Timely tips for first-time homebuyers
Real estate is hot, hot, hot. Just ask anyone trying to buy a home in Vancouver or Toronto. The Teranet-National Bank National Composite House Price Index was up 0.5% in January from December. The rise matched the largest January increases in the index, set in 2003 and 2010. Home prices were up in seven of the 11 metropolitan markets surveyed by Teranet. And the composite index rose above 200 in January, signalling that home prices in the 11 markets as a whole have doubled since June 2005.
Just how hot are real estate markets?
In January the composite index was up 13% from a year earlier – a 12th consecutive month of acceleration and the largest 12-month rise since January 2007. This increase was led by prices in Toronto (a record surge of 20.9%), Hamilton (a record 17.6%), Victoria (17.1%), and Vancouver (16.4%).
Faced with such a competitive market in Canada’s largest urban areas, where demand is strong and inventory of homes for sale is tight, younger, first-time home buyers are getting caught up in “bidding wars” – and, yes, some of these are staged. It’s unethical, but it happens more often than you’d believe. Inexperienced homebuyers frequently get caught up in the heat of the moment, and often feel pressured to “just give in.” They’re pressured to take on that extra one hundred grand in debt for what may be an absolute “handyman’s delight.” After all, “it’s only money.” It’s as if it’s the last property on earth. As financial advisors, we hear this all too frequently. Unfortunately, we often hear it after the fact. And by then it’s too late, with a young family being pressured financially by too much debt.
What are the rules for getting a mortgage?
The federal government has tried to cool some of the residential real estate mania by tightening the rules for high-ratio insured mortgages. The minimum down payment without being required to purchase mortgage default insurance is now 20% of the purchase price of the home. So, on a $500,000 purchase, your down payment would have to be $100,000, and you would take on a mortgage of $400,000, or 80% of the value of the home. Mortgages for more than 80% of the purchase price (so-called high ratio mortgages) must be insured, and the insurance premium is added to the monthly payment.
New rules for high-ratio mortgages mean you’ll need to put a minimum 5% down payment on a purchase price of $500,000 or less. If your purchase price is over $500,000 you’ll have to put down that initial 5%, and then another 10% down on the next $500,000. Sale prices over $1 million aren’t affected because they don’t qualify for high-ratio mortgage insurance anyway.
However, these rules haven’t really cooled the market, as shown by Teranet’s January house-price index. Buying a home is different from buying a bottle of detergent or a loaf of bread. But only in degree. It’s bigger, and it’s way more expensive. And most people will be paying it off for up to 25 years. But it’s really still a commodity. And when you’re planning a real estate purchase, you have to treat it as such.
Can you really afford to buy that dream home?
You need a place to live. And you have certain finite financial resources with which to acquire it. The trick is to be really honest with yourself. How much can you really afford right now? How much of your lifestyle are you willing to give up – right now – to afford that extra hundred grand you’re tempted to pay for that “roach motel”? Which, by the way, will need another hundred grand to bring it up to habitable standard.
Financial planning experts use a couple of ratios to determine whether you can afford to carry that mortgage debt. First they look at the gross debt service ratio, which includes only the costs of mortgage debt, tax, and heating. That should be no more than 32% of annual income. Next they look at your total debt service ratio, which includes revolving credit card debt, car payments, and other personal loans. That should be no more than 42% of annual income. It’s a pretty tight window.
That 20% down payment for non-high-ratio mortgages can be a huge hurdle. Many younger first-time home buyers go the bank of Mom-and-Dad for support on that down payment, in addition to accumulated savings from Tax-Free Savings Accounts and funds borrowed from RRSPs through the Home Buyers’ Plan.
So first-time homebuyers really have to ask themselves whether they can compromise even just a little and settle for a cheaper, but larger and newer, home in the suburbs, with maybe a longer commute? Have you really thought this thing through?
Protecting that investment
Then, of course, you’re going to have to take steps to protect this incredibly valuable asset you’ve just purchased. In the event of injury, illness, or death, you don’t want your family losing the house because they can’t make the mortgage payments. So you’ll have to think about mortgage insurance (if you’re not already buying it through a high ratio mortgage). Mortgage insurance is a total bargain, and young families should consider it even if they aren’t required to buy it.
And here again you have choices: You can buy mortgage insurance (which is used solely to pay off the mortgage in the event of your death), or you can purchase a term life policy (which will pay off all your debts and maintain your family’s lifestyle). There are pros and cons to each, but the decision will almost always come down to term life – it’s cheaper and it offers more protection.
© 2017 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice. Securities mentioned are not guaranteed and carry risk of loss.