Financing and other options for first home buyers in Canada

Financing and other options for first home buyers in Canada

Getting your name on the title deeds of a new home is an exciting prospect for any Canadian. The mortgage process can seem daunting, however, with so many things to consider and issues to overcome. From setting a budget and checking your credit score through to organizing a down payment and researching your finance options, it’s important to tackle these issues in a clear and logical manner. Let's take a detailed journey through the entire mortgage process so that you can find the right financial arrangement for your new home. It's never too early to get started.  

Setting a budget

Before you can buy a home in Canada, you need to have an understanding of how much you can afford. Like most real estate markets, there are huge differences in prices depending on what you're looking for and where you want to live. While some parts of Canada are relatively affordable for first home buyers, other markets are overheated and notoriously difficult to enter. Building a budget based on your location is a good first step, even it you're a few years away from making a deal. Once you have a budget and down payment target in place, you have something to work towards.

Your budget should always be based on your location and the lending criteria used by lenders in your area. Generally speaking, banks and other lenders will look at your down payment amount, your income, your recurring monthly expenses, your credit scores, and your credit history. They will also be interested in your employment history, personal savings and assets, including other property and businesses. Along with the cold hard figures, you need to be honest with yourself about whether or not you're financially stable and disciplined enough for the responsibility of home ownership.

At the end of the day, how much house you can afford is based on the relationship between your deposit, income, and expenses. While this might sound simple enough, it's important to note that your recurring expenses are likely to increase significantly as a homeowner. If you own a house, you will have to pay for repairs and renovations on a regular basis. If you own a condo, monthly condo fees are impossible to avoid. Interest rates are the glue that hold this relationship together, with rates changing all the time based on wider economic conditions. Not only that, but the more you need to borrow for your home, the bigger affect interest rates will have on your monthly payments.    

Checking your credit score

Your credit score has a huge impact on the mortgage process. Not only will your credit score affect your chances of approval, it will also affect the interest rate that’s offered to you by lenders. Credit scores in Canada work much the same way as they do in the United States, although there are some key differences. Unlike the three bureaus in the US, there are two major credit bureaus operating in Canada, Equifax and TransUnion, each of which provides a different score.

The credit scores themselves also operate on a slightly different scale, with Canadian credit scores ranging from 300-900 as opposed to the 300-850 range used in the US. This is important, with a "good" credit score needing to be between 20 and 50 points higher in the North. For example, while 700 may be considered a good score in the US, lenders will be looking at a minimum of 720 or 730 in Canada, with excellent credit being 800+. To give you a rough idea of what to expect, you can check your score and view sample summaries from both Equifax and TransUnion.

Average property prices and mortgage payments in Canada

Before purchasing property in Canada, it's a good idea to have a basic understanding of current market trends and price movements. After all, you can't set a working budget for your new home if you don't know average market prices in the surrounding area. Whether you want a large house in the suburbs or a sleek inner-city condo, prices vary considerable based on location, demand, and other key market drivers. According to the Teranet-National Bank House Price Index, the average sale price of all housing types across Canada in September, 2018 was $624,931.48.

As you can imagine, this figure varies considerably from city to city, with growth in most markets lackluster over the last year. Despite the mostly stable national reading, some cities experienced much more growth than others. Vancouver recorded the most growth over the last 12 months at 6.23 percent, followed by Victoria at 5.46 percent, Ottawa-Gatineau at 5.12 percent, and Montreal at 4.85 percent. The worst performing locations were Calgary at -1.28 percent, Toronto at -0.78 percent, and Edmonton at -0.5 percent. According to a different report from TransUnion, the average outstanding mortgage amount in Canada is currently $260,547, which is 4.76 percent higher than a year ago.

If you're thinking about getting a mortgage, it's important to consider your monthly payments along with the overall purchase price. According to separate data from the Canada Mortgage and Housing Corporation (CMHC), the average monthly scheduled mortgage payment in Canada for the fourth quarter of 2017 was $1,231 nationally and $1,438 in large centers. Once again, this figure differed a lot between locations, with Vancouver recording $1,772 followed by Toronto at $1,635, Calgary at $1,486, Edmonton at $1,421, Ottawa-Gatineau at $1,198, and Montreal at $1,051.

Types of mortgages

First home buyers have a number of options available to them, with important decisions to make regarding interest rate structure, payment options, mortgage terms, and loan providers. Not all mortgages are created equal, which is why it's so important to compare and contrast loans based on the criteria that's important to you. There are a number of standard mortgage types available in Canada, with each one offering distinct advantages over the others.

Fixed vs variable

Deciding between fixed and variable interest rates is perhaps the biggest decision you'll make when you take out a mortgage. If your mortgage is fixed, one interest rate will be locked down for the entire period, with some fixed terms available for a set period of time before they become variable. This provides a number of advantages, including easier budgeting, improved transparency, and the advantage of lower interest rates if they rise in the future. If your mortgage is variable, interest rates will change according to the wider economic conditions. While this kind of arrangement can be hard to manage due to changing repayment amounts, people with variable rates are not stuck at a specific rate if interest rates get lower in the future.   

Open vs closed

Along with the interest rate available to you, it's also important to consider the flexibility of the loan conditions. An open mortgage allows you to make both early and lump sum repayments, which allows you to pay off the mortgage principal sooner. Open loans do come at a price, however, including higher interest rates and mortgage fees. In contrast, a closed loan is associated with a fixed payment schedule that can't be changed to match your budget or income. Despite the inflexible nature of this arrangement, closed loans are normally associated with lower interest rates.

Mortgage term vs amortization

The term of a mortgage is the length of time that you're committed to a particular lender or interest rate. This can vary between 6 months and 10 years, with 5 years a typical example in Canada. When the initial term is up, you must renew your mortgage on the remaining principal or change lenders, in effect resetting the loan at a new rate or under new conditions. This is different than 'amortization', which is the period of time over which your entire mortgage will be repaid.

Interest rates are the most crucial factor to consider when you're comparing mortgage terms and options. When you have a mortgage, you pay back a portion of the loan each month, with the bank or lender in question using a formula that determines how much of the payment goes towards the principal and how much goes towards the interest. While longer mortgages can be more affordable on a month-to-month basis, they come with higher interest rates and are more expensive overall.

Conventional vs high-ratio

An up-front down payment is required to purchase any kind of property in Canada, with 20 percent being the conventional figure and all other home loans referred to as high-ratio loans. While you can still purchase a home with a small 5 or 10 percent deposit, these non-conventional mortgages are difficult to obtain and can be risky. High-ratio loans generally come with higher interest rates and more stringent lending criteria.

Generally speaking, the healthier your deposit is the less imposing the qualification criteria of your mortgage will be. While there are alternative lenders out there for high-ratio loans, this road can be dangerous for first-home buyers or anyone who doesn't have existing real estate experience or equity. In Canada, all high-ratio mortgages that involve a deposit of less than 20 percent need to be insured by the Canada Mortgage and Housing Corporation (CMHC) or a similar organization.

Mortgage lenders vs mortgage brokers

It's important to understand the differences between mortgage lenders and brokers. Unlike lenders, mortgage brokers don't actually lend any money. Instead, brokers act as middle-men during a mortgage transaction, connecting lenders with borrowers for a fee. Just like lenders, not all mortgage brokers operate in the same way or have access to the same lending pool. While dealing with a mortgage broker is unlikely to cost you anything, because they make money off commission rather than fees, their interests may not align with your own.

Mortgage lenders and tier options

As well as traditional lenders such as banks, Canadians also have the option of dealing with private companies and alternative lenders. There are many types of lenders operating in the Canadian mortgage market, including banks, mortgage companies, caisses popularies, private money lenders, investment corporations, insurance companies, trusts, loan providers, and credit unions. Lenders can differ significantly with regard to interest rates, fee structures, and terms and conditions, so it's always important to do your homework.

Conventional lenders such as CIBC, RBC, and BMO are often referred to as A-lenders, with alternative mortgage lenders known as B-lenders. While A-lenders offer more competitive interest rates, they also have stricter lending criteria. On the other hand, B-lenders have more flexible lending criteria and conditions at the expense of higher interest rates. Even though the majority of home loans still go through conventional channels, the new mortgage regulations in Canada have led to increased rejection rates and increased opportunities for alternative lenders.  

Canada’s banking regulator recently imposed a new stress test via the Office of the Superintendent of Financial Institutions’ (OSFI), with these rules applicable for new home buyers who don’t need mortgage insurance and those who don't have a 20 percent down payment. Introduced on January 1, 2018, these stricter rules have led to a significant downturn in mortgage approvals from conventional lenders. While some alternative lenders have decided to implement the stress test on a voluntary basis, the new rules may have actually led to an increase in riskier lending practices.

Pre-approval

The pre-approval process is a valuable first step for anyone who's getting a mortgage. Pre-approval by a lender will give you a pretty good idea of how much money you can access for your home loan and what interest rate will be available to you. While the pre-approval amount is no guarantee and things can change between pre-approval and approval, it's impossible to start comparing properties when you have no idea of how much you can borrow. Pre-approval typically includes a maximum loan amount, available interest rate, and mortgage payment estimation. While this information can be incredibly valuable, remember, you don't have to use the maximum amount that's available to you.

Credits for first home buyers

First home buyers in Canada can access a number of tax incentives and financial aid programs, including the First-Time Home Buyers' (FTHB) tax credit, Home Buyers Plan (HBP), and GST/HST Housing Rebate. While not all people will qualify for these programs, the extra assistance they provide can provide a key advantage to some buyers.

  • The FTHB tax credit is a $5,000 non-refundable income tax credit on a qualifying home acquired after January 27, 2009. This credit will provide up to $750 in federal tax relief for eligible individuals.

  • The HBP is similar to IRA withdrawals for US citizens, with Canadians allowed to borrow up to $25,000 from their Registered Retirement Savings Plan in order to finance their first home purchase.

  • The GST/HST Housing Rebate allows new home buyers in Canada to qualify for a government GST or HST rebate on a home purchase. This program can also be used for renovations, revisions, and conversions.

Finding your team

Once you've researched your finance options, saved your deposit, and received pre-approval, it's time to assemble a team and start hunting for the property of your dreams. First and foremost, you'll need to find a real estate agent who specializes in the type of property that you're looking for. Word of mouth can play a crucial role during this process, as can online review systems and time on the street. If you already have a particular neighborhood in mind, there's likely to be real estate agencies and particular agents already known to local residents.

Along with location proximity, property specialization, and experience, it's also crucial to choose a realtor who you're comfortable with. All the experience in the world is useless if someone doesn't listen to your needs. While official licensing requirements for realtors vary widely across Canada, people often become members of the local real estate board and Canadian Real Estate Association (CREA). Other than a realtor, it may also be important to find a legal team you can trust, a mortgage broker, a property inspector, a builder, an appraiser, and a moving company.

Finding the perfect home

Finding the ideal home to meet your financial and lifestyle needs is half art and half science. While you want somewhere that will grow in value over time, you also want somewhere that feels like home. Before looking at specific properties, it's important to be aware of the different types of ownership arrangements in Canada and decide whether they're likely to meet your needs as a future property owner.  

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Types of ownership

Freehold - A traditional freehold arrangement gives you ownership over the home itself and the ground where it stands. While this gives you the most control over the property, this arrangement comes with the responsibility of property maintenance and repair.  

Condominium - Condos or strata arrangements are incredibly popular in Canada, with people who purchase condos owning the apartment itself along with the part ownership of common areas. While you have to pay monthly condo fees and lose control over the building itself, this arrangement makes it easier for people to afford inner-city locations.  

Leasehold - A leasehold arrangement gives someone the right to use and occupy a building for a set period of time, while ownership itself remains with the landlord. While not particularly popular, this kind of deal is often used when apartments reside on land owned by the city.

Co-operative - Co-op arrangements involve a form of multiple occupancy, with people buying an individual share of the property or building and assigned a particular apartment or plot of land. Mortgage insurance is typically not available for co-op purchases.   

Comparing properties

Before choosing a property, it's important to compare individual houses or apartments based on set criteria. After all, you don't really know if you've got a good deal until you've compared the property with others in a similar condition and location. Some of the things to look at include home size, amenities, number of bedrooms, number of bathrooms, parking, overall condition, and whether it will meet your future needs. It's especially important to look at critical building components such as footings, roofing, HVAC systems, electrical systems, and landscaping.  

Comparing neighborhoods

Along with the property itself, its the neighborhood that will have the biggest impact on your lifestyle and future equity. Property prices vary considerably across Canada based on location alone, so take a detailed look at the surrounding area to ensure you're making the right decision.

Factors to consider include proximity to public transportation, major roads, eating and entertainment venues, parks, schools, and employment opportunities. Where you decide to live will have a huge impact on your lifestyle, so take your time to look around and get a feel for a place before you make an offer.  

Negotiation and making an offer

Property negotiations can be complex and daunting if you don't know what you're doing. Confidence plays a key role when you’re making a deal, as does market knowledge and local experience. It's important to do research before you sign a contract, so take your time to understand price growth rates, sales volumes, and time on market figures.

If you can develop a strong sense of supply and demand in specific locations, you will feel much more confident when it comes time to make an offer. When you're ready to go, it's important to specify relevant terms and conditions and get yourself prepared for the possibility of a lengthy offer and counter-offer process.

Closing your home

Once you've made a offer that's been accepted, it's almost time to get out the champagne and celebrate - but not quite. Closing on your new home can also be stressful, both financially and psychologically. While you feel like you're at the finishing line, closing a home in Canada can take one or two months if you want to do it properly.

Along with a ton of paperwork and lots of legal fees, you will also need to organize a home inspection, secure insurance, pay taxes, and deal with all the fun of moving. Closing day itself is when you can really let go, with the final signing usually taking place at your lawyer's office along with the transfer of your down payment, closing costs, and property keys.  

FAQ

Q. Are fixed or variable interest rates cheaper?
A. Fixed and variable rates can both be more affordable over a certain time period depending on the official cash rate and mortgage term.

Q. How do I compare different properties?
A. When comparing properties, it’s important to measure different properties, or comps, against one another based on specific criteria in order to create a relative measure.

Q. What is the most expensive city in Canada?
A. According to Mercer's survey, Toronto and Vancouver are Canada's most expensive cities, with both coming in at 109th place globally based on housing and living costs.

Q. What location features are likely to add equity?
A. Location has a big impact on future property growth, including proximity to employment and education resources and transportation infrastructure.

Q. What are the advantages of alternative lenders?
A. Credit unions, private lenders, and other alternative lenders are more flexible and less stringent despite being associated with higher interest rates.