Mortgage essentials for first-time home buyers

Lisa D’Souza and her husband recently bought their own place. The B.C. mortgage consultant admits that becoming a home owner for the first time is a roller-coaster ride.

“I’m excited, proud and a little scared,” says D’Souza, who now calls Port Moody home. “We ended up moving to a new city so it was a really big change for us. It was scary at first, but it turned out to be the best decision we could have made. Coming home to a beautiful house and knowing that we own it is such an amazing feeling.”

The D’Souzas decided to make the leap to home ownership now before rates creep up even higher. Canada’s big banks have increased the cost of fixed-rate mortgage by more than a third in the past few months, announcing recently that they’ve risen again to just below 4 per cent for a five-year term.

In the new rate reality, there are some mortgage essentials rookie home owners need to consider.

The down payment
Given the rising-rate environment, should a first-time buyer save up the standard 20 per cent or lock in now with what you have?

In an ideal world, everyone would have 20 per cent to put down. That means you can apply for a conventional mortgage and don’t have to be insured against default by the Canadian Mortgage and Housing Corporation.

“The premiums can either be paid up front or added to the mortgage and paid off as mortgage payments are made," says RBC mortgage specialist Susan M. Hrdlicka

A larger down payment also equals lower carrying costs. The interest savings in the long run with a big down payment can be significant. “An average homeowner can save more than $16,000 in interest costs on a $100,000 home by making a down payment of 20 per cent versus the minimum down payment of 5 perc cent,” Hrdlicka says.

But let’s get real. How many people can afford to save a 20 per cent down payment, particularly in markets like Toronto and Vancouver?

“I think a lot of first-time buyers have been spurred on to buy now even without the 20 per cent down payment,” says mortgage broker Karen Gibbard of Gibbard Group Financial, pointing to the numbers.

Consider the Real Estate Board of Greater Vancouver’s benchmark prices and the corresponding 20 per cent down payment requirements:

• Apartment benchmark price: $366,100

• 20 per cent down payment = $73,220

• Detached home benchmark price: $923,700

• 20 per cent down payment = $184,740

“These large down payments, coupled with the closing costs such as property transfer tax, legal fees, et cetera, make it challenging for a first time buyer to come up with enough funds to get into the market with the full 20 per cent down,” Gibbard says.

Farhaneh Haque, director of mortgage advice at TD Canada Trut, notes that first time buyers can take advantage of the government’s Home Buyers’ Plan and use savings in their RSP to bolster the down payment. She also advises people zero in on their own unique circumstances.

“Notwithstanding what the market might do or what the rates might do, think about your own personal situation and do a stress test,” Haque says. “Compare your situation as a renter and your situation as a buyer. Look at today’s rates and see if the math makes sense for you today. Then evaluate what the payment looks like when rates do go up. Bump it up a quarter or half point or even 1 per cent and see what the payment looks like and look at your budget.

“Don’t stretch yourself out too thin,” she adds. “If you’re paying $1,500 in rent and buying will put you at $2,500 with your mortgage, property tax, maybe that’s too much. But if you end up at $1,600 or $1,700, logically you can do that. You can say, ‘I won’t eat out as often,’ or maybe you’ll buy something in the city so you’re not commuting. You can make sacrifices because you see the value in it.”

Consider mortgage types and terms
It can be overwhelming for first-time buyers to go through all the options and decide whether they’re going to go for a fixed-term or a variable rate mortgage (VRM).

“Most first-time buyers are taking a fixed-term mortgage over a VRM,” Gibbard says. “The main reason is that most folks believe that … the rates will increase within the next few years.

“Another reason is simply qualification,” she adds. “The lenders and high-ratio insurance companies have brought in new rules that demand that a borrower qualify on a government prescribed interest rate when taking a VRM."

Even though the current VRM is at prime minus 0.40 per cent, lenders are required to qualify home buyers using a rate of 5.14 per cent.

"The difference in these two interest rates can affect the mortgage payment enough to force a client to take the five-year fixed term in order to qualify for the mortgage. They simply can’t qualify at the 5.14 per cent interest rate," says Gibbard.

First-time buyers need to honestly assess their comfort level
“Think about your risk appetite,” Haque says. “While variable rates in the short term tend to be low, there is that chance that as rates increase, the variable rate will shift. If you can’t tolerate that risk or you’re on a fixed income or because of your budget you say ‘I cannot afford to take that risk,’ then you need to go with a fixed rate.”

Look for opportunities to pay down the mortgage faster
Accelerated payments are an obvious way to chip away at the mortgage, though not everyone considers doing weekly or biweekly payments as opposed to monthly ones.

Prepayments are another way for homebuyers to pay their mortgage faster without locking into a payment schedule that could make it a challenge to manage their monthly cash flow, Haque notes.

“It doesn’t have to be all or nothing,” she says. “You could pay some of the mortgage down using your tax refund or you maybe have an extra $1,000; you can make small tweaks along the way.