Friday, August 15, 2014

How Much Mortgage Should a Canadian Couple Carry?

Let’s imagine a nice Canadian couple, Karen and Steven.

Their credit rating is good, their jobs steady, household income secure. They’re prime meat for banks hungry to sign them up for a new mortgage.

But when buying a home, how should Karen and Steven determine how much to borrow? How much house should they buy? We asked mortgage brokers for some advice.

1. An obvious one: Draw up a personal budget including the new mortgage payments
Banks generally don’t like the burden of a mortgage to exceed around 32 per cent of household income. But we all have our vices and vanities. That percentage may not fully reflect Karen and Steven’s lifestyle now or down the road, said Raj Babber, mortgage broker and president at the Canadian Lending Network in Toronto and president of the Independent Mortgage Brokers’ Association of Ontario.

“Are these the types of individuals who like to go out for dinner three times a week and ask for the reserve wine list?” They might be serious foodies.

So, “even though the banks, based on their ratios and insurer guidelines, might state that you’re able to qualify for a certain amount, you should always look at yourself personally and say, ‘This is how much I can afford to pay for a home [and] maintain my lifestyle,’” Mr. Babber said.

Those weekly, bi-weekly or monthly mortgage payments can also, of course, change with a variable-rate mortgage as interest rates change, a risk requiring some buffer. Or with fixed-rate mortgages, it could change at term’s end, necessitating a budgetary rethink, say, five years down the road.

Brokers note, though, that Karen and Steven may feel less sticker shock toward mortgage costs compared with older friends, since they’ll likely be used to paying the soaring rents seen throughout much of urban Canada.

Still, lifestyle choices need to be seriously factored in. “Are the mortgage payment, principal and interest and taxes, and insurance going to be somewhat in line with [expenses before]?” asked mortgage broker Mike Boyle of the Mortgage Group Inc. in Calgary. “You don’t want to take yourself out of a comfort level and be house poor.”

2. Reconsider the old maxim of first buying a small starter home
The dream of a bigger house in the ’burbs, although cheaper than an equivalent-sized property in town, may have all sorts of extraneous costs for many homebuyers.

“They should take a look at the entire situation. Some people like to get a bigger house and travel into work, not realizing that the cost of travel is going up,” Mr. Babber said. “The commute ends up being more of a nightmare.”

Yet, the flip side is that buying a larger house now could be a better option if a couple knows they will soon be graduating to a bigger house anyway. Everything from transportation costs to property tax should at least be considered. A $50,000 difference between two homes’ selling prices may not be much in the long run if a family is sure it will spend more years in the larger home, Mr. Babber said.

3. Don’t get carried away comparing rates
“I find banks and brokers have created this situation where purchasers are focused on rates to the exclusion of everything else. Every mortgage is so different from lender to lender,” said mortgage adviser Rebecca Awram with DLC Origin Mortgages in Vancouver.

She points in particular to collateral charges. Toronto-Dominion Bank, for instance, registers its mortgages as collateral mortgages, which the bank says allows more ease in taking out a line of credit from the house, yet the mortgage can’t be easily switched to another bank.

Other banks do this too when a line of credit is opened from a mortgage. That loan similarly becomes a collateral loan which can’t be transferred easily, not only because it’s a floating rate, but also because it’s a floating balance. Transferring the loan requires paying title insurance and other fees, Ms. Awram explained. In contrast, a conventional mortgage can be transferred to another lender for no cost to the consumer at the end of the term.

“Because a collateral charge cannot be switched or transferred for free at the end of the term, a lot of lenders have noticed, not surprisingly, that the retention levels on these types of mortgages are much higher at the end of the term compared with traditional mortgages,” Ms. Awram said.

So whether homebuyers will want to set up a line of credit stemming from the mortgage, in order to do renovations later, for instance, is a factor to consider. That line of credit can limit the ability to transfer the mortgage to another bank.

4. Pre-payment options can make a world of difference
The ability to double-up payments or skip payments, or pay off the mortgage faster in large chunks, should greatly affect the choice of which mortgage to purchase.

Often preferences for paying down a mortgage faster vary with the individual. For instance, someone who is not paid a steady salary, but on a contract basis, may rely more heavily on using doubling-up mortgage payments whenever they may find themselves flush with money. It’s a highly personal preference, making the choice of various different pre-payment options crucially important.

“It’s a harder thing to advertise. It’s a harder thing to get across in a snappy one-liner or a cute catchphrase, whereas rates are so easily identified, understood and compared,” Ms. Awram said.

Guy Dixon, Globe and Mail

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