11 Tips for first time home buyers
Buying your first home is a complicated and often confusing affair. There is much to know, legal issues to face and many mistakes can be made. We’ve compiled a list of tips that are a good starting point to help you avoid the biggest pitfalls.
1. Deal with your personal finances first
Buying a home is one of the largest financial decisions in anyone’s life. So it’s important to make it from a financially stable place.
Pay down any major and high-interest debts you may have now and aggressively. Student loans are generally low-interest enough (and you can claim a 15% tax credit on the interest paid) so you can continue to pay them off normally.
2. Save up a 20% downpayment
Your savings plan for your first home should be based on saving enough for a downpayment that avoids CMHC insurance premiums, which means you need to make at least a 20% downpayment. CMHC premiums add unnecessary cost to owning a home and should be avoided.
3. Take advantage of the first-time homebuyers plan
The first-time homebuyers plan (HBP) is a government program which allows you to withdraw up to $35,000 from your RRSP towards the purchase of your first home without paying tax on it. At today’s home prices that isn’t much, but it is still a $35k that’s tax-free. You will have to pay back the $35,000 to your RRSP–and you won’t get to claim those contributions a second time–but over a lengthy period of up to 15 years. We certainly hope you’re planning on contributing more than $35k to your RRSP in the next 15 years.
Some have suggested the HBP is a bad idea and encourages people to rob their retirement savings to pay for their first home. We disagree and feel that even if you were to save up your downpayment using another account it would still be worth it to take the $35k from your RRSP and just pay it back immediately. Tax-free is tax-free. If anything the HBP maximum should be increased to keep up with rising home prices. That said we do agree that you shouldn’t use it to buy a home you can’t afford and you should ensure you can both afford to pay for your home and continue to save for retirement.
There are situations where using the HBP doesn’t make sense, such as for some incorporated individuals where saving for retirement in an RRSP doesn’t work out tax wise. You’re best talking to a tax expert or a financial advisor if you’re not certain.
4. Plan to pay your mortgage in less than 25 years
Mortgage lengths of up to 30 years are possible but it’s best to ensure you can afford to pay for your home in 25 years, longer mortgage periods means significantly more interest paid. However, there’s a bit of a trick here. It can actually work out better to take up to a 30-year mortgage (if it’s available to you) and then accelerate your payments. You keep the payments the same as the 25-year mortgage but can also take advantage of things like a mortgage cash account (MCA). The MCA is a flexible line of credit at your mortgage rate that grows whenever you overpay your mortgage payments either through accelerated payment plans or lump sum deposits. The mortgage cash account makes a good emergency fund for things like unexpected home repairs. It can also provide some short-term flexibility if cash flow becomes an issue, just be sure to catch up later on.
5. Don’t take a mortgage with unfavourable terms
Many “great” mortgages have unfavorable payment terms. You can’t accelerate payments or make lump sum deposits and there is no mortgage cash account. These aren’t worth it and usually, the rates aren’t that much better than you can get elsewhere.
6. Never take the mortgage insurance
Specifically, the insurance offered with your mortgage. You have to sign a waiver saying you don’t want the insurance. Do it. Get proper term life insurance to cover the mortgage. If you are buying as a couple each of you needs to be insured. This is much cheaper and the insurance terms are far better. We’ve written more on this here.
7. Ensure you can afford both your home and your retirement
This is crucial. Owning a home free and clear is great; it means (usually) you get to live rent-free in retirement (but remember taxes and maintenance are ongoing costs). However, that’s not very useful if you’ve failed to save for retirement. A reverse mortgage might help you out in a pinch, but that should really be a last-resort option. Create a financial plan first and determine how much you need to budget for the mortgage, maintenance, and long-term savings; and compare this to the costs of renting.
Also, if you’re starting to save your downpayment, get used to saving this amount now. Take the difference between your current rent and your planned mortgage + maintenance + savings. Start saving at least this amount now towards your down payment (of course, feel free to save more if you can afford it and want to get to your goal sooner). Learn to live with your future budget today and avoid a budget shock after you buy.
8. Work with experts
Don’t go into this alone. A lot can go wrong in a real estate purchase, and at great expense. Work with experienced experts. An experienced realtor will help you craft an airtight offer and walk you through handling the deposit and the property transfer process so there are no problems.
9. Historically variable is better than fixed
The banks are pretty smart when it comes to interest rates and they know how to ensure they don’t lose money on the fixed rates. They are good enough at this that you’ll almost always pay a premium for the “piece of mind” of a fixed rate. Some will argue that fixed is better when you don’t think you’ll be able to afford a sudden increase in mortgage payments, however, in that case, we’d suggest you consider if you can afford the mortgage either way. Stretching your finances too thin is a certain recipe for disaster.
10. Don’t fear to rent
Many new prospective home buyers are afraid of “missing out,” particularly in many of Canada’s “hot” urban real estate markets. While we don’t really see urban real estate markets cooling for a while, renting is still a completely sensible and practical option financially, even for the long term.
Don’t buy a home simply because you believe the housing market will “beat” renting financially. Your primary home is where you’ll be living for quite a while, possibly the rest of your life. It isn’t meant to be just another investment vehicle. Renting offers considerable flexibility as long as you ensure you are also saving aggressively and building up wealth towards financial independence.
It’s a good idea to play around with a good buy-vs-rent calculator to see what the numbers look like over the long run. Check out “Is It Better to Rent or Buy?”. It’s simple to use and easy to understand.
11. Begin with a financial plan
I’ve mentioned this now a few times but I really can’t stress enough how important it is to have a financial plan when making these important financial decisions. You can sign up here and we’ll help you create yours.