If you are thinking of home ownership, you are potentially looking at one of the most rewarding financial decisions you will ever make. At the same time, a home purchase is a significant investment that requires careful consideration. Financial institutions are committed to ensuring that you are an informed buyer and to this end, I would like to address five indicators that you are probably ready for the responsibilities (and joys) of home ownership.
1. You have a handle on debt
A mortgage comes with significant debt responsibility so borrowers need to show they have a handle on their overall debt. Financial institutions will only approve your mortgage if your current debts are within reason and if you have been consistent in your payments.
A good measure of this is your credit score. Any time you fulfil a debt obligation or seek new credit, the lender conveys information to the credit reporting agencies, Equifax and TransUnion, for use in calculating your credit score, which typically ranges from 400 to 900. A score above 600 is considered good, while 750 or more is excellent (to learn your credit score, visit www.equifax.ca or www.transunion.ca). A good credit score is also important because it may qualify you for a better rate on your mortgage.
2. You can afford a mortgage
In layperson’s terms, affordability means you have sufficient funds to make your minimum monthly mortgage payments. Lenders, however, use a couple of technical measures to determine affordability. One is your gross debt service (GDS) ratio, which is the percentage of your gross monthly income that goes towards housing costs (mortgage payments, property taxes, all or a portion of strata fees and heating). Your GDS needs to be 32 per cent or lower. The other measure is your total debt service (TDS) ratio, the percentage of your gross monthly income needed to meet all your debt obligations (housing, credit cards, and other loans). The magic number here is 40 per cent or less. If you’re not a math genius, don’t worry, there are online mortgage calculators that simplify these calculations and help you ballpark what you can afford (you may need to estimate some of the required numbers). For a good mortgage affordability calculator, visit www.coastcapitalsavings.com/Personal/Borrowing/Mortgages.
3. You have steady income
To qualify for a mortgage, lenders expect you to have a steady job with a stable flow of income. Although you’re not expected to be able to predict the future, a good candidate will have some measure of job security, which means if your work is sporadic or temporary, this may not be the right time for a mortgage. A steady income does not mean your monthly pay is the same each month – self-employed individuals, for example, often see fluctuations. Regardless, when your annual income is averaged out, it should show that you have reliable earnings to support mortgage payments.
4. You have a minimum five per cent down payment
This is the least amount of down payment required for homes costing less than $1 million and one of the biggest challenges faced by first-time homebuyers, so congratulations if you’ve saved the needed funds. Although five per cent meets the minimum threshold, any amount less than 20 per cent will require that you purchase mortgage default insurance, which will increase your mortgage debt. Unlike insured high-ratio mortgages (where the homeowner has a down payment of less than 20 per cent), conventional mortgages with a down payment of 20 per cent or more do not require this insurance. As a rule, the larger your down payment, the better, because the extra payment upfront will reduce your interest costs over the long term.
5. You have finances for “hidden costs”
Have you factored legal fees, insurance, inspection, taxes, and other miscellaneous additional costs into your calculations? If so, you are thinking like a future homeowner. Many first-time home buyers can be blindsided by these less-obvious costs of home ownership, focusing primarily on the mortgage itself. But these costs can add up and some of them, such as annual property taxes and monthly strata fees, are new recurring items you’ll need to include in your budget going forward.
Important costs you need to be prepared for include GST for new or substantially renovated homes, lawyer’s fees to transfer the property, appraisal costs (to determine the home’s value), inspection charges (to identify any red flags), and costs for any repairs or renovations you may wish to make. You will also need to pay the property transfer tax, although first-time home buyers may be exempt from part or all of the tax under certain conditions. If you are moving from renting to owning, maintenance costs now fall to you so it’s advisable to set aside regular savings for this. Last, but not least, you will need to account for insurance costs.
If you believe, after reading this article, that you meet the requirements described, you may be ready for the next step, which is having a chat with your financial institution. Ultimately, your credit union or bank will decide if you qualify for a mortgage, based on a comprehensive review of your financial situation, but these indicators can help with your initial self-evaluation.
Kathy McGarrigle is Chief Operating Officer for Coast Capital Savings, Canada’s largest credit union by membership size.