Your Home Purchase: Part 1

The average Canadian homebuyer takes 11 months to plan their purchase, according to CMHC. If you’re thinking about buying in the next year, our four-part series will explain how you should be dividing your time.

Part 1: Getting your ducks lined up

While you don’t necessarily need a year to plan your home purchase, a little preparation never hurt anyone – in fact, it’s been known to save people money. Below are a few things you can do right out of the gate that can save you hassles (and plenty of headaches) in 11 months’ time:

a)    Become one with your credit score

There’s nothing worse than finding your dream home and realizing, upon talking to the bank, that you don’t have good enough credit to obtain a mortgage. That’s why the more in tune you are with your credit score – and the earlier you’re in tune with it – the better.

Both of Canada’s two major credit bureaus – Equifax and TransUnion – offer one free credit report per year. Take advantage of this offering to make sure you don’t have any outstanding bills you didn’t know about, or incorrect charges on your report. If you do, a year is usually enough time to clear up any minor blemishes so that your score is in tip-top shape when it comes time for that pre-approval. Remember – the better your score, the better your rate (and the more money you’ll save in the long run).

b)    Establish your household budget

If you don’t already have one, now is the time to sit down and draft an accurate household budget. This means going through your expenses, tracking your spending and figuring out which luxuries you can’t live without – and which ones you might be able to trim.

This will likely be a work in progress, and something you’ll revise over the coming months as you (and, potentially, your partner) receive raises, change jobs or simply learn to reign in your spending. Once you get into the habit of it, you’ll be able to determine how much you can really afford to spend on housing every month, which will come in handy later on.

c)    Estimate your potential mortgage payment.

While you don’t have to know the details quite yet, it pays to know roughly how much your “ideal” home is going for price-wise, where interest rates are sitting, and how much you’re aiming to have for a down payment.

Once you have these numbers in mind, you’ll be able to plug them into an online calculator and figure out how much a monthly mortgage payment is likely to cost. Once you know this magic number, determine the difference between that and the current rent you’re paying – and sock it away. Not only will this help you get used to the added costs of a mortgage payment, but it will also help you establish a bit of a savings fund – either to strengthen your down payment or use as an “emergency fund” for the day something inevitably needs repair in your new home.

Turning your principal residence into a rental

So, you're ready to move out of your starter home and into a larger residence. The thing is, your first home is so well-located that you'd love to hold onto it for a little longer - and maybe use it as a tool to launch you into the rental market. Before you make the commitment, however, here are a few things to consider: 

1.    Will you need to refinance?

Chances are, in the time you've owned your primary residence, you've had an opportunity to build up equity. The question is, will you need some of this equity to use towards a down payment on a second home - or do you have a separate down payment fund saved up?

If you need to tap into your home's equity, you're going to have to refinance - and you can only do so up to 85% of the value of your home. You'll also have to consider that, with a refinance, you'll likely have to take on a new mortgage term, rate and amortization - and, depending on the details of your mortgage, this may come with some hefty fees. It should also be noted that keeping that 35-year amortization with less than 20% equity can prove difficult since it's been phased out under new government rules.

2.    Ensuring positive cash flow.

If you have to pull out some equity in your home for a second down payment, your mortgage payments are going to increase on your primary residence. For a rental property to make sense, you're going to have to make sure that you have positive cash flow - which means the going rental rate can cover your mortgage payments, property taxes and maintenance costs. Check out similar rental properties in your area either through viewit.ca, craigslist.com or kijiji.ca.

To keep your costs as low as possible, it's best to go with the longest amortization you can get your hands on - and the lowest mortgage rate.

3.    Tax implications.

If you end up using the money from your refinanced first property as a down payment for your second, you're going to find it difficult to legally take advantage of the tax deductibility of your new rental property. This is because borrowed funds are only tax deductible if they're used to fund a rental property - and you'll be using them to fund a new primary residence. This article at Million Dollar Journey does a great job of explaining the issue, and ways to get around it:

http://www.milliondollarjourney.com/converting-a-principal-residence-into-a-rental-property.htm

4.    Are you really ready to be a landlord?

Becoming a landlord brings on its own new set of responsibilities - and potential late-night emergencies. Before you pull the trigger, really think about if you're ready to take care of the maintenance needs of two residences - and if you're prepared to carry the costs of two residences if you can't rent your first one out for a month or two.

For further reflection, consider reading these articles about nightmare tenants:

13 outrageous tenant excuses

http://realestate.msn.com/13-outrageous-tenant-excuses?page=2

Tenants from hell

http://www.property118.com/index.php/tenants-from-hell-part2/