Buying a home is one of the biggest financial decisions you will ever make. A mortgage is a loan that helps you pay for your home, but it also comes with many responsibilities and costs. Before you apply for a mortgage, there are some things you should consider to make sure you are ready and able to afford it.
Check Your Credit Report and Score
Your credit report and score are important factors that lenders use to determine your eligibility and interest rate for a mortgage. A good credit score can help you qualify for a lower interest rate and save you thousands of dollars over the life of your loan. A bad credit score can make it harder or impossible to get approved for a mortgage.
You should check your credit report and score before you apply for a mortgage to make sure they are accurate and up to date. You can get a free copy of your credit report once a year from each of the three major credit bureaus: Equifax, TransUnion, and Experian. You can also get your credit score from various sources, such as your bank, credit card issuer, or online service.
If you find any errors or discrepancies on your credit report, you should dispute them as soon as possible. If you have a low credit score, you should work on improving it by paying your bills on time, reducing your debt, and avoiding new credit inquiries.
Stay Within Your Budget
Another thing to consider when getting a mortgage is how much you can afford to spend on your home. You don’t want to stretch yourself too thin and end up in financial trouble. A general rule of thumb is that your total monthly housing costs should not exceed 39% of your gross household income. This percentage is also known as the gross debt service (GDS) ratio1.
Your total monthly housing costs include:
- Mortgage payments
- Property taxes
- Heating
- 50% of condo fees (if applicable)
You should also factor in your other debts, such as credit cards, car loans, student loans, etc. Your total debt load should not exceed 44% of your gross income. This percentage is also known as the total debt service (TDS) ratio1.
You can use online calculators or tools to estimate how much mortgage you can afford based on your income, expenses, and interest rate.
Compare Different Mortgage Options
Not all mortgages are created equal. There are different types of mortgages that vary in terms of rate, term, amortization, features, and penalties. You should compare different mortgage options to find the one that suits your needs and goals.
Some of the common types of mortgages are:
- Fixed-rate mortgages: The interest rate stays the same for the entire term of the loan. This means that your monthly payments are predictable and stable.
- Variable-rate mortgages: The interest rate fluctuates with the market conditions. This means that your monthly payments can change depending on the interest rate.
- Open mortgages: You can pay off your mortgage at any time without any penalty. This gives you more flexibility and freedom.
- Closed mortgages: You have to pay a penalty if you want to pay off your mortgage before the end of the term. This gives you more security and lower interest rates.
You should also consider the length of the term and amortization of your mortgage. The term is the period of time that you commit to a certain interest rate and conditions with your lender. The amortization is the total number of years it will take you to pay off your mortgage in full.
A shorter term and amortization can help you save on interest costs, but it also means higher monthly payments. A longer term and amortization can lower your monthly payments, but it also means more interest costs over time.
You should weigh the pros and cons of each option and choose the one that matches your financial situation and preferences.
Pass the Stress Test
Since 2018, federally regulated lenders, such as banks, require that you pass a stress test to get a mortgage2. This means that you have to prove that you can afford your mortgage payments at a higher interest rate than the one in your contract.
The stress test uses the higher of:
- The Bank of Canada’s five-year benchmark rate
- Your contract rate plus 2%
The purpose of the stress test is to ensure that you can handle potential increases in interest rates or decreases in income in the future. It also helps prevent overborrowing and overheating in the housing market.
You have to pass the stress test even if you have a large down payment or don’t need mortgage insurance.
Save for Your Down Payment and Closing Costs
The down payment is the amount of money that you pay upfront for your home. The minimum down payment required in Canada depends on the purchase price of your home:
- If your home costs $500,000 or less, you need a minimum down payment of 5%.
- If your home costs more than $500,000 but less than $1 million, you need a minimum down payment of 5% for the first $500,000 and 10% for the remaining amount.
- If your home costs $1 million or more, you need a minimum down payment of 20%.
The larger your down payment, the less you have to borrow and pay interest on. A down payment of 20% or more also exempts you from paying for mortgage insurance, which is an extra cost that protects the lender in case you default on your loan.
You should save for your down payment as early as possible and use various sources, such as your savings, investments, gifts, or government programs.
Besides the down payment, you also need to pay for the closing costs, which are the fees and expenses associated with finalizing your home purchase. Some of the common closing costs are:
- Land transfer tax
- Legal fees
- Appraisal fees
- Home inspection fees
- Title insurance
- Mortgage insurance
- Moving costs
- Utility hook-ups
The closing costs can range from 2% to 5% of the purchase price of your home. You should budget for these costs and have enough money set aside to cover them.
Conclusion
Getting a mortgage is a big step towards homeownership, but it also requires careful planning and preparation. By considering these things before you apply for a mortgage, you can increase your chances of getting approved, finding the best deal, and avoiding financial stress.