How To Plan For Mortgage Financing
One of the biggest milestone in one’s life is buying your first home. It represents an investment in your and your family’s future and usually it is the biggest investment you will make. Although, the adrenaline flows freely when thinking about owning a home, it is also overwhelming. However, at Sunny Homes Mortgage Brokers “We straighten the CURVES of mortgage financing™” for our clients.
Although mortgage professionals are there to help you, but a little planning and preparation by you will go a long way to determine the home that is the “right fit” for you and your family today and in the future as well as aligns with your financial objectives.
Here is a suggested 6-step process that you could use to plan, assess and analyze your options to secure mortgage financing to own your dream home:
Step 1: Create a current annual cash flow budget
First step is to keep track where your cash is coming from and where it is going. This requires you to create an annual cash flow budget. You can download our Residential Cash Flow spreadsheet to help you get started or you can download a similar spreadsheet from the internet.
Creating a cash flow budget allows you to see what is your current bottom line – whether you have surplus cash or your cash flow has a negative bottom line. It will allow you to analyze your monthly spending pattern and determine where you can cut expenses to ensure that your goal of owning a home can be met. For example, discretionary expenses such as entertainment, eating out, gifts, clothing purchases etc. can be reduced or eliminated. You can also look for cheaper alternatives to offset your cash outflows. For example, instead of buying lunch at work you can take lunch from home. This alternative on the average can save you at least $200/month or minimum $2,400 annually. Similarly, you analyze each category of expense and determine how you can reduce or eliminate the expense if it is discretionary. This approach can help you to increase your surplus cash position or decrease/eliminate your negative cash flow position.
Step 2: Determine the total cost of owing a home
The total cost of owning a home also includes many other expenses other than mortgage payment. For example, you need to consider the amount of property taxes, condo fees, if applicable, and home insurance costs. Furthermore, you will incur expenses such as utilities, heating costs, maintenance and repairs, transportation costs from home to work.
The monthly housing costs (mortgage payments, property tax, heating, condo fees) should not be greater than 32% of you monthly gross income and your total debt payments (housing costs plus payments on your credit cards, personal loans, lines of credit, leases etc.) should not exceed 40% of your gross income.
Other costs that you need to factor into your budget are the “closing costs” which include legal fees, land transfer fees, home inspection fees, mortgage insurance premiums and life insurance premiums.
If you are a first-time homeowner, then you can be eligible for the First-Time Home Buyer’s Tax Credit which can provide up to $750 in federal tax relief when you file your income tax return.
Step 3: Your saving strategies
Nowadays, to obtain a conventional mortgage, you will require to make a down payment of 20% of the purchase price from your personal savings. If you are unable to come up with 20% down payment then you don’t qualify for conventional mortgage. Anytime when you need to finance more than 80% of the purchase cost, you will need to purchase mortgage default insurance from Canada Mortgage and Housing Corporation (CMHC), which adds about 1%-3% to the cost of the mortgage.
To save for your down payment you can use the following savings strategies:
- Saving in RRSP:
Registered Retirement Savings Plan (RRSP) has a RRSP Home Buyers’ Plan. If you qualify as a first time buyer then you can withdraw up to $25,000 tax-free from your RRSP as long as you agree to pay back over the next 15 years. If you and your spouse each have their own RRSP accounts then cumulatively you can have access to $50,000 as your down payment, as long as you both qualify as first time home buyers.
- Save using a Tax-free Savings Account (TFSA)
You can also create a TFSA account to accumulate savings for your down payment. Any withdrawals you make from your TFSA account are fully tax-free. Any income generated using the TFSA is also tax-free.
- Personal Savings:
You can also come-up with a plan to personally save for the down payment. For example, you can decide that 10% of your net family income will be saved every pay-period. You can invest in short-term GICs or other investment vehicles to help you come-up with 20% down-payment.
Step 4: Redo your annual cash flow budget
Although current mortgage rates are at historically low levels, you need to remember that mortgage rates can creep upwards. If you have a variable mortgage rate then the interest charged on your mortgage can increase although your periodic mortgage payment will not. Also, if you have a fixed interest rate and at the time when you renew your mortgage your periodic mortgage payment may increase. Therefore, have a contingency plan to offset such issues and for other uncertainties such as job loss.
Knowing all the costs of owning a home, you should now redo the cash flow budget you did in Step 1. Once you have done that analyze your cash flow position once more.
Step 5: Decide the mortgage that will align with your situation
Now that you have all the information at your disposal you can make an informed and confident decision. By planning assessing and analyzing various options you will be able to stay focused on your goals and help you to purchase a home that fits with your current and near future financial plan.
Step 6: Get mortgage pre-approval
Securing mortgage pre-approval is a way to determine what mortgage amount you qualify for based on your current and near future financial background. It also helps to narrow down the property options that can be available to you. One of the rule of thumb that can be used is to show whether the amount you want to borrow falls below 2.5 times your family’s annual gross income. Based on this information, it helps to determine the property price that you can feel comfortable with financially.