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Mortgage essentials for the rookie homebuyer

Posted on 02 October 2013 by admin

TD Canada Trust breaks down the financial commitment for first-time buyers

Buying a home is the biggest purchase most Canadians will ever make, and with the high cost of real estate today, understanding the full financial commitment is critical. TD Canada Trust breaks down three key home financing decisions for first-time homebuyers to consider: down payments (20% is the goal), mortgage options (it’s not just about the lowest interest rate possible) and accelerated payments (pay down more than you need to).

“Home ownership is a major goal for many Canadians, and in today’s market it is especially important that prospective buyers understand home financing options in order to manage their overall monthly costs, assess the flexibility they will need, and help plan for the future,” said Farhaneh Haque, director of mortgage advice at TD Canada Trust.

The following tips can help first-time homebuyers structure their mortgage so that it works best for them before signing on the dotted line:

 1.      Down Payment: how much and how to finance?

There are many benefits to a larger down payment. For example, homebuyers with a down payment of greater than 20% do not have to obtain mortgage default insurance, the premium for which is calculated as a percentage of the mortgage and is paid up front or by adding it to the principal portion of the mortgage. So, the larger the mortgage balance, the higher the monthly mortgage payments. Eliminating or decreasing this premium can result in significant savings.

Haque suggested that first time buyers can take advantage of the government’s Home Buyers’ Plan and use savings in their RSP to bolster the down payment.

 “Homebuyers can also consider withdrawing up to $25,000 from an RRSP to put towards the down payment on a first home,” said Haque. “While this can be a huge help upfront, among other conditions it must be repaid within 15 years, so make sure to factor in the repayment schedule into the monthly budget.”

 2.      Mortgage Options: fixed or variable interest rate, open or closed term, flexible payment features?

A low interest rate isn’t the only factor to consider when choosing a mortgage. A mortgage specialist can help you navigate options like flexible payment features, and discuss monthly payment amounts in the context of your overall cash flow and future home-buying plans.

“Buyers choose a home because it fits their lifestyle needs,” said Haque. “A mortgage should pass the same test, and that means weighing the current term options against an overall long-term plan to pay that mortgage down. Once you find the best option for you, look for opportunities to realistically accelerate repayments.”

Fixed vs. variable interest rate

With a fixed interest rate mortgage, the interest rate and monthly payments do not change throughout the term of the mortgage and it’s clear upfront how much will be paid off at the end of the term. With a variable interest rate mortgage, the interest rate may fluctuate during the term. If interest rates go down, more of the monthly payment is applied to the principal, helping to pay off a mortgage faster. If interest rates rise, more of the monthly payment is applied toward interest. In addition, with a variable interest rate mortgage, you may be required to revise your payment arrangements at certain times.

“This choice usually comes down to whether homeowners are comfortable with the possibility of paying more money toward interest and less to principal some months as a trade-off for potential interest savings other months, or if they prefer the stability of a fixed interest rate mortgage,” said Haque.

Open vs. closed mortgage

With a closed mortgage, a homeowner agrees to a term anywhere from six months to 10 years. There are conditions that limit when a closed mortgage can be renegotiated or refinanced and there may be a prepayment charge for renegotiating early or paying off the mortgage prior to the end of the term. Often negotiated for a shorter term, an open mortgage can be paid off at any time without prepayment charges. While it offers greater flexibility in terms of repayment, the interest rate for an open mortgage may be higher than for a closed mortgage.

Flexible payment features

Some mortgages offer features that give homeowners added flexibility to react to changes in their financial situation. For instance, flexible mortgage options may allow homeowners to make prepayments on their mortgage when they can and then reduce their monthly mortgage payment or take a payment vacation for a short period of time when they need to.

“Until it’s paid off, a mortgage will become a part of a homeowner’s life. Homebuyers need to ensure the terms of their mortgage match their plans, now and for the future,” said Haque.

3.      Accelerated payments: how can a mortgage get paid down faster?

Homebuyers can pay off their mortgage faster and save money on interest by choosing a shorter amortization period or setting up an accelerated weekly or biweekly payment schedule instead of a monthly payment schedule. Prepayments are another way for homebuyers to pay their mortgage faster without locking into a payment schedule that could make it a challenge to manage their monthly cash flow. Many lenders allow mortgage holders to make prepayments up to a percentage of the original mortgage amount each year.

“It’s wise for homeowners to strive to be mortgage-free quickly; however it’s important they don’t stretch themselves too thin with the amount of their payments,” said Haque. “Beyond their mortgage, there are ongoing expenses that come with homeownership such as property taxes, utility bills and maintenance. It’s important that home buyers budget for these expenses when deciding on the mortgage payment schedule they can afford. They need to be realistic and not put themselves in a position where they’re struggling to keep up with payments.”

Canadians can ask questions related to broad range of financial advice, including buying a new home, at the TD Helps community:

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