Your first home is one of the most exciting – and important – purchases you’ll make in your life. It’s a major life milestone that many of us spend years saving for and working toward.
Once you’ve saved up a big down payment and found that beautiful place – whether it be the adorable, two-bedroom flat with a balcony on a quiet side street, or the charming, single-family home in the suburbs – the temptation to simply grab the keys, sign anything and start browsing Etsy for new home decor can be monumental.
But, buying your first home is a major financial decision; the last thing you want is to be impulsive and live with buyer’s remorse later. So, before you sign that property deed and hand over your down payment, ensure you don’t stumble into any of these financial pitfalls on the road to your dream home.
- Not Knowing What You Can Actually Afford
This sounds pretty obvious, but you’d be surprised. Sure, a two-bedroom with a massive walk-in closet, a kitchen island and a balcony sounds dreamy. But, can you actually afford the square-meters you want, in the neighborhood you want it in?
Most mortgage lenders suggest the “20% rule” for first-time homebuyers, which advises that your down payment should be at least 20% of the property’s purchase price. If you pay less than that, you’ll end up borrowing much more. You might even have to buy mortgage loan insurance to protect against a potential default, which would significantly increase your monthly payment.
So, before you feel yourself getting all heart-emoji-eyed over that duplex with the amazing natural light, make sure you can actually afford at least 20% of the price. Otherwise, it’s time to look in another neighborhood, sacrifice some features or consider downsizing.
The 50:30:20 rule is another good rule of thumb. It states that your needs for housing, healthcare, and groceries should be no more than 50% of your income.
- Applying with the First Lender You Find
Your mortgage will be a significant part of your homeownership journey and will represent a major monthly cost that you’ll need to factor into your budget. For the sake of this article, we’re assuming you’re buying your first home to live in, not to rent out. (If you were renting it, the rental income should cover the mortgage payments, plus you’d be eligible for some tax deductions.) When you’re buying a home to live in yourself, you’ll need to cover the monthly mortgage payments. Financial advisors typically suggest that your monthly payments should not exceed 30% of your gross monthly income.
In order to ensure you’re getting the best rate, do the same thing as you would when looking for a car or even just the best pair of noise-cancelling headphones: shop around.
Monthly rates can vary quite significantly among different mortgage providers, so don’t just go with the first rate that’s offered to you. Additionally, some lenders may also have additional expenses, such as processing fees and closing costs.
- Ignoring “Bad” Debt
Yes, a mortgage is a debt. But, if you ensure you’re getting a good rate and meeting your payments each month, it’s the kind of debt that can gain tax advantages, build equity, and help you grow long-term wealth.
However, other kinds of debt – particularly high-interest debt, such as credit card debt or car loans – need to be addressed as soon as possible before they continue snowballing and become unmanageable.
If you’re buying a house with a small down payment (such as 5% of the purchase price) and have a lot of high-interest debt, you’re putting yourself in a very uncomfortable situation where your debt will feel insurmountable. In the worst-case scenario, you might even end up defaulting on your mortgage payments, which could end up getting you evicted or foreclosed upon. Avoid this scenario at all costs by paying off as much high-interest debt as you can before starting the home-buying process.
Your entire monthly debt load – which includes housing costs, credit cards, property taxes and any other types of loans – ideally should not exceed more than 3.5 times your gross monthly income. This figure is called your total debt service ratio (TDS); when you’re shopping around for mortgages, you’ll have a hard time finding a lender if your TDS exceeds 40% of your income.
- Ignoring Government Programs for First-Time Buyers
Buying your first property can be tough. That’s why it would be foolish to ignore any opportunities created specifically to make this process easier for first-time homebuyers.
Savings are obviously at the core of smart home-buying, and the more savings you have, the more you can add to your down payment. This is where your Registered Retirement Savings Plan (RRSP) comes in. It’s a tax-advantaged account available to all Canadians that allows you to defer paying taxes on the amount you contribute to the RRSP each year. So, if you make $50,000 per year and contribute the maximum amount – 18% of your past year’s income, or $9,000 in this scenario – you’d only pay taxes on $41,000 in income for that year.
But, RRSPs also come with some pretty strict rules, and if you withdraw from them before retirement, you could be saddled with a pretty high tax bill. The exception is if you’re a first-time homebuyer, which makes you eligible for the RRSP Home Buyers Plan; you should absolutely take advantage of this program.
Administered by the Canadian Revenue Agency (CRA), the Home Buyers Plan allows eligible first-time homebuyers to withdraw up to $35,000 tax-free (as of March 2019) from their RRSP to be used toward a down payment on the purchase of a home. That means that you can take advantage of the tax benefits while contributing to your RRSP, and then withdraw the funds tax-free to pay for a down payment.
However, there’s a catch: You’ll need to pay back the money at a later date, albeit without interest. You’ll start repaying 1/15th of the withdrawn amount per year by the second year that you’ve withdrawn from your RRSP; all of the funds withdrawn must be repaid within 15 years. But still, as long as you stay on top of your payments, the Home Buyers Plan is an incredibly tax-effective way to finance your first home. You can find other first-time buyer programs on the Canada Mortgage and Housing Corporation site.
- Underestimating Repair & Renovation Costs
The fixer-upper that’s in a great location and is being sold at an attractively low cost can be very tempting. But, if you’re dealing with a crumbling roof, a weird wall that awkwardly splits up the living room, or water damage, it can get expensive very quickly.
And, while hiring an inspector to assess damage and repair costs is fundamental to buying a home, always assume that the quoted estimate for repairs is lower than it will actually be. If you’re dealing with expensive repairs that could count as remodels, definitely seek out more than one estimate to get a better idea of what you’ll actually have to pay.
Homeownership is an exciting prospect, and with the right approach and financial awareness, you’ll be on your way to building long-term wealth and a home that will truly be yours.