Calculate a Workable Home-Buying Budget

About two-thirds of Manitobans own their own homes and every year thousands more buy a home for the first time. It's a similar story across Canada. Home ownership is an essential part of life.

If you are thinking of buying a home, don't start shopping until you know exactly how much home you can afford. Find your price range by calculating three amounts: the amount of cash you can put toward the purchase (down payment), the maximum amount of loan (mortgage) you can comfortably pay back and the costs associated with actually completing a purchase (closing costs).

Down payment

Canada's National Housing Act keeps lenders from providing the entire amount of a home's market value, so you will need a cash down payment to cover part of the purchase price.

The Act says a lender cannot normally provide more than 75 per cent of a home's market value unless the mortgage is insured by the Canada Mortgage and Housing Corporation (CMHC) or a private insurance company.

With mortgage loan insurance you can borrow up to 95 per cent of a home's value. The loan is known as a "highratio" mortgage because of the high proportion of borrowed funds to cash.

Mortgage insurance is available through chartered banks, trust companies, life insurance companies, credit unions and caisses populaires and costs between one-half and two-and-a-half per cent of the loan amount, depending on how much of the home's value is being borrowed. It protects lenders against borrower default and remains in force for the life of the mortgage.

The amount and cost of a mortgage is strongly affected by how much of a down payment you make. The bigger the down payment, the smaller the loan you will need and the less you will pay in interest over the years. It makes sense to put down as big a down payment as you can afford, but keep in mind there are other costs involved in buying a home. It is a good idea to have some cash in reserve.

Mortgage Basics

A mortgage is simply a long-term loan secured by using real estate as collateral. To get a mortgage, you have to fit the same criteria that lenders apply to any application for a loan - you need a certain income level, employment stability, a low or manageable debt load, a good credit history and other things.

Even though qualified borrowers can choose a number of different mortgage options, some things are constant from mortgage to mortgage and lender to lender.

Interest is what you pay for using a lender's money and it is usually a percentage of the amount borrowed, calculated semi-annually. Theoretically, if you borrowed $1.00 at 10% annual interest, you would pay $10 per year in interest. In real life, payments usually pay for interest and repay some of the money borrowed, too. This is called a "blended" payment.

Loan payments are made periodically during a set length of time called the amortization period. Common amortizations are 20 or 25 years. The longer the amortization period for a given loan amount, the smaller your monthly payments will be. However, the amount of the interest paid goes up substantially as the amortization period increases.

Payments

Most mortgage payments are made once a month, but other options are twice a month, every two weeks or every week. Usually, your principal (the amount still owed) is reduced more quickly if you make more frequent payments and you will end up paying less interest.

At first, most of each blended payment goes toward paying interest; the amount borrowed is only reduced a little. As the end of the amortization period gets closer, more and more of each payment goes toward paying back the amount originally borrowed.

For example, with a $40,000 mortgage at 10% amortized over 20 years, after five years only about ten per cent of the principal amount has been paid off, after ten years about 26% has been paid, after 15 years a little more than half, with the remaining half paid off in the last five years of the amortization period.

The interest rate, amortization period and other conditions between borrower and lender are specified in a legal document called a mortgage loan agreement. The agreement stays in effect for a time period called the "term" of the mortgage - usually six months to five years, but sometimes longer.

A mortgage loan is due and payable at the end of a term. At that time a borrower may either pay off the amount owed, renew the loan with the same lender or change lenders. If borrowers can't meet their payments, lenders can "foreclose" or take possession of the property before the term is up.

A typical mortgage amortized over 20 years might end up divided into eight terms - say four three-year, a five-year and three one-year terms - each renewed at a different rate of interest set by the lenders and guided by the government's Bank of Canada rate.

Mortgage Options

A "pre-approved' mortgage can be set up before you shop and guarantees rate, term, payment periods and other conditions for a certain period of time.

"Fixed rate" mortgages are structured so that each loan payment is the same amount, based on an interest rate that doesn't change during the term. "Variable rate" mortgage also have standardized payments, but the interest rate can fluctuate from month to month as mortgage rates vary. When rates rise, more interest is paid and a smaller proportion of the payment goes toward paying off the principal. In times of falling rates, less interest is paid and more goes to the principal.

"Open" mortgages let you pay off all or part of the principal without penalty before the end of the term, cutting down on your total interest cost. There may or may not be a fee to do this, depending on the mortgage, and the interest rate is usually higher than for a closed mortgage. "Closed" mortgages allow only regular, agreed-upon mortgage payments to be made but usually carry a lower interest rate.

"Assumable" or transferable mortgages let buyers take over a seller's loan, with conditions intact, if the buyers meet the lender's criteria. Property with an assumable mortgage can be very desirable. For example, buying a home with a ten per cent assumable mortgage and eighteen months left in its term is a real bonus if the current interest rate is two or three points higher.

On the other hand, if you are buying a home and don't intend to live in it for long, you may want a "portable" mortgage. A portable mortgage can be transferred to your next home purchase with the rate, balance and term intact. If you find you will need a larger mortgage, some lenders will blend your portable mortgage with your new one.

To find a competitive interest rate and options that best suit your needs, shop around for a mortgage before shopping for a home. Be sure you look into the administration fees, penalties and other costs that can come with a mortgage too.

Closing Costs

Finalising or "closing" a real estate transaction can involve substantial costs that may come as a surprise if you don't know what to expect. A wide variety of fees, taxes and other expenses require payment before you take possession of your home.

If you are getting a high-ratio mortgage, the cost of mortgage insurance can be paid immediately. On the other hand, you might have the option of adding the insurance fee to the loan, but then it will cost more because you will pay interest on it over the life of your mortgage.

You will probably pay a fee to your lender for having an appraisal done as well, because most lenders appraise a property before approving a mortgage. They just want to be sure they are lending you no more or less than the home is worth. You will have to arrange for pre-paid home insurance too, since you usually can't get a mortgage without a home-owners' policy to protect your home and the lender's investment.

There will be some delay while mortgage documents are being registered in the government land titles office. When that happens you may not get your loan until after the possession date and you will have to pay interest to the sellers on money owed to them at the same rate as your mortgage until they receive the full sale price.

Taxes

No matter where you live, you can't escape property taxes. The tax year is the same as the calendar year, but tax in Winnipeg is generally paid in one amount towards the middle of the year. Depending on when you take possession, you may have to reimburse the seller for part of the year if they have already paid, or may find the seller owing you money if you have to pay after you move in. Either a credit or a debit for taxes will be included in the statement of adjustments prepared by your lawyer. For information about property taxes in a specific area, contact the appropriate municipal or city government.

You also pay land transfer tax in Manitoba (some exemptions apply; for more information please refer to Manitoba Laws, 'The Tax Administration and Miscellaneous Taxes Act'). There is no tax on the first $30,000 of purchase price, but after that it is half a per cent up to $90,000, one per cent after that $150,000 and one a half percent on the rest. Buying a $100,000 home means a $400 tax bill.

Services

A real estate agent's fee is usually paid by the seller, but other professional services aren't. Almost all home buyers need a lawyer to provide a title search, title and mortgage registration, location certificates, zoning memorandum, a tax certificate and other things. You might also need a surveyor, engineer, home inspector or appraiser.

Consider your moving costs, too, as well as any repairs, renovations or redecorating you might want to do when moving in. Don't forget fees for having new telephones, cable TV and other utilities hooked up. The GST must be paid on services, too.

You can see that using all your savings for a downpayment is not a good idea. Plan for closing costs well in advance to avoid financial surprises.

Buying a home isn't just the biggest investment most people make in their lives, it's one of the most complex. It can be one of the most pleasant and rewarding, too, with a little financial planning before you start shopping
 


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