Class is in session and today we're tackling mortgages! Learn everything you need to know about buying a home-from rates and down payments, to open vs. closed mortgages and everything in between.
April 20th, 2018
By: Northern Credit Union
So you’re thinking of buying a home, eh? It’s a big, exciting step. But before you charge in and start making offers, it pays to do a little homework. Luckily, we’ve done most of it for you by rounding up answers to the burning questions you’ll encounter when buying a home.
WHAT CAN I AFFORD?
The first step of your journey towards home ownership begins with figuring out how much you can afford. You’ve probably heard the term ‘house poor’ – you don’t want to bite off more than you can chew and find that all your income is being eaten up by your mortgage. Instead, try and find a comfort zone, where you can pay your mortgage but still have money to enjoy life.
Finding your comfort zone depends on several factors such as how much you’ve saved up for a down-payment, your monthly expenses and mortgage rate, to name a few. To figure out your comfortable number, check out our handy mortgage affordability calculator.
TIP! As a general rule of thumb, most prospective homeowners can afford a property that costs between 2 to 2.5 times their gross income.
HOW BIG SHOULD MY DOWN PAYMENT BE?
Ideally, you want to save as much as you possibly can for your down payment. You can put down as little as 5% of the purchase price (for homes $500,000 or less). But it’s highly recommended to put down at least 20%. Why? Two reasons: First, if your down payment is less than 20%, you’ll need to purchase mortgage loan insurance (and it’s not cheap). And second, the bigger the down payment, the smaller the mortgage, which can save you a bundle in interest charges.
TIP! Thanks to the Canadian government’s Home Buyers’ Plan, you can withdraw up to $25,000, tax-free, from your Registered Retirement Savings Plan (RRSP) to put towards your down payment.
SHOULD I GO WITH A FIXED OR VARIABLE RATE?
It’s a question that all homeowners face and there’s no definitive answer. Instead, it depends on you, your situation and risk tolerance.
With a fixed rate, as the name suggests, your interest rate remains the same over the course of the term. You might want to lock in with a fixed rate if, for example, you’re at your limit and will find it difficult to manage your mortgage if rates go up. It affords you a degree of stability—you know exactly what your payments will be each month.
Variable rates, on the other hand, fluctuate with the prime rate throughout the term of the mortgage. That means that your monthly payments could potentially go up or down depending on interest rates. Because there is a degree of risk, variable rates are often lower than fixed rates, where you’re paying a bit more for stability.
TIP! Historically, variable mortgage rates have proven to be less expensive over time. However, there is no guarantee this will continue to be the case in the future.
IS AN OPEN OR CLOSED MORTGAGE RIGHT FOR ME?
One of the best ways to save on your mortgage is with lump-sum prepayments above and beyond your regular monthly payments. Easier said than done, right? But if you have access to the funds, you can save big on your interest payments.
It works like this: With each monthly payment, a portion goes towards the principal loan and a portion goes towards the interest on your loan. But with a lump-sum prepayment, the entire amount goes towards your principal—and that can lower the interest you pay over the course of your mortgage.
That’s where open and closed mortgages come in. An open mortgage is more flexible and allows you to freely pay off your mortgage sooner if, say, you come into some money. Whereas, a closed mortgage has a fixed amount that you can prepay each year and if you want to go over that amount, you may have to pay extra fees.
TIP! A closed mortgage typically has a lower rate than an open mortgage for the same term.
Buying your first home is a big decision. Luckily, we’re here to help. Don’t be shy to get in touch with one of our advisors if you have any questions along the way!