Consider These Financial and Tax Implications When Buying a Home
The Canadian real estate market has performed well in recent years, though analysts and economists have long warned of its potential overvaluation.
Potential homeowners often find themselves seduced by their vision of the perfect home in the perfect neighbourhood and often 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.
Start with a Realistic Budget
A budget 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 rather than going out to restaurants or getting take-out, 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.
Understand the Full Cost of Homeownership
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.
Don’t Rely Solely on Mortgage Pre-Approvals
Most banks will pre-approve you for a mortgage based on your income, credit score, and debt levels. But remember, banks are in the business of lending money. Just because you’re approved for a certain amount doesn’t mean that’s what you should spend. Look at your own budget carefully and determine what you can afford based on your goals and lifestyle.
The Importance of a Down Payment
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 4% of the total value of the mortgage.
Choosing Your Payment Schedule
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.
Some lenders offer cash-back mortgage options, where you receive a lump sum up front in exchange for a higher interest rate. While it may sound appealing, the added interest usually outweighs the value of the cash received and should be approached with caution.
Account for Closing Costs
When closing on a home, there are several additional costs to consider. These may include:
Land transfer tax (or "welcome tax" in Quebec)
Legal fees
Adjustments for prepaid property taxes
Deposits or holdbacks
Any prepaid rental income (if applicable)
These closing costs often require a significant cash outlay and should be reflected in your overall budget.
First-Time Home Buyer Incentives
Home Buyers’ Plan (HBP):
Eligible first-time buyers can withdraw up to $35,000 from their RRSPs tax-free to put toward a qualifying home. Couples may each withdraw up to $35,000, for a total of $70,000. The home must be intended as your principal residence and purchased within a year. The withdrawn funds must be repaid over 15 years, starting in the second year after the withdrawal.
First-Time Home Buyers' Tax Credit:
This federal credit allows eligible buyers to claim up to $10,000 for a non-refundable tax credit, resulting in up to $1,500 in tax savings. If both spouses qualify, they may split the credit.
First Home Savings Account (FHSA):
Introduced in 2023, the FHSA is a registered plan that lets first-time buyers save up to $40,000 toward a home. You can contribute up to $8,000 per year, and unused room can be carried forward. Contributions are tax-deductible (like an RRSP), and withdrawals to buy a qualifying home are tax-free (like a TFSA). You can also combine the FHSA with the HBP to significantly increase your tax-advantaged savings. If you don’t end up buying a home, you can transfer the FHSA balance to your RRSP without affecting your contribution room.
If You’re Buying a Home with a Rental Unit
For homes that include a rental unit, all rental income must be declared on your personal tax return assuming you have not incorporated your rental property. This can be reduced by the rental unit’s share of expenses.
Capital Gains and Your Principal Residence
Luckily for homeowners, particularly in the current market where there has been significant appreciation of home values, 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.
Note that the sale of a principal residence must be reported on your tax return in the year of sale, even though no taxes are payable.
Final Thoughts
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 ownership is a great way to build equity and a better life, as long as you are well informed and you can afford it.
Need Personalized Guidance?
If you're navigating a home purchase, considering rental income, or unsure about how it all fits into your tax situation, I offer one-on-one consultations to help you make informed financial decisions. Book a consultation to get expert advice tailored to your circumstances.
