When financing a home, the following considerations can help you to save money and provide for greater economic stability in the event of financial challenges down the road such as lower income levels, increased monthly expenses and/or higher interest rates.
Determine your borrowing capacity
Before you even start looking for a new home, ask your financial advisor to determine your borrowing capacity. Together you will draw up your personal balance sheet using your income and expenses and determine the price range and monthly payments you can afford. This will give you more bargaining power with vendors. As a rule of thumb, you shouldn’t spend more than 32% of your gross income on the mortgage, taxes and heating of your new home, plus half of your condo fees, if applicable.
Use your RRSP for a down payment
To help you make a down payment on your first home you can tap into your RRSP. Under the Home Buyers’ Plan, you can withdraw up to $20,000 ($40,000 per couple) from your RRSP with no tax withheld. It’s a perfect opportunity to make good use of your RRSP.
Consider a lesser mortgage amount than the maximum you can afford
Mortgage Professionals use two simple calculations to determine the maximum mortgage that you can afford. The first calculation, your Gross Debt Service Ratio, assumes that your monthly housing costs (mortgage principal and interest, taxes and heating expenses and half of the monthly condo fee if you are purchasing a condominium) should not be more than 32% of your gross monthly income. The second calculation requires that your entire monthly debt load (including housing costs and other debts such as car loans and credit card payments) not exceed more than 40% of your gross monthly income. This figure is your Total Debt Service ratio.While these ratios help to determine the maximum mortgage and payment that you can afford, obtaining home financing at these levels may not leave you with much room to comfortably deal with any unexpected changes in your monthly budget. Taking a smaller mortgage can help to ensure that your monthly housing costs remain within your means.
Evaluate the impact of an increasing interest rate on your monthly payments
Over the past few years, interest rates have been at historical lows. While this helps to make homeownership affordable today, an increase in interest rates could have a significant impact on your future monthly housing costs. For instance, homeowners renewing a mortgage of $250,000 with a 5% interest rate could see an increase in payments of $300 per month if rates were to increase by 2%. Evaluating the impact of increasing interest rates on your monthly payment today may help you to avoid financial difficulties in the future.
Plan to be mortgage free faster by reducing your amortization period
The amortization period of your mortgage is the length of time it will take to pay off the entire mortgage. A longer amortization period can help to reduce your monthly housing costs, but will result in significantly higher overall interest costs. For example, choosing a 35 year amortization over a 25 year period on a mortgage of $250,000 would lower your monthly principal and interest payments ($1,254 vs. $1,454) but will result in additional interest costs of over $90,000. Besides higher interest costs, maximizing both the amortization period and mortgage amount can leave little room for flexibility in the event of future changes in your financial situation.
Create a “cushion” in case of unforeseen financial difficulties
In addition to choosing a shorter amortization period, there are other ways to pay your mortgage down sooner, save money, and create some breathing room should you face unforeseen financial difficulties in the future. These include making accelerated weekly or biweekly payments, taking advantage of pre-payment privileges such as making lump sum payments to your mortgage principal, and increasing your regular payment amount. Ask your Mortgage Professional for additional information on these topics when arranging your financing.
Seek help if you have difficulty making your mortgage payments
When unforeseen financial circumstances impact your ability to make regular mortgage payments, it’s important for you to take quick action. With early intervention, you can work together with your mortgage professional to find a solution to your financial difficulties. Your mortgage professional wants to establish and maintain a positive relationship with you over the long term, and is fully trained and equipped with the tools to help you deal with the temporary financial setbacks that you may be facing.