Preparing to buy a home
This is a guide to help you get a complete financial picture of purchasing a home.
March 12, 2024
Between mortgages, downpayments, closing costs and insurance, there’s quite a lot to think about when planning a home purchase.
Assess how much you can afford
Home prices vary greatly across different types of properties and locations in Canada (e.g. a condo vs. detached home, city vs. rural areas).
A general rule is that the size of your mortgage (the loan you get from the bank to be able to purchase the home) should be less than 3.5 times your gross annual household income.
Example: Let’s say you are planning to buy a $500,000 home with a 20% downpayment. Your mortgage will be around $400,000. Using the 3.5x rule ($400,000 / 3.5), your household income should be greater than $115,000.
Plan your downpayment amount
In Canada, you are allowed to make a 5% minimum downpayment on a home purchase of $500,000 or less. If you are buying a home for more than $500,000, the minimum increases to at least 10% of the home value in excess of $500,000.
Example: Let’s say you’re planning to purchase a home for $650,000 and you’d like to pay the minimum downpayment. You’ll need to save:
- $25,000, or 5%, for the first $500,000
- $15,000, or 10%, for the additional $150,000 between $500,000 and $650,000
- A total minimum downpayment of $35,000
However, we recommend aiming for a 20% downpayment if you can afford it. If you make a downpayment that is less than 20% of the purchase price, you’ll have to pay additional mortgage insurance that will get added to your mortgage debt. This protects your lender in case you can’t make your payments.
Example: If you pay the minimum 5% downpayment on a $500,000 home, you’ll end up with an additional $19,000 in mortgage debt due to mortgage insurance. This will cost an additional $960 per year in your mortgage payments over 25 years (assuming a 2% mortgage interest rate).
Save for a downpayment
The approach you take to saving for a downpayment should depend on when you need the funds available. If you think you’ll need the funds within the next three years, we recommend putting your funds in a savings account rather than investing them in the market. This is because three years might not be enough time to recover from a loss if the market goes through a downturn.
If you’re more than three years away, consider saving for your downpayment in an RRSP, TFSA or a personal non-registered account. You can withdraw any amount from your TFSA or personal non-registered account without penalty, and you can withdraw a maximum of $35,000 from your RRSP as a first time home buyer through the Home Buyers Plan.
Note: The average home value has been steadily increasing in Canada for more than a decade. If you think it will take multiple years to save for a downpayment, keep in mind that the price of your target property may go up over the next few years.
Plan for ‘closing costs’
Beyond your downpayment, you should also consider saving between 1.5% and 4% of the home purchase price for other costs like the land transfer tax, legal fees, renovations, relocation costs, and home inspections.
Example: If you are buying a $500,000 home, you should have at least $25,000 available as a downpayment, as well as $7,500 - $20,000 in additional funds available for other closing expenses.
Tip: Some provinces offer grants or other programs to reduce transfer taxes for new home buyers.
Update your budget to see how home ownership affects your cash flow
Beyond making a downpayment and the periodic mortgage payments, you need to also make sure that you are able to afford higher expenses that come with being a homeowner. Some additional expenses include:
- property taxes
- property insurance
- maintenance costs
Annual property taxes can range between about 0.3% and 1.2% of the assessed value of your home, depending on your location in Canada. Using a Canada-wide average, the annual property taxes on a home assessed at $500,000 will be about $2,225.
Maintenance costs could also be significant - particularly if you are purchasing an older home. This is also why it is very important to keep an emergency fund (about 3-6 months of your usual monthly expenses) in a savings account so that you do not have to dip into your investment accounts.
Compare different home insurance offerings
There are three different types of insurance you should consider when you buy a home –
- It’s not unusual for a mortgage lender to require you to insure your home before you can take possession.
- You also should consider life insurance that can cover the bulk of your mortgage debt if anything happens to you.
- If you are buying an older home, you may also consider Home Warranty Insurance to protect against any large unforeseen home repair expense.
Get pre-approved for a mortgage
Once you have a downpayment, consider shopping around with multiple lenders for different mortgage rates. Although a lower rate might seem very attractive, you should consider other factors such as whether the interest rate is fixed or variable, whether and how much prepayments are allowed, the default clauses and portability - the ability to change mortgage banks and other factors. It may be worthwhile contacting a mortgage broker to help you understand your options.
Note: A good credit score can help you qualify for a mortgage at a relatively low interest rate. If you’re just starting to think about saving for a home, consider adopting good practices that will boost your credit score over time, such as paying down your debts.