Should you lock in, or take a risk and how much should first timers spend?
Many homeowners are wondering whether to lock debt such as mortgages and secured lines of credit into a fixed-rate mortgage or stay variable. Even some who are mortgage free are concerned with how rate increases will impact secured lines of credit, the financing of vacation homes and recreational property. First-time buyers may be particularly concerned with entering the national capital’s expensive real estate market.
What can you afford?
As a first time home buyer, it’s essential to figure out what you can afford. A quick rule of thumb is that your household expenses should not add up to more than 40 per cent of your pre-tax household income. Household expenses include mortgage payments, property taxes, condo fees, utility and heating costs, and any payments on other loans such as car loans, credit card debt and lines of credit.
First of all you should get a copy of your credit history from the credit bureau and/or Equifax Canada. As this is what lenders will look at, it’s important to review its accuracy.
Secondly, do a household budget, list your assets and liabilities and meet with a bank or mortgage broker to be pre-approved for a mortgage. Try the monthly payments on for size. Let’s assume that your current rent is $1,000 and your anticipated payment as a homeowner is $2,350 for principal, interest, taxes, hydro, etc. Try putting aside the extra $1,350 immediately. It will get you in the habit of allocating the level of payment every month. Consider the maintenance costs as well, from normal upkeep to potentially larger expenses like a new roof or re-plumbing.
Start saving before you start shopping — the larger the down payment, the lower the financing costs. Although it’s not always possible for first-time home buyers, try to come up with at least a 20-per-cent down payment. Any down payments below this level must be insured with Canada Mortgage and Housing Corporation (CMHC) or Genworth Financial — another expense to factor in.
To assist with your down payment, consider using the Home Buyer’s Plan, which allows you to withdraw up to $25,000 from your RRSP for the purchase of a qualifying home.
Fixed rate: If the prospect of rate increases is causing you significant concern, then perhaps you should consider locking in all or some of your debt. With the inflated home equity line of credit rates that consumers have been charged (prime plus 0.5 to one per cent instead of the traditional prime), it’s not that big a jump to a five-year fixed rate, perhaps as little as one per cent more.
If your fixed-rate mortgage is renewing in 2011 and you are interested in another fixed-rate mortgage, it may be worthwhile negotiating with your lender to close out your current mortgage and move into the new lower rate mortgage without penalty. As a strategy to pay off the mortgage sooner, consider increasing the payment and utilize weekly or accelerated bi-weekly payment schedules.
If you would like some level of security but don’t want a fixed rate on all your debt, consider a blend where a portion is at a fixed rate and the balance at a variable rate.
Variable rate: There are many studies that show that despite its volatility, a variable-rate mortgage tends to save more interest in the long term.
Variable-rate mortgages are best for consumers who are financially stable and can financially and emotionally handle the day-to-day fluctuations. One strategy is to benchmark your variable rate payment to that of a five-year, fixed-rate mortgage. Not only will you apply thousands of dollars against the principal and shorten the mortgage term, you will also build a higher potential payment into your budget.
Here are other tips for a variable-rate mortgage:
• Ask for a variable-rate mortgage at below prime. You might even be able to get prime minus 0.80 per cent.
• Negotiate a better rate on your home equity line of credit. Try to get the prime rate or prime plus 0.5 per cent, as opposed to the current prime plus one per cent that you are probably paying.
• Consider moving all of your debt to a combination of these two options.
For consumers who like the variable-rate mortgage option but are concerned about rate increases, ask your financial institution to give you a 90-day rate guarantee at their best discounted five-year rate. Keep the five-year, fixed-rate guarantee as insurance if rates increase significantly and renew it every 90 days until you feel rates have stabilized.
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