When it comes to financing your new home, there are three important things to educate yourself about: mortgages, government programs, and closing costs.
Mortgages can seem intimidating, especially for the first-time buyer. Once you’ve qualified for a mortgage, there are some basic decisions you will have to make: Mortgage term, amortization, interest rate and type of mortgage. Read on to find out what all of that means, or use our handy Mortgage Calculator to estimate what your payments would be.
Mortgage Term and Amortization
The mortgage term and amortization period affect the amount of money you can borrow (and thus the price of the home you can buy) and dictate how much your monthly payment will be.
A mortgage term is the amount of time a lender will loan you money for – typically from 6 months to 5 years. When the term is up, the remaining amount is payable in full unless you arrange new financing for another term.
Choosing a mortgage term is tricky and requires you to be knowledgeable about trends in the marketplace, as well as having a sense as to the amount of risk you’re willing to endure. If you choose a six-month term, and interest rates increase drastically in that time frame, will you still be able to afford your home?
Few (if any) of us can pay off the entire principal of a large mortgage in a six month or even a five-year term. Imagine how big your payments would be! To help you out, lenders calculate or amortize, the mortgage payments over a much longer time, often as long as 25 years. They aren’t loaning you the money for a single 25-year period–they’re just calculating the payment schedule as if it will take you that long to pay back the principal plus interest. You will probably renew the mortgage several times during the amortization period, and you always have the option to change the amortization depending on market conditions or your financial situation. The longer the amortization period, the lower your individual payments will be – but this also means you’ll be paying more in interest.
Most mortgage payments consist of two parts: principal and interest. This is known as a blended mortgage payment. Each payment reduces the balance owed on the mortgage by the portion of the payment that is credited to the principal. Over time, the proportion of your payment that reduces the principal balance will increase. The faster you can pay down the remaining balance, the less total interest you’ll pay. There are many ways you can pay down your mortgage faster, from accelerating your payments (i.e. 26 payments per year instead of 24) to making lump sum payments on your mortgage; your lender can help define the right strategy for you.
The interest rate is one of the biggest contributing factors to how much you end up paying for your home both on a monthly basis and over the life of your mortgage.
Interest is the cost of borrowing money. Interest rates fluctuate with the economy. The interest rate you commit yourself to at the beginning of the term can have a significant effect on the amount you pay each month for your mortgage. There are two basic types of interest rates used in mortgage products: fixed-rate and variable-rate.
Fixed-rate mortgage – Essentially, this means committing to a single interest rate that will not change for the term of your mortgage. This strategy equalizes how much of your monthly payment repays the principal vs. interest. Fixed-rate mortgages are great in an economy where interest rates are going up, as you never have to risk paying higher interest rates. But in an economy where interest rates are going down, you could be stuck paying more in interest than the going rate.
Variable-rate mortgage – With a variable rate mortgage, your monthly payments are fixed for a specific term, while the interest rate portion of the payment floats in relationship to the bank’s prime interest rate. If rates go up, more of your payment is applied to interest and less is applied to the principal. If rates drop, more of your monthly payment is used to pay off your principal and your mortgage is paid off sooner. Variable rate mortgages can protect you if interest rates are high at the time you arrange your mortgage; when rates fall, you’re not stuck with high-interest payments and more of your payment is applied to the principal. But if interest rates increase, that could mean more of your payment is being applied to interest than you bargained for. In some instances, lenders will allow you to convert to a fixed-rate mortgage in this kind of situation.
Types of Mortgages
- Conventional mortgage – Aptly named because they are the most common type of mortgage. The lender will loan you up to 80% of the appraised value or purchase price of the property (whichever is lower) and you generally need to come up with the other 20% as a down payment.
Second (and third) mortgages – These are additional financing arrangements behind an existing mortgage, also secured by your property. Secondary financing is generally arranged at a higher interest rate and for a shorter term than the first mortgage.
High ratio mortgage – When you don’t have the 20% down payment required to get a conventional mortgage, a high ratio mortgage can advance you up to 95% of the home’s appraised value or purchase price. However, since you are borrowing more than the usual 80%, the government insists that the mortgage is insured against default and that you pay the cost of the insurance. That cost can be a few percent of the mortgage amount, and is added to the mortgage principal.
Home Buyer Plan for First Time Home Buyers (HBP)
The federal government’s Home Buyers’ Plan (HBP) is a program that allows you to withdraw money from your registered retirement savings plan (RRSPs) to buy or build a qualifying home. This money is not taxed as income as it would normally be, but you do have to pay it back. You have 15 years to repay the money, starting two years after the initial withdrawal. The maximum for such withdrawals is $25,000.
The purchase must be for a principal residence, you can take the cash out up to 30 days after buying the home, or if you take it out beforehand, you must own or build the home by October 1st of the following year.
N.B.: For this plan the government defines a first-time buyer as someone who has not owned a home that they occupied as their principal place of residence during the period beginning January 1 of the fourth year before the year of withdrawal and ending 31 days before your withdrawal. So basically, if you owned a home five years ago, or had a property that wasn’t your principal residence, you are still considered a first-time home buyer.
For more info on the HBP, go to the Canada Revenue Agency’s website at www.cra-arc.gc.ca
Land Transfer Tax Refunds for First Time Home Buyers
The Ontario government also helps first time home buyers (which it defines more strictly as having never owned a home ever, anywhere) by offering a refund on the land transfer tax in Ontario, up to a maximum of $2000 (equivalent to the Provincial Land Transfer Tax on a $227,500 home).
If you are buying in the City of Toronto, it has an additional Municipal Land Transfer Tax as well, with its own rebate for first-timers that maxes out at $3725.
First Time Home Buyer Tax Credit (HBTC)
The costs associated with purchasing a home can be a particular burden for first-time home buyers, who must pay these costs on top of saving the money for a down payment. Closing costs include one-time items such as lawyer fees, HST (on newly constructed homes), and adjustments (e.g. taxes or utilities prepaid by the seller) that allow you to complete the house purchase.
To assist first-time home buyers with these costs, the government created the First-Time Home Buyers Tax Credit, a $5,000 non-refundable income tax credit that results in up to $750 in federal tax relief.
Canada Mortgage and Housing Corporation Insurance (CMHC)
The Canada Mortgage and Housing Corporation helps buyers by providing mortgage loan insurance so that a buyer can buy a home sooner–with as little as 5% down payment. To find out all about the programs, including the costs of insurance, visit the CMHC website.
Closing Costs (a.k.a. How Much Does it Cost to Buy a Home?)
As you go through the process of buying a home, you’ll naturally want to know how much money this will cost you. Your lawyer, accountant and real estate agent can help you estimate your costs. Some of the things you can expect to pay are:
- Deposit (usually 5% of the purchase price in Toronto, paid within 24 hours of your offer being accepted)
- Property Appraisal ($400- $500, often paid by the lender)
- Home Inspection ($400-$600, paid to the home inspection company at the time of the inspection)
- The balance of the Purchase Price – the purchase price less your initial deposit. Usually, the bulk will come from your lender and become your mortgage.
- Legal Fees – amount varies depending on purchase price and lawyer (approximately $1,800 for a $500,000 purchase)
- Title Insurance – sometimes included in your legal fees ($250-$400)
- Mortgage Broker Commission – if applicable, usually paid by the lender
- Property Survey – if required ($1,000-$2,000)
- Ontario Land Transfer Tax – varies depending on purchase price (see our Land Transfer Calculator)
- Toronto Land Transfer Tax (varies depending on purchase price (see our Land Transfer Calculator)
- Property Tax Adjustment – reimbursement to Seller of property taxes they paid beyond the closing date
- HST – generally only applicable on new construction condos and houses
- Tarion Warranty Fees – warranty on new construction condos and houses only, not resale, (click here to estimate Tarion Fees)
- Provincial Sales Tax – only applicable on chattels purchased from vendor (amount varies)
- Adjustments for Utilities/Condo Fees/etc. – reimbursement to Seller for prepaid utilities, etc. (amount varies)
- CMHC Insurance Premium – insurance premium charged if you have less then 20% down payment (click here to estimate CMHC insurance)
- Moving Expenses ($1,000+)
- Utility Connection Charges (varies)
- Redecorating and Renovating Costs (varies)
- Immediate Repair and Maintenance Costs (varies)
Click here if you’d like to calculate your closing costs.
Your lawyer will calculate the final amount that is owing, and you will need to provide him/her with a certified cheque for the full amount before the property comes into your possession. (Click here for a description of the role of your real estate lawyer).
If you’re a first time home buyer, you’ll qualify for some great government programs that can save you thousands of dollars in closing costs. Scroll up to the Government Programs section for more details.