4 Step Guide for First Time Home Buyers in Canada

Although it’s never too late to crunch the numbers for your first home, you’ll be in a much better position financially if you investigate the money side of owning a home before you go to your first viewing. Doing your financial homework before you’re ready to buy – even a couple of years before – can save you significant money and stress in the home buying process.

1. How much mortgage can I afford?

This is the key element to your financial calculations, and it’s not as straightforward to work out as it may at first seem. The general rule of thumb was that you could borrow up to five or six times of your gross annual income for a mortgage with your payments being less than 32% of your gross monthly income [1].

However, the Canada Mortgage and Housing Corporation (CMHC) introduced a mortgage stress test in 2018 that changed the limit on the amount you can borrow [2]. The purpose of this regulation was to prepare homebuyers for a possible rise in the interest rate considering that the current rates are some of the lowest ones in Canadian history. Anyone applying for a new mortgage must be able to afford their mortgage payments if the interest rate goes up – the test used is the higher of the mortgage rate they qualify for plus 2% or the Bank of Canada 5-year fixed-term rate. The outcome of the stress test calculations is that you may only be able to borrow less than 5 times your gross income. Understanding how much mortgage you can afford is the first step in the home buying process. 

Now you know the maximum amount of mortgage you can ask for, the next step is to calculate what mortgage payments you can afford. Not knowing their budget is one of the biggest mistakes that home buyers often make. It’s important to use an accurate mortgage payment calculator that reflects the current mortgage rules – you can find one at Wowa’s mortgage payment calculator.

The calculations provided are estimates based on your current situation. When you start the home-hunting process in full, visit your financial institution to get a pre-approved mortgage that makes your qualified amount official. It may also help you lock in your interest rate. (Another biggest mistake is not to shop around for the best interest rate.)

2. How much money do I really need to buy a house?

Your next steps are to calculate how much you need in your budget to cover the needed down payment of buying a home.

2.1 Your minimum down payment

The minimum down payment on a home is 5% of the purchase price for homes up to $500,000 and then 10% on the portion above that up to $1 million. For any property above $1,000,000, you’ll need to put down 20% of the purchase price [3]. However, you can put down as large a down payment as you want, and it’s typically recommended that you put down at least 20% of the purchase price to avoid paying CMHC mortgage insurance.

If your down payment is less than 20% of the purchase price, you have to pay CMHC mortgage default insurance. Mortgage loan insurance premiums that should be paid by buyers can vary from 2.8% to 4% of the amount of your mortgage [4]. With CMHC mortgage insurance, you may be able to negotiate a more favourable mortgage interest rate as, with the insurance in place, there’s less risk to the lender.

Let’s take a look at this with numbers: consider a $500,000 home purchase and a mortgage insurance premium of 3.1%. With a 10% down payment of $50,000, the home buyer has to pay mortgage insurance at 3.1% of the mortgage amount of $450,000 (price minus down payment), coming to $13,950. If the buyer has a down payment of $100,000, or downpayment of 20%, they will avoid the mortgage insurance premium. By contributing an additional $50,000, you save $13,950, leading to a total return of 28%.

2.2 Closing Costs

Purchasing your home involves many closing costs that you must pay before you get the keys. Wowa provides a calculator that itemizes the closing costs for you. The largest of these costs is the Land Transfer Tax payable to the provincial government (and to the municipality if you buy a home in Toronto). In most parts of Canada, the land transfer tax can be over $5,000 on a $500,000 property. Home purchasers in Alberta and Saskatchewan get a break as the land transfer tax there is less than $300 on an equivalent $500,000 home.

3. What ongoing expenses will I have?

As part of your pre-purchase homework, calculate your mortgage payment (monthly, bi-weekly) as this is usually the first on-going cost of homeownership. You can compare this to your current rent to determine if such a payment is within your budget. The property tax for the type of property you may buy is another large expense you should know, along with how often (annually or in installments) you will need to pay it. If you have an idea of the area in which you will buy your home, ask a local real estate agent about the average annual utility costs or condominium fees for that neighbourhood.

4. Is there anything I can claim as a first-time buyer?

Your homework so far has covered your expenses. This step is to investigate and calculate any first-time home buyer incentives you can apply for.

4.1 Land transfer tax rebates

First-time homebuyers who purchase their property in British Columbia, Ontario or Prince Edward Island are eligible for land transfer tax rebates, usually capped at a maximum amount. For example, in Ontario, the maximum rebate is $4,000. Homebuyers in Toronto pay an additional land transfer tax but can apply for an additional rebate to a maximum of $4,475. 

4.2 First-Time Buyer Incentive Program

The First-Time Buyer Incentive Program started in September 2019 and allows first-time homebuyers to reduce their down payment by sharing the equity in the property with the federal government through CMHC [5]. In this program, the CMHC will contribute 5% of the home’s value (5% or 10% for a new-build home) towards the down payment in exchange for the same percentage of the profits (or losses) when you sell the home.

Strict rules exist for this program including the definition of homeownership, your own down payment amount and a maximum home purchase price. The government is looking at giving home buyers in Toronto and Vancouver a higher maximum purchase price to account for the more expensive real estate market there. Be aware that the incentive is only in place until September 2022 or until the $1.25 billion fund dedicated to the program runs out.

4.3 RRSP Home Buyers’ Plan

Putting money for buying your home into an RRSP is a step you can take to get a significant advantage in getting closer to your home purchase. You can put before-tax income into it and have it grow tax-free, two advantages that make saving in an RRSP much faster than in a regular account. The Home Buyers’ Plan (HBP) allows you to withdraw up to $35,000 (per spouse) from an RRSP to buy or build a qualifying home. You do have to pay the funds back into the RRSP in annual installments, but you have 15 years to do so [6]. As always, there are specific criteria to meet to be eligible for the HBP; these include that you are a resident of Canada when you withdraw the funds, that the funds have been in the RRSP for 90 days or more and that neither you nor your spouse has owned a house in the last four years.

Using this program to withdraw money to increase your down payment will also help to lower your mortgage payment. For example, perhaps you have $50,000 in an RRSP and then withdraw it to add to the other $50,000 you’ve saved as a down payment for a total of $100,000. At an interest rate of 3%, your mortgage payment would be $1,892.98 monthly on a $500,000 home. Without the money from the RRSP, you would pay $2,195.62 each month. The $300 monthly savings adds up to a significant amount over the length of your mortgage.

The bottom line

Buying your first home, though exciting and life-changing, is a complex and emotional process. You’ll go into it with more confidence and self-assurance if you know what’s required financially and that you’re taking advantage of all the incentives for first-time buyers.

Resources 

  1. Know how much home you can afford. Royal Bank of Canada.
  2.  New Mortgage Rules in Canada. TD Bank.
  3. How Much You Need For A Down Payment.  Government of Canada.
  4. What is CMHC Mortgage Loan Insurance? Canada Mortgage and Housing Corporation.
  5. First-Time Home Buyer Incentive. Government of Canada.[6]     How to Participate in the Home Buyers’ Plan (HBP). Government of Canada.
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1 Response

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