The Backwards (But Right!) Way to Finance Your First Home

When it comes to getting a mortgage to buy your first home, many buyers decide on the price point of the house they want to buy before talking to a lender. They’ll say something like -- “We are going to buy a home for $500,000” -- and then they head out to open houses in that price range. Even though that’s how it seems like it should be done and how many people do it, that’s not at all the way to start your home-buying experience.
In fact, if you go about financing your first home this way, you’ll not only have a miserable experience, but it also could cause you to buy the wrong home!

 
Follow these Four Steps --
You’ll be all set and on the right path if you follow the 4 steps below. And keep reading since you don’t want to miss the BONUS section -- with even more tips on getting the right mortgage for your budget.

1. FIRST, decide what you want to pay PER MONTH before you talk to the lender.
This is the most important decision you’ll make when it comes to buying your first home. Everything else will fall into place once you make this decision.
Decide this before you talk with any mortgage brokers or lenders, before you start searching for homes online, and before you start going to open houses.

 
Why?
The reason is twofold.

• Most lenders will approve you for more than you want to spend. Whatever you are approved to spend on a home is irrelevant. Most people are ap-proved to buy way more house than they actually want to spend.
This often comes as a surprise, since most people feel like they won't be approved for enough. But that’s typically not the case; it’s actually the opposite! Most people are approved to spend way more than they want to shell out every month for a home.

 
That’s why you should start the conversation with your lender not by asking them what you are approved to buy, but rather telling them what you feel comfortable paying per month for your new home (inclusive of condo fees, if any, taxes and insurance).
The lender can then work backward to determine the correlating sales price and tell you if you would be approved for that amount.

They will need one other piece of information from you in order to provide a price point, which we will discuss when talking about cash for your transaction (see #3 below).

• If you plan to buy a condo or anything else with a monthly condo fee, your correlating purchase price will differ since you need to include this amount. For example, the monthly payment for a $500,000 condo with a condo fee of $500 per month is going to be a completely different monthly payment than a house with no condo fee. The difference in purchase price may be as much as $50,000 or more—that’s a huge difference in purchase price you need to account for!!

Conservative advice is to spend about 30 percent of your income on housing. Ask yourself if what you want to spend per month is in that range. If it is, you are okay.
You should also be looking at your monthly budget so you can compare future home expenses to your current rent expenses. That will help you determine an af-fordable mortgage payment.
Again, focus on your monthly mortgage payment rather than fixating on one big sales number or price range. It’s easier to comprehend since most of us budget for monthly expenses already, and will help you take into account any condo fees, etc.

 
3. Decide how much cash you want to spend on the transaction.
In addition to what you want to spend per month, you need to know how much cash you want to spend on your purchase. As we mentioned above, this is the sec-ond piece of information your lender needs in order to determine your price point.
You will need cash for down payment and closing costs.
Decide upfront how much cash you can put towards your home purchase. Will it include a gift from family? A loan from your RRSP or cash from your TFSA?
Some things to keep in mind when you are thinking about how much cash you want to allocate to your home purchase:
• Start with a dollar figure, not a percentage. You can work in percentages later when you have a sense of your purchase price.
You may be able to spend a little less cash to hit one of the points that lend-ers like to see. For example, if you have around 10% to put down, then put-ting 12% down won’t change your interest rate or really help anything from a loan standpoint. So you could save that extra 2% for moving expenses since it will do you more good as cash in hand than cash in your home.
• As a buyer, closing costs are going to run you between 1.5-2% of your home price. Be sure to set aside some of your cash for closing costs, not just for down payment. Your lender can help you with this.
• Don’t worry so much about putting 20% down. There is a very traditional mindset that says you must put 20% down in order to avoid mortgage insur-ance. Although that is accurate, 20% down may not be the best decision for you. Make sure you explore different downpayment options with your bro-ker or lender.

4. Now you’re ready with your two important figures!
You are all set to meet with a lender. You should now understand the two things that will help them determine your price range:
1. What you want to pay per month.
2. How much cash you want to spend on your purchase.

 
You can always make adjustments later on and see how that will change the price point, but start with some figures you are comfortable with in terms of monthly payment and cash for your purchase.
BONUS SECTION – More Information on Getting the Right Mortgage
When it comes to adjustments once you receive your price point from your lender, keep these tips in mind:

1. Mortgage “Rules of Thumb”
These are additional guidelines that you can use to help determine your mortgage payments. Remember, you still want to have some cash left over and not be wiped clean each month.
• The 5 % rule. This is an oversimplified rule, but if your rent is higher than 5% (annualized) of the cost to buy a similar home, then ownership would be a more affordable option based on monthly cost. For example, if you pay $2200 a month for a home, and it would cost you $500,000 to buy a similar home, than the cost of ownership would be approximately $2083. See more details on this rule here

• Every $10,000 change in your loan amount, whether that’s through increasing or decreasing your price point or increasing or decreasing your down payment will only change your monthly payment by about $50-$80 per month (depending on your purchase price, the lower the price, the lower the change in the monthly payment for every $10,000 change). Yep, that’s all! So, don’t worry as much about saving another year or two for an addi-tional $10,000 to put down if you can swing an extra $50-80 per month in-stead.
• It’s not one-size-fits-all when it comes to mortgages, and working with a mortgage broker to go over the options available is important. Make sure you are looking at the entire loan picture — the program, the time period you are going to own the home, and the terms of the loan; and how all of that creates the best financial position for you.

 
You should think of the loan summary and price points your lender gives you as rough drafts until you find an option that suites your specific finances and situation.
The loan your friend gets is not the one you should necessarily get. These days, when it comes to financing your first home, there are lots of different options available that you really need to focus on what’s best for your par-ticular financial situation and goals.

• Know your credit score since your score will also affect your mortgage interest rate. Your credit score is a major factor for lenders when determining your risk. That means your score plays a big part in the type of loan you will be offered and its interest rate. The higher your score, the lower your rate.
Remember, a credit score has nothing to do with your income or invest-ments. It’s based on how you’ve handled your credit card payments and other loan payments, like your car or student loan. It also takes into account if you’ve declared bankruptcy, have a tax lien, or you’re being sought by a collection agency.
• Having a score of 680 and above means you’ll have more options, lower interest rate, less down payment requirements.
• 620-660 is considered a fair score and lenders may work with you but may require more documentation to determine if they should take a risk and give you a loan.
• Below 620 is considered a poor score and many lenders will deny your loan application completely. You may have access to only one or two loan options, such as private lending at much higher interest rate.
If you need to improve your rate, you may need to delay getting your home until it’s higher.

2. See if you qualify for any first-time homebuyer assistance programs.
The First Time Home Buyer Assistance programs in Canada offered by the CMHC and is available to first time buyers with household incomes less than $120K. Other details can be found here 

3. Try to determine how long you plan to own this home.
Consider your current and future finances and also where you will be in 5 or more years. There are several loan products that may be better for you than a “go-to” 25-year fixed loan.

 
5. Keep an eye out for hidden fees or additional costs along the way.
• Don’t be fooled by advertised rates! Behind that rate could be a long list of fees, points, or closing costs. Ask the lender to break down the fees and give you the total amount for closing the loan.
• Understand what the pre-payment terms are for your loan if it is portable, and what the penalty is for refinancing prior to your term ending. There are different types of loans and lenders so make sure you read the fine print!
• Mortgage disclosure forms have been simplified. They do a much better job of disclosing a loan’s terms and cost to borrowers. Make sure you carefully review the Loan Estimate, given three business days after application, and the Closing Disclosure, given three business days before closing.

 
You’re off to a great start now that you know the best way to go about financing your first home. Now it’s time to show you how your budget, location, and your criteria for a home come together as a “roadmap” in your search for the perfect home. 

Next week’s article, Putting It All Together explains how these three factors are intertwined and will lead you to your new home!