The Canadian real estate market has been a good place to invest in recent years, although comparisons to the US real estate bubble, which finally culminated in 2008, are continuing to intensify. Potential homeowners often find themselves seduced by their vision of the perfect home in the perfect neighbourhood and end up in a difficult situation, referred to as “house poor”, where the majority of their disposable income goes to paying down their mortgages. This can be avoided by ensuring that you realistically assess what you can afford and being financially responsible.
Prepare a budget that includes all your household expenses. It is essential that you are realistic and not underestimate your expenses. Of course changes can be made to your current lifestyle, and many of us probably spend too much on non-essential purchases (although it would be criminal to NOT buy those shoes). However, your new house is not going to compensate for a dramatic downgrade to other aspects of your life. You might want a fabulous new kitchen figuring that you will cook all the time, but that becomes tedious after a while, particularly if you are used to eating out frequently. The best starting point for your budget is to take a monthly average of the past year’s expenses.
When budgeting keep in mind that In addition to the monthly mortgage fee, home owners are responsible for property taxes, insurance and other annual fees like condo fees and HOAs. There are also ongoing repairs and maintenance for which it is important to set up a fund. Everyone has heard horror stories about roofs caving in and pipes exploding. Anyone who has ever had a home knows that it is an ongoing maintenance project.
You can generally get a pre-approval from your bank for a mortgage amount based on your current financial situation. Keep in mind banks have an incentive to give you a bigger mortgage than you can necessarily afford.
Recent years have seen a dramatic decrease in the amount of down payments required to finance a home, which has been one of the major factors contributing to the housing crisis. Not only does a higher down payment reduce the amount of interest payable over the life of the mortgage, it reduces the monthly mortgage payments. Finally a 20% down payment will save you from having to pay mandatory CMHC fees, which can be up to 2.75% of the total value of the mortgage.
There are different payment options when taking out a mortgage. While monthly payments are the most common, there is a biweekly accelerated option, which allows homeowners who are paid on a biweekly basis to make a couple of extra payments per year. This can have a significant impact on your mortgage balance over time and reduce total interest costs. Another mortgage incentive involves giving the homeowner cash back which is offset by an increase in the interest rate over the term of the mortgage. The total additional interest is usually significantly higher than the amount of cash received up front, and is usually not a good idea.
Closing of a home purchase is usually accompanied by adjustments including welcome tax, property taxes paid for the year, deposits and rental income if applicable. OF these require a cash outlay, which should be reflected in your budget.
First time home buyers may qualify to for the Home Buyers Plan, which allows them to withdraw funds from their RRSP on a tax free basis. As long as you are purchasing a home that is intended to be your principal residence within one year of purchase, you may withdraw up to a maximum of $25,000. If your spouse also qualifies as a first time home buyer, they may independently withdraw up to the same amount. This has to be repaid on an annual basis, within 15 years.
First time home buyers are also entitled to a homebuyer tax credit. This was introduced in 2009 to encourage first time home buyers and represents approximately $750 of a reduction in taxes payable for qualifying home buyers. Spouses are allowed to share the credit as long as both qualify.
For homes that include a rental unit, all rental income must be declared on your tax return. This can be reduced by the rental unit’s share of expenses.
Luckily for homeowners, particularly in the current market where there has been significant appreciation of home value, gains on a principal residence are not taxable. In other words if you sell your home at a gain (subject to certain exemptions) you will not be required to pay tax on the appreciation or even declare it on your tax return, as long as it is the primary place that you live. You can only designate one primary residence at a time (no matter how much time you spend at your cottage or vacation home, you are still only allowed to have residence). You can change this designation at any time, however you will be required to pay capital gains from the date of the change in designation.
Buying a home can be very exciting and it is easy to get caught up in the momentum of it all and throw financial caution to the wind. This is almost always a bad idea. Home ownerships is a great way to build equity and a better life, as long as you are well informed and you can afford it.