Buying a Home
Buying a home is at the top of the list of a lot of people’s personal finance goals. It is a major milestone heavily connected with feelings of success. Rapid housing price inflation all across Canada has made it a very expensive goal to achieve. For those that do have home buying as one of their high priority goals, there is a couple things they should consider.
- Is home buying really for me?
- How much can I afford?
- Costs of home-ownership
- Getting a down payment
- Finding a home
Is home buying for me?
A common opinion is that renting is just throwing money away. If you are not in the correct financial and life position, this could not be further from the truth. You can lose more money buying a house than you could renting for a life time in many scenarios. Buying a home is not a risk-free purchase. On top of that, there is the argument that if you invested the money you would have otherwise used for a down payment, you could come out with just as much money at the end as the home buyer. The thing about calculations like that is there is simply way to many assumptions and unknown variables. Those posts don’t predict what the local housing market is going to do, and they can’t predict the future of the stock market. However, I can tell you a few scenarios that you will almost definitely lose when buying a home.
You are less than confident you will stay in the house long term. If there’s a possibility you will have to move or you want to buy a starter house and upgrade in a couple of years, don’t buy a home. Realtor and lawyer fees for buying and selling a $300k home will probably cost you over $15,000. Even if you sell the home for what you paid for it, you are still in the hole $15,000 and that’s a lot of inconvenience. Just wait until you are in a more stable position that you are sure you will be there for a long time. If you plan on upgrading a couple years after buying, rent and wait to get the long term home you want.
The second way is if your financials aren’t ready for it. Buying a home with a 5% down payment will incur CMHC fees (more on those later) that eat up 80% of that down payment. On a $300k house, that’s $11,000 down the hole right at the start.
Combine those two things and calculate how much you would save a month owning vs renting. You would be able to rent for a long long time and be holding a lot less risk.
How much can I afford?
You can get a pre-approval from a bank that will tell you how much they will give you. From what I’ve seen, the bank will lend you MUCH more money than you should actually spend however. One rule-of-thumb people use to estimate how much they can afford is the 28/36 rule. This rule states that the maximum you should spend on housing expenses is 28% of your gross income and 36% on total debt. This is a safe rule to follow, however with all general rules like this, it errs on the safe side. It doesn’t include personal values. If you would make other financial sacrifices because a home is very important to you, the 28% is a very conservative number. The maximum expense-to-income ratio that CMHC aims to allow is 42% for home and other debts. Percentages also change with your income. If you had a debt and housing expense of 50% of your income, your living situation would be a LOT different if that income was $4,000 or $7,000 (Having $2,000 left vs $3,500). Only you can decide how much you can afford. Estimate the expenses. Estimate them high. See how they stack up versus your income and whether you can still be comfortable. One piece of advice I have is to save until you have a 20% down payment. It will keep your costs down and help you avoid CMHC fees. CMHC is a loan insurance company that is mandatory on high loan-to-value loans. The cost scales with how high the loan-to-value ratio is. With a 5% down payment CMHC fees are 4%. This puts you underwater equity wise if you ever had to sell after you include selling costs. The only time you should buy a house with 5% down is if it is a hot market that is inflating faster than you can save.
All-in costs of home ownership
Owning a house isn’t cheap. There are lots of costs associated with owning a home and they are often over-looked. These costs include:
- Mortgage payments
- Property tax
- Home insurance
- Condo/Strata fees
Mortgage payments are the obvious expense – use a mortgage calculator to calculate what your payments will be. If you are still debating renting vs owning, make sure you check how much interest costs per year.
Property taxes is the tax you have to pay for owning property. If you are buying a home, the property listing should have the property taxes there, or the previous owner should have a copy.
You can get home insurance quotes from insurance companies to get an idea of the costs.
Maintenance is harder to estimate and depends on things like the condition and age of the home. Make sure to budget for standard big maintenance items like shingles or furnace replacement.
Condo fees should be on the property listing, the owners should have a copy as well. If you are buying a condo, there will often be condo documents to review. These documents will tell you about the health of the buildings financials, hire a professional to review them if it is outside your skillset.
To get an estimate of the utilities, ask the home owner or if you know anyone in the area with a similar home, that should give you a decent idea as well. Utilities to consider include: water, power, gas, and internet. If you plan on getting anything extra like an alarm system, television or a landline for telephones you might as well throw that in here too.
This should give you a pretty good idea of the cost of owning a home. Make sure to estimate high just to be on the safe side.
Getting a down payment
5% is the minimum down payment, but as I mentioned before, I recommend 20%. When saving for a down payment, do NOT invest it in anything risky. This means high interest savings accounts are your best friend. This is because the market can take a dip that takes years to recover and you’ll be forced to sell low or put your dreams of home ownership on hold until it does recover. On top of using your savings accounts, there are first time homebuyers plans to help you out in Canada. This is a government offer of 5-10% of the purchase price of a home for the same amount of equity in the home to help with the down payment. You will have to pay it back, but it is interest free. You can also withdraw up to $35,000 from your RRSP’s tax free, but this also has to be repaid within 15 years.
Finding a home
You know how much you can afford, you’ve been pre-approved for financing from the bank and you are ready to buy! While this should be a fun time, it should also be taken seriously. Do your research months before you are ready to buy. Watch the market and get comfortable with the prices. Find a good realtor. Interview them and don’t just hire the first one you find. Be diligent and do your research. When you are spending hundreds of thousands of dollars, overspending by a couple percent could easily be ten or twenty thousand dollars in the drain.