Buying a home is a common goal shared by most, but now more than ever, you must start preparing financially well in advance. This means saving money wherever you can, staying on top of your bills, and optimizing your credit score.
When you are ready to buy a home, saving money becomes even more important. An easy opportunity to do so is to partner with the legal real estate team at Axess Law. They’re an online real estate law firm, meaning that not only are they more convenient than a brick-and-mortar law firm, but they also don’t have the same overhead and pass the savings on to their clients.
Keep reading for more tips and information on the financial side of the home-buying process.
1. Saving Up for a Down Payment
The importance of having a large down payment increases as interest rates rise. The minimum allowable down payment amount is 5% of a home’s purchase price for homes valued at $500,000 or less in Canada. To purchase a home over $500,000, you are required to have a down payment that covers 5% of the initial $500,000 and 10% of the remaining value.
Homebuyers who have less than 20% of the purchase price saved as a downpayment will generally have to carry mortgage insurance to be approved for a mortgage.
2. Improving Your Credit
Your credit score and payment history not only have a significant impact on your ability to qualify for a mortgage, but they also play a vital role in the mortgage interest rate you are offered.
The easiest way to improve your credit is to always pay your bills on time. Unfortunately, there is no hack for having a long credit history of properly managing your finances. But there are some ways to make the most of the credit you have available to you that may help improve your score:
- Leave old accounts open, even if they’ve been paid off. As soon as you close the account, you lose some of the good credit histories you’ve built up.
- Aim to use around 35% of the credit available to you. Maxing out your credit harms your credit score, but you also want to show that you are using the credit offered to you.
- Diversify your credit. Having a few different types of properly managed credit accounts looks good while having several credit cards may not.
If you don’t have much credit history and don’t qualify for credit accounts, you can start building your credit history by applying for a secured credit card. It requires a deposit equal to the limit of the card, but you use it as you would any other credit card by making purchases that you pay off. After a while, you should qualify for an unsecured card or other type of credit.
3. Can You Survive the Mortgage Stress Test?
When you start shopping around for a mortgage, lenders will offer you a contract interest rate based on the type of mortgage you are looking for, market interest rates, and your credit score/history.
However, when you apply for a mortgage, the lender will put you through a “stress test” to see if you would still qualify for a mortgage if it was at a higher rate. This is done to prevent people from buying homes they would not be able to afford if interest rates rose, causing their mortgage payments to increase significantly.
This higher interest rate is called a “mortgage qualifying rate” and is currently the higher of either the rate offered to you by the lender plus 2% or 5.25%.
As the name implies, you must demonstrate that you can afford the mortgage payments at a higher rate to qualify for a mortgage at the offered rate.
Types of Mortgages
Knowing ahead of time the type of mortgage you will reasonably qualify for based on the rates being offered and the stress test you would have to pass can help you decide which type of mortgage to apply for and, therefore, help increase your chances of getting approved.
It can also help you make a more informed decision about whether it’s the right time for you to buy a home when you factor in the type and amount of the mortgage you would qualify for.
These are the most common types of mortgages.
1. Open Mortgages
An open mortgage allows you to make extra payments, known as “prepayments,” while also giving you the option to renegotiate the mortgage and switch lenders without paying a penalty.
2. Closed Mortgages
Closed mortgages are less flexible with prepayments and renegotiations but are generally cheaper (offer a lower interest rate.)
3. Fixed-Rate Mortgages
The mortgage interest rate remains the same over the term of the mortgage and is usually higher than a variable-rate mortgage. If interest rates increase, you’ll feel good about your decision, but there’s a risk that you’ll pay end up paying more for your home than was necessary if rates drop.
4. Variable-Rate Mortgages
Variable interest rates are tied to the prime lending rate, meaning that the mortgage interest rate you pay will likely fluctuate over the mortgage term. Because of this, variable-rate mortgages tend to offer lower interest rates than fixed-rate mortgages to offset the risk.
Variable-rate mortgages allow you the option to keep your mortgage repayments fixed or adjustable. With fixed payments, the amount you pay towards the principal vs the interest fluctuates with the interest rate. If lending rates rise, more of your payment is put toward the interest, and if they fall, you pay more toward the principal.
With adjustable payments, you ensure that your payments towards both principal and interest remain the same. Your mortgage repayment amounts will fluctuate to accommodate the interest rate fluctuations.
Other Considerations to Make When Deciding on the Type of Mortgage to Choose
There are other mortgage options to consider that can affect the rate you’re offered, the final price tag of your home, how long your payments will last, etc. These options include:
- Mortgage fees.
- Mortgage payment frequency.
- Whether you need mortgage insurance.
- The mortgage terms and amortization.
- Mortgage deferrals.
- Renewing your mortgage.
The Government of Canada’s Mortgages page is a helpful resource that provides detailed explanations of each mortgage option and how it can affect your long-term finances.
