Buying a home will probably be the most expensive purchase a person makes during their life. In order to finance a home, a mortgage is usually necessary. Below are some mortgage basics every homebuyer needs to know.
How much home can you afford?
Purchasing your first home is exciting, but can be overwhelming for many first time buyers. Having your finances in order is a must. It’s important to determine how much home you can afford and whether you should rent vs buy a home. The rule for buying a home is that you monthly mortgage payment shouldn’t be more than 32% of your total monthly income. So if you make $5,000 per month (that’s $60,000 per year) then your monthly mortgage payment should be no more than $1,600 per month.
There are primarily two types of rates. First, there is a fixed rate mortgage,which has a locked rate for the entire length of the loan term (usually 5 years). This means that if the interest rate is at 3.5%, it will remain at that rate the entire length of the term.
The second type is a variable rate or floating rate. This rate fluctuates every month depending on a variety of factors such as the economy and policies set by the Bank of Canada. Current veriable rates are around 2.5% or so.
Down Payment & Mortgage Insurance
The down payment is the amount of money you need to pay upfront. The more money you pay upfront, the less your mortgage loan will be. By law, Canadian banks require a 20% down payment, unless you have mortgage insurance. Mortgage insurance protects the financial institutions that are lending in case the homeowner defaults. If you have mortgage insurance, your down payment can be low as 5%. The insurance premium is paid when your home closes. It can be paid up front or added to the principal amount of your mortgage.
Open vs Close Mortgages
When you have a mortgage your expected to pay the entire amount plus interest. The term, or amount of time the mortgage conditions are in affect. Terms range from six months up to ten years. Once the term has ended, the mortgage can either be paid off or renewed.
The term can be opened or closed. Open term mortgages can be repaid at any time in full during the term without a penalty. You may benefit from an open term mortgage if you plan on paying off your mortgage quickly, however the interest rate may be higher. A closed term mortgage is a better choice if you’re planning on living in you home for the long run. With a closed term mortgage there is a penalty for paying off your mortgage before the term ends, however, interest rates tend to be lower.
Don’t start home shopping until you get pre-approved. A mortgage specialist will look at your finances to determine what you can afford. Once pre-approved, the interest rate is set and guaranteed for 120 days. This way you can work with your realtor in finding the perfect home for your budget.