12 things you should know before you buy a house

Home ownership is both exciting and stressful at the same time. I write a lot about real estate and home ownership because it’s the biggest financial purchase most people will make in their lifetime. And since we all need a place to live, it’s important to know what you signing up for with home ownership before you sign the papers. Here are my top 10 things you should know before you buy a house. They are not in any order of importance.

What’s the motivation behind your purchase?

A home is so much more than just an investment. It’s a place to raise your family, creating memories, and yes it also provides the most basic human need; shelter. But taking on a mortgage requires you to understand what’s the true motivate behind your desire to buy a home. Seeking shelter doesn’t require you to take a mortgage. Therefore, I feel it’s important you understand why you want to purchase a home. Identifying your motivation will allow you to stay focus and avoid falling for any emotional trap you might otherwise fall for if you don’t understand what’s motivating you to purchase.

Are you feeling pressured to buy? Is everyone around you buying a house and you feel like you’re missing out? Feeling pressured by your parents? Do you want to start a family? Whatever is behind your buying motive, it’s not for me to pass judgment but rather for you to be honest about what’s motivating you to want to take on a mortgage. Honesty and emotional balance are keys to a successful home purchase.

Know your budget before you even start to looking

Before you even call a realtor or a mortgage broker, figure out what you can comfortably afford as a monthly mortgage payment. Aim for a payment that doesn’t take more than 42% of your gross monthly income, that’s before taxes.

Don’t tell your real estate agent what you can truly afford

When we bought our house I didn’t tell my real estate agent what we could really afford. Why? Well, to be honest, there are some lazy real estate agents out there. They simply want a quick sale and first time home buyers are an easy pick. First time home buyers are unprepared, emotional, and lack the proper knowledge. So, if you tell a real estate agent who is lazy what you’ve been approved for by the bank, the agent will only show you houses at the top of your price range, even if there are cheaper housing that might fit your needs.

They do this because they know most first time home buyer will naturally fall in love with high-priced houses and feel the need to buy the house even though it’s not something they can truly afford. Remember it’s in the realtor’s interest for a quick sale at the highest possible price you can afford. I’m not saying all realtor are like this because I know great ones. But it is important to understand what’s motivating each of the parties that will be helping you throughout your home purchase.

This isn’t a race, take all the time you need

Pressure. It’s something you will feel as you begin to look for your house. You will be told you have to make a quick offer, offer above asking price or have no subjects. Basically, if you don’t act quickly when you see something you like it will be gone! To be fair, that’s something that could happen. But here’s what you also need to realize. It’s far easier to make an offer on something you can’t afford than it is to actually pay for something for the next 25 years that you can’t afford.

It’s important you think of the home purchase process like a marathon. You shouldn’t try and sprint through the process. Rather, you want to find a pace that suits you best in order to avoid financial disaster. When my wife and I were looking for a place we took several breaks. Sometimes they were up to a month. Don’t be afraid to take a break if you don’t see what you like or if things are not fitting your budget. If the process starts to feel stressful or  you feel you are starting to cave to pressure, take a break. Stop looking until you feel you’re ready to start the process again.

Apply for insurance once you start looking

Insurance is often the last thing on people’s mind when they are looking for a house. But you really should start this process once you’ve started the mortgage application process. Why is this important? Well, if you get a house for say $400, 000.00 and can’t get life insurance this might be a deal breaker. Therefore, it’s best to start this process right when you start looking for a house. I recommend you go with an insurance broker and look for a term life insurance that matches the same number of years as your mortgage.

Lastly, don’t forget to also look for home insurance. It’s not just life insurance but also insurance for the content in your home and overall property.

Is it a home or an investment you’re buying?

A home is a place of comfort and security. Somewhere along the way home ownership became an investment. Here’s the thing about investment; the vast majority of the time it’s based on past performance and past performance do not necessarily repeat again. If you’re overextending yourself because you believe it will be a good investment in the long term, please understand that real estate like any investment has ups and downs and there is no guarantee it will work out the way you hope. Do yourself a favor, buy a house that you can comfortably afford and avoid trying to overextend yourself in the name of it’s “good future investment”.

Can you handle the cash flow restriction?

A home can be a good long-term investment and possibly a good hedge against inflation. However, mortgage payments take up a considerable amount of your cash flow. If you’re under 30, this a major concern as the money you put in the house could restrict your monthly cash flow and other opportunities you could pursue. If you’re under 30, chances are you’re just starting your career and perhaps thinking about a family or perhaps marriage. At this point of your life cash flow is key and if you purchase a home too early in your life you can tie up significant cash flow that could prevent you from planning and saving towards other things you are soon to want such as; family, wedding, or travel. But on a more practically level, it prevents you from putting away money to ensure you stay liquid for opportunities and life’s challenges.

Housing isn’t very liquid

There are two ways you access money from a home. You can sell the house and take the proceed of the sale after all your expenses are covered. If you do not want to sell and have some equity built up, wait for it, borrow money from the bank against your house. So basically, you can move or you can borrow more money against your house to access the money you’ve put towards it. That’s a pretty terrible choice if you ask me. The reality is having a million dollar property means nothing if you’re not willing to act on the information and transfer that into cash.

Location is extremely important but even more if you’re purchasing a townhouse or condo

A starter home is something I tried to avoid in my first home. Since home prices are so expensive in cities, most of us can only afford townhouses or condos. The problem at least from my point of view with townhouses and condos is that they will forever be more of them coming on. Remember basic supply and demand rule. When there’s an oversupply of something prices have to drop to get rid of the over-supply of inventory. Therefore, if you’re buying a townhouse and condo, it’s extremely important you keep the location in mind. This will be your saving grace as people will generally pay more to be closer to all amenities they need. You shouldn’t avoid townhouse or condo rather just be mindful of demand and supply basics.

And if you’re buying a detached home the supply and demand rule still applies to you. However, since most people are not able to afford a detached home there tends to less inventory and prices tend to be higher. For detached home, the land is critical to be mindful of. Ensure you’ve bought in a good place with good land value for the area. Remember it’s local but local location is what’s really important, so buy in an area people want to move to.

Understand the true cost of home ownership

Housing cost a made up of two components; one-time cost and on-going cost. Most people are familiar with the one-time cost, which are costs that occur once during the home purchase process. Realtor fees, lawyer fees and inspection fee are examples of one-time fee. On-going cost are things such as mortgage payments, hydro, strata, property taxes, garbage, water, home insurance, and general maintenance. Most people only think of the mortgage payment as their on-going cost. To be able to afford a home you not only have to be able to afford the one-time cost but you also have to be able to afford the on-going cost of owning the house. Failure to truly understands a house’s on-going cost could mean financial disaster.

Like any investment, think long term

I view investment such as stocks and bonds the same as real estate investment. They both carry the same level of risk and ultimately to be successful with either it’s best to think long term. When it comes to home purchase you should be thinking long term about the house you’re purchasing. Look for a house you can stay in for a long time, somewhere around 15 to 20 plus years. The less moving you do the better. Don’t have kids now? What if you did, would this house still work? Purchasing a townhouse or condo, you should look into strata bylaw with respect to renting. Can you rent this house out perhaps in the future? Bottom line, don’t just buy a house for what you need today. You have to think long term about what you could do with the property today and also in the future.

Read The Wealthy Renter Book

I’ve read a lot of books on the topic of home ownership and real estate Alex Avery, author of The Wealthy Renter : How to Choose Housing That Will Make You Rich, is by far one of the best books with a focus on the Canadian housing market. If you truly want to be successful at home ownership you must read this book! If you own a property you must read this book! And if you’re a millennial or younger this book is not a choice but rather mandatory!

There are so many things to know about real estate and I hope those 10 tips put you on the right path to buying a home you can afford and create memories for your family.

 

How to reduce your debt in 8 simple steps- Guest Post

Debt, Debt, Debt, that’s all you hear about. Student Debt, Credit Card Debt, House Debt (Mortgage), family debt (borrowing from Uncle Ben), you name it we all have it! None of us like it either. It just eats away at our good earned money and we are all trying to get rid of it. Most people don’t want to face the music; to get rid of debt it’s imperative that you have a PLAN.

Look no further, here is a strategy that will get you lowering debt in no time. I learned this debt crushing tactic from Dave Ramsey, the personal finance legend himself. It’s called the debt snowball plan, and I’ll explain it in steps. The easy part is understanding it, the hard part is executing! However, the more you stick to it, the fatter your pockets get!

Here’s a scenario, John is 28 years old and has $500 of credit card debt, a $15,000 car loan, and a $150,000 mortgage. The minimum payments he makes on his credit card is $35, $300 for the car loan and $750 for his mortgage (If you want to get the most out of this exercise, I encourage you to follow along using YOUR numbers).

Step 1. Grab a piece of paper, or use excel, and jot down the lowest amount of debt you owe. In this case, the lowest amount John owes is $500. Next, list the second lowest and continue this process until you have all of your debt written down. This step allows you to SEE the amount of debt you owe.

John’s Debt List

Credit Card $500
Car Loan $15,000
Mortgage $150,000

Step 2. Add up all the debt and jot down the total number under your list. Congratulations, you have just set a long-term goal. What’s your long-term goal you ask? Getting rid of that bottom number.

   John’s Total: $165,500

Step 3. On the right side of the list, jot down the minimum payment you have to make for each loan and add them together. This number represents the total minimum payment you have to make each month.

Debt Minimum Payment
Credit Card – $500 $35
Car Loan – $15,000 $300
Mortgage – $150,000 $750

Minimum Payment Total: $1,085

Step 4. Here comes the part everyone will hate, making a sacrifice. Pay an extra 10% on your minimum payment of the lowest debt item. It gives you a starting point to get the snowball rolling. How long will you have to pay extra? Well, it depends on how long it will take you to pay off the lowest amount of debt. Let’s look at John’s scenario. Based off of paying $38.50 (35 + 10% of minimum payment) it will take John 13 months to pay off the first line. Paying off the lowest debt is your first short-term goal.

Step 5. Jot down your short-term goal. Our short-term goal in this case is to get rid of the lowest amount of debt 13 months from now. Great! Now that we have a plan and the ball is rolling it’s time to build momentum.

Step 6. Once you are done getting rid of the first line of debt, pat yourself on the back and congratulate yourself! Don’t forget, while you are focusing on the lowest debt amount, you are still chipping away at the other lines of debt since you are making minimum payments. 13 months from now John will have his credit card paid off. Here is how the rest of the debt will look:

John’s debt 13 months from now

Car loan: $15,000 – $3,900 (300 * 13 months) = $11,100 Minimum payment = $300
Mortgage: $150,000 – $9,750 (750 * 13 months) = $140,250 Minimum payment = $750

Step 7. Rollover the minimum payment you made on your lowest debt item to the next level. Now you are making the minimum payment for the second lowest PLUS the minimum payment you would have made for the first lowest. Remember that extra 10%? At this point, you can choose whether or not to keep it, but by this time you will be so used to it I’d keep it in.

John’s new minimum payment for the car loan: $300 + $38.50 = $338.50

Step 8. Repeat these steps until all of your debt is reduced!

There you have it! Do you see how we got the snowball tumbling? Let’s take a step back and look at the big picture. You constructed a game plan to become debt free. You wrote down your short-term goals and a long-term goal to accomplish this feat! Now all that is left is doing it!

Why is prioritizing your debt related to building wealth?

Prioritizing your debt does three things. First, you develop a habit of setting short-term and long-term goals. Wealthy individuals set goals to help them accomplish their dreams. Think of short-term goals as the small steps you take to achieve a long-term goal. Second, your credit score will increase. Consistently paying off debt on time while paying extra will significantly increase your credit score. I dive further into what makes up your credit score and how to increase it here. Last but not least, in the long run, you are putting more money in your pocket. The more debt you get rid of, the more money you have in your pocket. Getting rid of debt = more money.

About Youngwealthbuilders.org

This article was written by @ywealthbuilder, a site dedicated to helping others build wealth through personal finance and career development. If you are interested in reading more articles YWB has written, please visit www.youngwealthbuilder.org. You can follow them on facebook at www.facebook.com/ywealthbuilders/ and twitter @ywealthbuilder.

When it comes to home ownership: buy a home not an investment

Over the last year, one topic has dominated the conversation in Vancouver, real estate. The dramatic price increase has priced many Vancouverite’s out of the market. Organizations such as the Bank of Canada, CMHC, and OSFI are raising concerns about Vancouver and Toronto’s housing market. Perhaps the biggest confirmation for concern was done by the British Columbia government with its new foreign buyer tax. A tax that blindsided everyone with a 15% tax on foreign buyers who purchase real estate in some parts of the province. It was 360 degree turn around by a government who spent the last year telling the public the housing market was both stable and operating as normal.

And while it might be tempting to view the housing problem as only a Vancouver or Toronto issue. Any housing correction or possible crash in these markets will impact homeowners all across Canada. Therefore, this isn’t just a Vancouver or Toronto problem but rather a Canadian problem.

It begs the question: how did we get ourselves into such a position with respect to housing? When did we lose sight of the true meaning and purpose of owning a home? The recent shift in how we view homeownership and our expectations from our homes is completely changing how we think about real estate. We’ve moved from purchasing a home to solely buying an investment that we happen to live in.

Millennials and everyone else is feeling the pressure…

There’s a common theme I find when I have conversations with my friends. They all want to be successful and feel a conscience or unconscious pressure to become successful. I also see an increasing gap between my friends who are doing well and those we are struggling. As a result, there is greater inequity among my friends.

I also find it interesting how millennials are viewed as the most entitled generation yet among my friends I don’t really see that. When I talk with my friends they simply want the same basic things their parents were able to have and provide for them.  Things such as a good job, a family, good friends, good community, and the ability to care for their family if they chose to have one. Most of my friends want the basics in life. What frustrates them and I is obtaining the basics in life is becoming increasingly difficult.

And perhaps the most difficult of those basic needs is home ownership. Buying a home is a huge accomplishment and many millennials or anyone for that matter feels it’s an important milestone to becoming an adult. The problem is home ownership is becoming more difficult for millennials to acquire on their own. TV stations such as HGTV or DIY Network offer an endless stream of housing shows and home improvement projects that constantly add to the pressure of getting a home, while falsely portraying home ownership as always a great investment. As my friends see huge mortgage’s as the only means towards homeownership they are forced to view their newly acquired home as an investment to justify the cost. In short, most of them end up buying an investment rather than buying a home.

Keep the focus on buying a home and you will not care if it goes up or down

A shelter is a basic human need but when you purchase a home you’re also making an investment decision in addition to fulfilling a basic need. The trick is to ensure you stay focus on your primary need, which is shelter. Good investment decisions are made based on factual information available while limiting emotional impulses. Buying a home is 80% emotional and 20% driven by factual information. Therefore, it’s simply not possible for most of us to purchase a home based on its investment value alone since most of our decisions are based on our emotional feel about a house.

Real estate investing is different than buying a home. If you choose to invest in a property, the way you view and assess the property is completely different than how you view and assess a home you want to live in or raise a family in. And since most of us are more likely to purchase a home more for its emotional triggers, it’s best not to pretend to yourself you’re making a solid investment decision. There is always an exception to every rule and I’m aware some people buy a home while also making a good investment. However, we all believe we are the exception to every rule. To avoid the investment trap, buy a home for you and your family to live in while creating wonderful memories. Do not overextend yourself in the name of a good investment.

My wife and I followed kept this in mind when purchasing our first home. We kept the focus on practical and basic things we needed. We did not max out our purchase price because of a view or some fancy kitchen. We were happy to have those things but not over our established budget. If we couldn’t find what we wanted, we were prepared to just keep renting and wait till something came up in the future. We understood home prices will go up and go down and ultimately the price increase and decrease mean nothing unless you’re looking to sell or buy.

Since we bought a home and not an investment, we’re less concerned about the daily ups and downs of real estate market. We did not overextend ourselves by convincing ourselves that it will be a great future investment because the truth is we don’t know what the future holds. And since we cannot see the future we did the following things; bought the house at fair market value at the time, stayed within our budget, did not tell our realtor our max mortgage approval, and ensured we still were able to put money away for savings each month. We had no interest in being house poor in the name of becoming an adult. Being a true adult means being comfortable with who you are and making decisions that are best for you and your family.

It’s worth repeating again. When it comes to home ownership; buy a home, not an investment.

Which is better: renting or buying a home?

The debate about buying a home versus renting a place is an old age debate that’s been around since mortgages were created. And for the foreseeable future, it will continue to a topic we debate. Purchasing a house is one of the biggest investment decisions most people make along with the biggest debt they will take on.

To be transparent, it’s important I let you know I own a property.   Whether you’re purchasing a home or renting one, the decision-making process for both is similar. Most of our purchase/ renting decisions are 80 % emotional while 20% is rooted in simple math. We like to believe it’s the other way around, particular on such a big decision, but the ratio is still an 80/20 split with our emotions making the bulk of our decisions.

This debate is particularly important for my generation. Why? My generation wants the same things their parents provided them. A home to create memories and a decent job to provide for their kids. The problem for my generation is while there are tremendous opportunities available to us we also face increased difficulty in starting our home ownership dream. Naturally, renting isn’t such a dirty word these days given the Canadian housing market. But let’s dive into the debate.

Rent vs Buy Overview

Preet Banerjee is a financial commentator, who did an excellent video comparing renting vs buying. I love video because it both balance and makes the numbers side of the debate less intimidating. Rather than reading my breakdown, I want you to watch the video and then review my comments after.

 

As you can see from the video, from a numbers point of view, the homeowner isn’t guaranteed a clear win. The renter isn’t a clear winner either as a lot of variables need to line up for the renter. What is clear though is our assumptions about either side isn’t entirely rooted in facts or even supported by facts. The more accurate answer to this old age question as to whether renting is better than buying is; it depends. It depends because there are many assumptions and variables at play in order to determine which option is better. If the correct and honest answer is it depends, then why do we continue to believe one side of the argument is always correct? From my observations, there are 3 potential reasons why one side of the debate continues to be portray as the clear winner.

Herd mentality

Our economic system makes the assumption that given all the necessary facts on a topic, we will make the logical decision based on the facts provided. In the real world though people do not make logical conclusions based on the facts available. Just think about the last major decision you made. It was probably an 80/20 split. When a large group of people are making decisions more on their emotions rather than looking at the facts, then you create a herd of irrational decision makers who actually believe they are making a rational decision because everyone else is coming to the same conclusion.

Whether you’re purchasing a car, a home, or stocks it critical you spend some time looking at the facts and trying to come to a conclusion based on those facts. The debate about renting vs buying is clouded as the herd mentality means getting factual information about which is better is hard and honestly we don’t want to really know the truth.

Timing matters

When it comes to renting vs buying; timing matters a great deal. It’s possible to make a great decision but if the timing is wrong it could be a poor decision. If you purchase a home too soon it might become too much of a burden as you’re unable to save up for an emergency fund, travel, relocate for a job, or build up your investment account early in life. A home purchase too late in life can also make homeownership unappealing. Timing doesn’t get enough attention on this debate. This isn’t timing in the sense of market timing or purchase timing. This is about the individual trying to ensure the timing makes sense for a home purchase. The assumption is usually that getting a home at any point is a great investment. But as the video illustrated that’s not always factually true.

False premises

If you rent, the belief is that you’re wasting your money as you’re giving away rent each month when you could be owning your own place. This argument appears to have a logical premise at first glance. But in reality, it has nothing to do with numbers and more again about emotions and reconfirmation of our decisions. Renting isn’t throwing away your money unless you assume the individual has no other savings plan other than the money that he or she is currently using as rent.

On the other side, you have people who say home ownership is a losing game when you factor in ongoing upkeeping costs and interest cost. Again, the assumption here is that an individual will keep the mortgage for 25 years and the owner has bought a house at their full capacity. It’s unreasonable to assume every homeowner who buys a house does so at their full financial capacity. Some homeowners purchase a home and still have enough cash flow to save towards their retirement or raise their family. The bottom line is we make the wrong assumption about the renter and buys. These false assumptions are made to reinforce the decisions we’ve already made.

My conclusion

The one thing you should take away from this debate is, renting vs buying isn’t a slam dunk for either side. There are a lot of variables that need to line up for either side to claim victory. Secondly, this is an emotional decision/ debate and as such the numbers matter little. Said differently, we avoid looking at the numbers side of things because ultimately we know buying a home or renting is less about the numbers and more about our emotional need that buying or renting fulfills. And at the end fo the day, it’s those feelings of security, pride, ego, flexibility or shelter that matters to us.

Lastly, you probably should air on the side of caution regardless of what side of the debate you side with. If you own a home, you should ensure you have enough money left over to invest and create an emergency fund. This means you don’t view your home as your sole retirement plan. The same goes for renting. Don’t simply rent and then spend your disposable income on vacations or eating out every day. Rather put your leftover money towards investments and perhaps consider buying a home when the timing is right. Diversification is the key to this old age debate.

Take years off your mortgage with this payment option

I’ve yet to meet someone who likes having a mortgage. Once the honeymoon phase of home ownership fades the focus quickly turns to how best to pay off the mortgage.

The key to getting rid of your mortgage may come down to the type of mortgage payment you select. Before I go any further, it’s important to understand a couple of things about mortgages. The interest on a mortgage is not calculated in advance and the compounding period for  mortgages are semi-annually.  What does that mean for you? It means frequency along with additional payments are critical to cutting years off your mortgage and saving on interest cost.

What types of mortgage payment options are available?

There are 6 different types of mortgage payments available. They are monthly, semi-monthly, bi-weekly, weekly, accelerated bi-weekly, and accelerated weekly. When deciding on a payment option most people pick the one that matches their pay schedule. If you’re paid monthly, you’re likely to lean towards a monthly mortgage payment. Picking a payment option that matches with your pay schedule might be convenient but could  result in you having a mortgage longer and paying more in interest costs.

What’s the best mortgage payment option?

The best mortgage payment is one that enables you to make more frequent payments within a year while also making extra payments within the year. As such, the best mortgage payment option would be an accelerated weekly payment as you make payments every week. While it’s the best mortgage payment options to taking years off your mortgage, most of us do not get paid weekly. Therefore, the most common payment option selected by most people is biweekly or monthly still as it more convenient with their pay schedule.

What’s the difference between a bi-weekly and an accelerated bi-weekly payment?

Most people select a bi-weekly payment option when they are seeking the effects of an accelerated bi-weekly payment option. Bi-weekly payment takes the equivalent yearly monthly mortgage payments and divides that figure by 26 to determine your bi-weekly payment amount. The actual dollar amount you pay with a monthly or biweekly payment will the same, however, you will reduce your amortization slightly and save some interest due to the frequency of bi-weekly payment.

Accelerated bi-weekly payment calculation is slightly different. To calculate your accelerated bi-weekly payment you take your monthly equivalent mortgage payment and divide that amount by two and then make 26 equal payments throughout the year. As a result, you end up paying more per year with an accelerated bi-weekly payment option compared to bi-weekly payments.

A case study to illustrate the effects of mortgage payment options

Let’s assume you get $100, 000 mortgage and put down 5% on a 5 year fixed term mortgage. The interest rate on the mortgage is 3% and there is mortgage insurance since it’s a high ratio mortgage. The chart below shows all the different payment options available and the impact they would have on the amortization.

Payment Frequency Monthly Semi-Monthly Bi-weekly Weekly Accelerated bi-weekly Accelerated weekly
Payment amount $465.77 $232.89 $214.97 $107.49 $232.89 $116.45
Amortization 25 years 25 years 24 years & 11 months 24 years & 11 months 22 years & 2months 22 years & 2 months
Term Interest Cost $13, 650.19 $13, 631.46 $13, 579.70 $13, 571.00 $13, 399.43 $13, 390.02
Amortization interest cost $41, 310.21 $41, 180.14 $40, 940.82 $40, 878.81 $36, 040.74 $35, 984.02

 

After reviewing the chart, you can see a monthly payment option is the least effective payment option for reducing your amortization and saving on interest cost. The best option is an accelerated weekly payment option which cuts a 25-years mortgage down to 22 years and 2 months. A bi-weekly payment will reduce your mortgage amortization to 24 years and 11 months, which 1 month less than a monthly payment option. If you selected an accelerated bi-weekly payment frequency will take almost 3 years off the mortgage amortization.

The difference between a bi-weekly and accelerated bi-weekly payment is $17.92 biweekly. Yet, the payment made with an accelerated biweekly payment at the end of the year is $465.90 more than a bi-weekly payment. That works out to an additional $2, 329.50 by the end of the 5-year term simply by selecting an accelerated bi-weekly payment option.

The takeaway is clear. Accelerated payments are the way to go.  Since most of us get paid bi-weekly you should be select an accelerated bi-weekly payment frequency for your mortgage. Avoid selecting a monthly or a bi-weekly payment option for your mortgage due to the long term costs it can have.

What is a fixed rate mortgage?

A few weeks ago I reviewed what a variable mortgage was. Today, I want to provide an overview of what a fixed rate mortgage is. Similar to a variable rate mortgage, a fixed rate mortgage comes in two varieties; open and closed. Some of the main differences between a variable mortgage and a fixed rate mortgage include the interest rate and prepayment costs. A fixed rate mortgage, whether open or close, has a constant interest rate throughout the term of the mortgage. This means the interest rate you secure doesn’t change for the term of your mortgage regardless of economic conditions.

An open fix rate mortgage can be paid off in full at any time without any prepayment penalty (cost to break the mortgage).  Since the mortgage can be paid off in full at any time, you can expect a higher interest rate compared to a similar closed rate mortgage.

With a closed fixed rate mortgage, it’s possible to pay off the mortgage at any time, however, you will incur prepayment cost. The prepayment cost calculation for a fixed rate mortgage is a little more complicated than the standard 3 months of interest on a variable rate mortgage. I will be writing a blog dedicated to this calculation but for now, just know the prepayment cost are usually higher with a fixed closed rate mortgage.

Choosing a fixed rate mortgage might be a good option if you would like to keep your interest rate fixed throughout your mortgage term. If you believe you might pay off your mortgage before the term but still want a constant interest rate, then an open fixed rate mortgage might be a good option to consider. While a fixed closed rate mortgage will secure you the best interest rate, the associated prepayment cost are much higher than a variable or an open fixed rate mortgage.

Similar to my advice on the variable rate mortgage option, it’s really important you pick the right mortgage option that suits you best. Don’t feel pressure to pick a fixed rate mortgage option if it doesn’t fit or meet your needs. Take the time to determine which mortgage option is the best option for you.

What is the difference between a high ratio and a conventional mortgage?

 

As house prices continue to defy logic, I increasingly find myself having more conversations around real estate.  For this post, I wanted to shed some light on come common financial terms used in the mortgage industry and explain what they mean.

When getting a mortgage you might hear the terms conventional, low ratio, or high ratio mortgage being tossed around. And while you might nod your head proclaiming to understand these terms, you might actually be wondering what exactly do they mean.

There are two types of mortgages you may qualify for depending on your available down payment. The first type of mortgage is known as a high-ratio mortgage (non-conventional). The second type is known as a conventional (low-ratio) mortgage.

If the available down payment you have for a home is less than 20% of the purchase price, you have a high ratio mortgage. Said differently, the mortgage loan will be for more than 80% of the purchase price. Most first-time purchaser will fall into this category since they are less likely to have a 20% down payment.

A high ratio mortgage requires mortgage insurance. Mortgage insurance can be obtained from CHMC, Genworth, or Canada Guaranty. The mortgage insurance cost can be paid up front if you have the funds but it’s commonly financed with the mortgage. It’s important to note the mortgage insurance is to protect the lender, not you. In addition to mortgage insurance, high-ratio mortgage maximum amortization is 25 years.

If you have at 20% or more of the purchase price available as a down payment, the mortgage is referred to as a low ratio or conventional mortgage. As a result, you might not be required to get mortgage insurance depending on the property and lender’s guidelines. A low ratio mortgage can be amortized up to 30 years compared to only 25 years on a high ratio mortgage.

High ratio mortgages are viewed by a lender to be of greater risk, therefore, they require mortgage insurance to reduce that risk. While low ratios mortgages are viewed less of a risk compared to high ratio mortgages, it’s possible a lender might still require mortgage insurance on a property in order to provide you with an approval.

 

What is a variable rate mortgage?

When it comes to mortgages, there are two primary types; variable or fixed rate mortgage. A variable rate mortgage is one which the interest rate is subject to change, unlike a fixed rate mortgage where the rate is constant for the entire term.

Variable mortgages can be either an open or closed term mortgage. The main difference between the two is their corresponding prepayment cost if the mortgage is broken or paid off before the mortgage term.

An open variable mortgage will have a higher interest rate compared to a closed variable mortgage due to the fact the mortgage can be broken at any time without any prepayment penalty (cost to break the mortgage early). With a closed variable mortgage, the interest rate will be lower than a comparable open variable rate mortgage. However, the prepayment penalty will be 3 months of interest charge with a closed variable rate mortgage. Closed variable rate mortgage can also be advantageous when it comes to refinancing or porting a mortgage as it’s possible for prepayment charges to be eliminated while securing a lower interest rate by choosing a variable closed mortgage.

The common thing both an open and a closed variable mortgage share is their interest rate is subject to change. The rate you secure is a discount off the current prime rate. For example, the prime rate is currently 2.700% and assuming your bank offered you a 70 basis point discount off the prime rate, your mortgage rate would be 2.00%.  This rate is subject to change base on prime rate movement. In the event prime increase to let’s say 3.00%, your new rate would work out to 2.20% (3-.70). This is due to the fact variable rate mortgages are a discount off the prime rate.

In an effort to avoid individuals signing up for mortgages they can’t afford if the prime rate increases, individuals have to be qualified at a higher interest rate in order to get a variable rate mortgage. As it stands, CMHC qualifying benchmark rate for a variable mortgage is at 4.64%. That means, anyone looking to qualify for a variable rate mortgage must first be able to qualify for the same mortgage at 4.64% interest rate.

Going with a variable rate mortgage can offer you a lower interest rate and greater flexibility. It’s a good option particularly if you know you might have to break your mortgage before the term ends.

The key to making a variable mortgage work is to first understand your rate could be subject to change should things significantly change in the economy. Spend some time to develop a plan in the event things change to ensure you can handle a couple of percent increase.

Lastly, this is really a personal preference from my experience. I think it’s important you pick a mortgage option you feel comfortable with. Don’t feel pressured to pick a variable rate mortgage if you do not feel comfortable with it. You are the one who will be responsible for making payments and you should pick what you feel will work best for you.

Mortgage insurance or term insurance: which is better for protecting your home?

The excitement of purchasing your first home can quickly disappear after you realize the responsibilities of home ownership. One of the things that soon becomes apparent after successfully securing a home is the need to protect your investment. Purchasing a home will start the insurance conversation if you’ve avoided it or never had a reason to discuss it before. There are two primary options available when it comes to protecting your home. The first is mortgage insurance and the second is term insurance. If you’re purchasing your first home, especially as a young buyer, you’re likely to select mortgage insurance by default. But is that the best option? Before I give you the answer let’s review what these two products are.

What is mortgage insurance?

Mortgage insurance is insurance coverage against your mortgage in the event you die. Most mortgage insurance offered by financial institutions will also offer some form of disability coverage in the event you become disable and unable to work. However, the disability insurance isn’t indefinite so please be sure to look at the insurance policy in detail.

A couple of things to keep in mind regarding mortgage insurance. First, mortgage insurance is insurance coverage against a debt. And as it’s name indicates the debt is the mortgage. Any proceed or benefit from the policy is to be used to pay off the debt and cannot be used for anything else. That means if there’s a payout, it has to be used to pay off the mortgage and nothing else.

Additionally, mortgage insurance premiums do not change as long as they are in effect even though the mortgage balance will decrease over time. For example, if you purchased a $100, 000 mortgage insurance policy and after 10 years you die with only $60, 000 left on the mortgage. The mortgage insurance will pay the $60,000 mortgage even though your premium is based on $100,000 coverage. There’s a $40, 000 gap that isn’t recoverable to you even though you’ve paid premiums based on $100, 000 coverage.

What is term insurance?

Term insurance is life insurance coverage that provides a fixed coverage amount at a fixed premium for the term of the insurance policy. Term insurance is usually anywhere from 10-30 years term but can be longer or shorter. There are some term 70 policies, which offer life insurance till age 70. But since I’m talking about mortgage insurance alternative the most common term selected is usually 30 years to match the mortgage term. As an alternative to mortgage insurance, you simply get a life insurance policy with a similar dollar amount as your mortgage and term to match your mortgage.

The main thing to understand with life insurance is it’s a policy against your life. That means the proceed can be used by your beneficiary towards anything they choose. In the case of getting term insurance policy instead of mortgage insurance, your beneficiary is not required to use the payout to cover the mortgage. The proceed can be used for anything.

Furthermore, the amount of coverage stays the same. For example, if you purchased a $100, 000 term 30 life insurance policy and died after 10 years with only $60, 000 left on your mortgage. Your beneficiary would receive $100, 000 cheque, which they could use $60,000 of it to pay off the existing mortgage balance and would still be left with $40,000 to help with any other expenses.

Which option is better?

Perhaps it best to answer that question by sharing my experience. I have a term 70 life insurance policy. My wife and I were relatively young when we purchase our house which made the term insurance price attractive. Before deciding to go with term insurance, we considered all the options available to us including whole life insurance. We decided against mortgage insurance for two main reasons; cost and flexibility. Our mortgage insurance which included some disability coverage amounted to about $300 or $400 for the two of us.

The mortgage insurance would have continued making our mortgage payments in the event one of us died. While I felt comforted by that, I wasn’t feeling great as my wife would still have to get additional insurance to replace my salary for a year, along with any additional cost funeral cost should I die.

We also consider where life might take us in the future. If my wife and I were to have kids in the future, we would need additional money to help raise the kids should one of us not be around. Having the mortgage paid would not be enough as my wife or I would still need to work and would require additional cash flow. I also knew we might pick up an additional rental property in the future and figure our premium would be more expensive as we got older.

When we considered all those things we realize having mortgage insurance just did not offer us the flexibility or coverage we required. We wanted to take advantage of our age to have a reasonable premium while also trying to secure as much insurance as needed for any potential future needs.  Also, if we picked the mortgage insurance option and decide to upgrade our house and purchased a house that’s more expensive than our current mortgage, we would be required to apply for mortgage insurance on the new amount. And since we would be older, the new mortgage amount might be too expensive for us or worse we might not qualify due to health issues.

To our surprise getting a term 70 life insurance policy was actually much cheaper than the mortgage insurance, it came in around $189 for the two of us. We ended up getting a lot more life insurance than we currently need at our current age. We tried our best to anticipate our future needs and went about $200K more than we anticipated we might need today and in the future.

For disability coverage, we also shopped around and there were some products that included disability and life insurance but found them to be too expensive for our budget.  We decided to use our work disability plans and supplement it with additional savings and a line of credit. We both selected the maximum amount of coverage available at our work plans, which for me is 60% of my wages that’s indexed to inflation. That’s not a lot since most of us live on 100% of our net income. That being the case, we decided to open a line of credit up to provide us quick access to emergency funds and put in place a plan to save enough cash on hand to provide us liquidity to deal with emergencies.

For my wife and me, term insurance was the right option. I hesitate to say one option is better than another because this is a really personal decision that needs to be discussed in detail. When it comes to insurance coverage you want to look at your entire life needs and avoid getting insurance in isolation.

Some things to remember

When applying for a mortgage you should always sign up for mortgage insurance. You do not want to be approved for a mortgage or sign a purchase agreement without having some sort of coverage in place. Even if you plan to go with a term policy, if you do not have one already in place, opt for the mortgage insurance your lender is offering in the meantime. If you currently have mortgage insurance and are thinking of getting term insurance, do not cancel anything until you’ve been approved.

The key with insurance is to ensure you not only have enough to cover your immediate needs but also additional expenses. If you get term insurance for your mortgage, don’t simply get a $300,000 policy because you have a mortgage for that amount.  Think beyond your mortgage. What about your spouse, your kids, and any other expenses that might come as a result of your death.

Should the worse happen, you need to provide your family time to grieve and time to recover. To do that, you have to think about all the possible things they might face or challenges and find the right amount of coverage and type of plan that will fit your needs and budget.

 

What is the first time home buyers program?

If you’re thinking about buying a house and looking for a source of down payment, your RRSP might be the perfect source. Under the first time home buyers’ program, you can withdraw money from your RRSP account to use as a down payment towards the purchase of a property. Currently, an individual can withdraw up to $25, 000.00 from their RRSP account to purchase a property without incurring any withholding tax.

To qualify for the first time home buyer’s program, you must be a resident of Canada, have entered into a written agreement to purchase or build a qualifying home for yourself, and have not purchased or occupied a property you or your spouse own. In short, you haven’t purchased a property and this will be your first home you’re purchasing.

The funds being pulled under the program must have been in the RRSP account for at least 90 days before being withdrawn. Once the money has been pulled from your RRSP account to purchase a home, you have 15 years to repay the money back into your RRSP account. You are required to payback  1/15 of the amount each year until the balance is fully repaid. Repayments start in the second year after the funds were pulled. Any amount you fail to repay in any year will be added to your income in that particular year and might result in additional taxes.

For example, if you were to pull the full $25, 000.00 from your RRSP account to help with the purchase of a new home. You would be required to pay back approximately $1, 666 ($25,000/15) per year, which works out to about $139 ($1666/12) per month. Any year you fail to pay the full balance that portion will be added to your income.

But like anything in life, there are some drawbacks to this program. One of the biggest drawbacks is you give up any potential future growth the money in your RRSP might have had if you had continued to invest the money.  The yearly repayment requirement might cause some cash flow problems, therefore, it’s important you ensure you can afford the repayment requirement before pulling the money from your RRSP account under the program.

Lastly, some tips and things to keep in mind. While most people use the first time home buyers program as a down payment, it’s not the only thing you can use the funds for. As long as you qualify for the first time home buyer program, what you ultimately decide to use the funds for is up to you generally speaking. For example, the funds could be used to cover moving or legal cost.

It’s also important to note that while you’re able to pay more than 1/15 each year, it’s best to pay just the minimum amount you’re required to under the program. If you claim more of your RRSP contribution against the first time home buyers repayment plan, less of your contributions can be claimed against your income. Remember, this is a loan to yourself and there’s not an absurd high interest rate being charged to you, in fact, there isn’t any interest being charged. RRSP contribution towards the home buyers program cannot be deducted against your taxable income, therefore, there’s no real advantage to repaying more than the yearly required from a tax standpoint.

The first time home buyer program is my favorite type of financing. Why? Because you get to be the lender, the customer, and the borrower. But more importantly, you get all the benefits and future profit when using this program to buy your first home.