Everything You Need to Know as a First-Time Home Buyer
Buying a home is a significant milestone, especially for millennials and zoomers (Gen Z!) who grew up with limited personal finance education. So we’re here to guide you through the financial aspects you need to consider before making this life-changing purchase. Let’s dive into the essentials that will help you avoid common pitfalls and make a financially sound decision.
Siobhan’s Experience as a First-Time Home Owner
When Siobhan and her husband bought their first house, they faced an unexpected hiccup just hours before finalizing the purchase.
Neither of them had a chequebook to write the deposit for their new build. In a scramble, Siobhan called her dad, who drove down and wrote them a cheque for $5,000.
This experience was a stark reminder that, even in our digital age, having cheques on hand can still be crucial in certain situations.
She shared a few other things that caught her by surprise when she purchased her very first house, which I’ll share later on in this blog post.
Understanding Your Real Budget
One of the first steps in buying a home is understanding what you can truly afford. It’s easy to get excited when a lender approves you for a certain amount, but borrowing the maximum isn’t always the best move. Here's why:
Monthly Expenses: Your mortgage payment is just one piece of your monthly budget puzzle. Don’t forget to factor in other living home-related living expenses such as insurance, property taxes, maintenance costs, and utilities. You’ll also need to keep room in your budget for groceries, transportation, and of course some leisure activities to really enjoy life (like going out for dinner with friends, date nights, shopping, and vacations). Life goes on after you buy a house, and those costs add up! When the bank tells you how much they’re willing to lend you, they’re not factoring in the rest of your budget to make sure you’ll have enough money to cover ALL of your expenses, not just the mortgage payments!
Emergency Fund: It's crucial to have a cushion for unexpected expenses. Life can throw curveballs like car repairs or medical bills, and having an emergency fund can prevent financial strain. And when you own a home, those surprise expenses can come out of nowhere and seriously add up. Fixer-uppers are the obvious culprits here, but new builds aren’t a home run either- there’s loads of news article highlighting the reduction in quality for new builds, which can lead to huge issues that may or may not be covered by insurance. We love using the Wealthsimple Cash Account to hold our emergency funds since they offer 4% interest (free money!). They also have a joint account that you can use if you want to share an emergency fund with a partner.
To figure out how much house you can afford, we recommend checking out Nerdwallet’s free mortgage calculator.
Another thing that can help you determine how much house you can truly afford is your Debt-To-Income Ratio. Think of the debt-to-income ratio as a way for lenders to measure how much of your monthly income is already committed to paying off debts. It's a percentage that compares your total monthly debt payments to your gross monthly income (that's your income before taxes and other deductions). Why does this matter?
Lenders use this ratio to gauge how much additional debt you can handle. If your ratio is too high, it suggests that you might struggle to keep up with mortgage payments on top of your existing debts. Generally, lenders prefer a ratio of 43% or lower. The lower your debt-to-income ratio, the better your chances of getting approved for a mortgage, and possibly even securing a lower interest rate.
So, if you're thinking about buying a house, it’s a good idea to keep your debt-to-income ratio in check. Paying down existing debts before applying for a mortgage can help lower your ratio and increase the amount you can borrow, making home ownership more accessible.
How to Calculate Your Debt-To-Income Ratio
First, calculate your monthly debts. Add up all your monthly debt payments. This includes things like car loans, student loans, credit card payments, and any other debts you have. Don't forget to include what your new mortgage payment would be!
Next, calculate your gross monthly income. This is your total income before taxes. If you have a salary, it's your monthly paycheck before any deductions. If you have multiple sources of income, add them all together.
Now divide your total monthly debt payments by your gross monthly income and multiply the result by 100 to get a percentage.
For example, if your total monthly debt payments are $2,000 and your gross monthly income is $5,000, your DTI ratio would be:
2000/ 5000 × 100 = 40%.
So, your DTI ratio would be 40%.
The Concept of Being House Poor
Have you heard the term "house poor"? It refers to a situation where a large portion of your income goes towards housing expenses, leaving little room for other financial goals or necessities. With the rapid rise in housing prices over the last 10+ years, it’s unfortunately becoming more and more common. Here are some tips to help you avoid ending up in this situation:
Realistic Mortgage Payment: Ideally, you should aim to keep your mortgage payment to no more than 30% of your monthly income. Now, this used to be a lot easier when housing prices matched salaries, but today it’s not very easy to achieve this. If you’re moving to a large city or an expensive area, you might instead aim to keep your mortgage payment to no more than 40-50%, and cut back on other expenses (like getting creative with groceries, utilities, and “fun” spending. This ensures you have enough left for other essential expenses and savings. It’s going to be SUPER tempting to stretch your budget for a dream home, but financial freedom feels a lot better (trust us!).
Future Financial Goals: Think about your other financial goals like retirement savings, travel plans, or starting a family. Your home purchase shouldn’t hold you back from achieving these other major life goals. You want a home that supports your lifestyle, not one that restricts it, so keep that in mind when you’re tempted to over-spend on a house.
Lifestyle Considerations: Make sure your home purchase aligns with your lifestyle. If you enjoy dining out, traveling, or hobbies that require spending, you’ll need to budget accordingly and look for a house where the mortgage payment is low enough to leave room for spending on “life”! Your home should enhance your life, not control it. You don’t want to move into a home and suddenly be unable to afford to do the things you enjoy just to avoid going into debt while paying off your mortgage.
Hidden Costs of Homeownership
Owning a home involves more than just the mortgage payment. Here are some often-overlooked costs that you should factor into your budget:
Maintenance and Repairs: Homes require regular maintenance and occasional repairs. Budget around 1-3% of your home’s value annually for upkeep if it’s a fairly new build, and add a bit more if it’s an older home or a fixer-upper.
Property Taxes and Insurance: Property taxes can vary widely based on location, and homeowners insurance is a must to protect your investment. These aren’t optional, and they can add significant costs. Do you research on how much property tax you can expect to pay before you sign the documents- this number takes a lot of people by surprise! To find the best home and car insurance rates available, check out this comparison tool by Rates.ca!
Homeowner Association (HOA) Fees: If you buy a condo or a home in a planned community, you may have to pay HOA fees. These can add significant cost to your monthly budget. It’s important to know what these fees cover and if they fit into your budget.
Utilities and Upgrades: Larger homes generally have higher utility costs. The same goes for older homes that have poor insulation or appliances that suck a lot of energy. Additionally, I’m sure you’ll want to upgrade certain features of your home (like a kitchen reno or finishing a basement), which can be costly. It’s not just about buying the house – it’s about maintaining and improving it over time.
The True Cost of Home Renos
Did you know the average cost of a kitchen renovation is anywhere from $13,000 for minor changes to $40,000+ for a major change? Simply switching out countertops will run you on average $3,000, and add another $1,500+ to replace the flooring. Here’s a great guide from Nerwallet to help you plan for these expenses.
Reflecting on her homebuying journey, Siobhan shared a few financial surprises that her and her husband encountered when purchasing their very first house.
Before moving in, she and her partner meticulously listed every possible house-related expense—heating, water, WiFi, and more. Thankfully their estimations were quite accurate, making the monthly budget less shocking once they settled in.
However, they missed out on using a First Home Savings Account (FHSA) for their down payment, opting for a Tax-Free Savings Account (TFSA) that earned no interest. Additionally, their home insurance bill increased every year, but bundling their car and home insurance saved them a few hundred dollars annually.
Lastly, property tax was another unexpected expense during their first year. Not knowing the exact amount, they had to dip into their savings to cover the bill. After that, they made sure to include property tax in their yearly budget to avoid any future surprises.
Pre-Approval vs. Pre-Qualification
Understanding the difference between pre-approval and pre-qualification can also help you in your home-buying process:
Pre-Qualification: This is an initial assessment of your finances. It gives you an estimate of how much you might be able to borrow based on the information you provide. It’s like getting a rough idea before diving into the details. But like any rough estimate, you’re not guaranteed to get approved for this high of a loan when the time comes to officially apply.
Pre-Approval: This is a more detailed process where the lender verifies your financial information and gives you a more accurate loan amount. A pre-approval letter can make you a more attractive buyer to sellers. Think of it as getting a firm commitment, which strengthens your position.
Your credit score can significantly impact if you’ll be approved for a mortgage, and the interest rate you’ll have to pay for your mortgage. That’s why monitoring your credit score is really important, especially leading up to a large purchase like a house. We’ve both been using a service called Borrowell for the last 4+ years to monitor our credit scores and we highly recommend it to other Canadians. The best part? It’s free! And for our American and British friends, we recommend checking out Credit Karma or ClearScore!
Making a Smart Down Payment
The size of your down payment can significantly impact your mortgage and overall financial health:
5% Down Payment: As a first-time home buyer in Canada, you’re eligible to put up just 5% on a downpayment, which can make saving up for a house a bit easier. However, if you make a downpayment that’s less than 20%, you’ll have to pay an extra monthly fee called Private Mortgage Insurance and you may also end up with a higher interest rate on your mortgage. Make sure to weigh the long-term costs. It’s about finding a balance that works for your financial situation.
20% Down Payment: While not always possible, a 20% down payment can help you avoid private mortgage insurance (PMI), reduce your monthly payments, and build equity faster. It’s a solid goal that can save you money in the long run. Sometime savign up for an extra year or two to make a larger downpayment is worth the savings, so weigh the costs before deciding how much money you’ll put down.
First Home Savings Account: In 2023, the Canadian government introduced something called a First Home Savings Account (FHSA), which helps Canadians save for their first home. Starting at age 18, you can open and add up to $8,000 per year to this account that will go towards a future home purchase. You can contribute up to a total of $40,000 to your FHSA over time. The benefits are that you won’t pay income tax on any money you withdraw to buy or build your first home, plus any money you add to this account will be deductible on your income tax return (just like RRSP contributions). To learn more about how the FHSA works, check our this article by Nerdwallet. And if you’re looking to open a new FHSA, we highly recommend this one by EQ Bank, which offer 3% interest on your savings, tax-free!
First Home Buyers’ Plan (HBP): This is a program for Canadians that allows you to borrow from your registered retirement savings plan (RRSP) tax-free if you are purchasing your very first home. The catch is that you need to repay the funds back to your RRSP within 15 years, so you will need to plan to pay it back. Of course you can only do this is you’ve been contributing to your RRSP account, otherwise there will be no money to borrow from!
Long-Term Financial Planning
Homeownership should fit into your long-term financial plans:
Retirement Savings: Don’t neglect your retirement savings to afford a home. It’s crucial to balance current desires with future needs. Remember, you’re investing in your future with both your home and your retirement fund. You shouldn’t be relying on your home price going up to fund your retirement some day… you never know what’s going to happen with the housing market. You should look at the purchase of a home as a secure place to live that will hopefully go up in value when you retire. Don’t forget to also invest money in a retirement fund (like a TFSA or RRSP in Canada, or a Roth IRA or 401K in the US).
Market Trends: Stay informed about market trends. Buying in a declining market can be risky, while buying in a booming market might mean higher prices. Knowledge is power, and staying informed helps you make the best decision.
Final Thoughts
Buying a home is a major financial decision that requires careful planning and consideration. By understanding your real budget, avoiding the pitfalls of being house poor, and accounting for all costs associated with homeownership, you can make a smart and informed purchase. Remember, it's not just about buying a house—it's about creating a home and a stable financial future. As you embark on this exciting journey to become a home owner, consider these tips and plan wisely to ensure your first home is a source of joy, not financial stress. There’s no race to purchase a house, so make sure you’re ready financially before you take the leap.
About The Authors
Amanda and Siobhan found a shared passion for personal finance shortly after completing their MBAs in 2018. Amanda excelled as a Director of Product in the tech industry, while Siobhan established herself as a leader in e-commerce before transitioning to academia as a Professor.
In 2020, they joined forces to found Hiver Academy, a platform born from their own experiences and triumphs in conquering student loans and building wealth. Realizing that financial success is within reach once the complexities are simplified, their mission now revolves around empowering individuals to achieve financial freedom.
With a wealth of knowledge and a commitment to demystifying money and investing, Amanda and Siobhan are dedicated to helping others navigate the path to success.
