these fees will cost depends on how complicated your deal is, but you can budget for $1 000 to $3 000 to cover legal fees.

Appraisals, Surveys, Inspections and Condominium Certificates

Here are five more items that you may have to pay for before closing day:

  • Appraisal:  You’ll probably need to get an appraisal for your lender.  A basic appraisal fee is about $150 to $300, but that figure goes up if you’re buying a large home.  If you ask nicely, you can probably get your lender to pay for the appraisal.
  • Survey:  The land titles office, or your lender, may require a up-to–date survey in order to approve your mortgage.  The price of a survey varies widely, and in Alberta, is usually provided by the seller (including the expense).  If a seller is not providing a survey, Title Insurance may be offered or needed instead.  If none is provided, and you wish to inquire one, budget for around $1 000.
  • Title Insurance:  Title insurance policies protect the insured against losses arising from some title related and non-title related matters, but it is not the same as a Real Property Report and is not a replacement for a Real Property Report.  Pricing varies, budget around $300.
  • Inspection:  Get a professional home inspection done on the home you are going to buy.  An inspection is a report on the presence and apparent condition of the structural and operational systems of the home.  Pricing again varies.  Budget around $600
  • Condominium Certificate:  If your buying a condo, you’ll need a document confirming the seller has fulfilled all obligations to the condominium corporation, (The Estoppel Certificate).  The seller usually provides this.  Budget under $200.

Taxes

Of course, your new home-owning adventure wouldn’t be complete without taxes.

  • Property Tax:  The tax paid is pro-rated to the closing date and you have to reimburse the seller if the taxes where pre-paid to the end of the year.

Your property tax is made up of:  A municipal portion, a provincial education portion and some residents also pay local improvement charges.  Property taxes are due by June 30 every year.  They can be paid in full or in monthly payments.

Call 311 well in advance of June 30 to enroll in the monthly payment plan.

The final tax rates are not set until late April or May, when the budget for municipal services is finalized and the provincial requisition for education taxes has been received.

Little extras

  • Utility charges:  Be prepared to pay connection fees for hooking up your telephone, cable, internet, electricity, water and gas.  Some companies may ask you to pay a deposit.
  • Security system:  Installing a system, or arranging monitoring of the system in your new house.
  • Mail:  Redirect your mail at the post office.
  • Moving costs:  Do some research to arrive at a reasonable budget and style for your move.  Your options usually are do it yourself with friends and family and rent a u-haul or pay to hire professional movers.  Make sure you book your moving plan well in advance!
  • Renovations or repairs:  Some are necessary to do immediately.
  • Appliances:  Does your new home come with appliances?
  • Gardening equipment:  Purchase necessary items for each season.
  • Window treatments:  Does your house come with blinds or curtains?
  • Home owners insurance policy:  Contact your insurance company for both content and dwelling insurance protection.

Summary

There are two types of costs in buying a home:

The amount of money you will need for the initial purchase.  This consists mainly of the down payment and other costs such as legal fees, inspection fees and taxes.

The ongoing costs of paying back your mortgage, along with monthly operating costs for utilities, insurance and annual property taxes.

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