Paying rent sucks. Every month, you spend hundreds of dollars to live in someone’s basement, only to have your landlord stop returning your calls each time the bathroom starts flooding. Sure, for a lot of people renting makes more sense than taking on major debt to buy a home they can’t afford. But no matter what, kissing away a big chunk of your paycheque every first of the month is straight up depressing.
Maybe, like me, you’ve dreamt about losing the rent, rats, and roommates and just buying a place of your own. Maybe you’ve also come to the realization that you don’t make $700,000 a year, and so if you want to buy some property, you’ll have to borrow some money.
Enter one of the most important financial decisions you’ll ever make: your mortgage. You’ll be agreeing to a relationship with a bank that might last 30 years, so it’s best to know what you’re getting into.
Time for a little mortgage 101:
How much money will a lender give me?
This will depend on a lot of things, but a good rule of thumb is that no more than 50 percent of your income should go to housing. Don’t let anyone pressure you into taking on much more than this.
So let’s say you and your partner together make $80,000 — around the average income for Canadian households. If you’ve put together a $50,000 down payment, the biggest mortgage you should ask for is $400,000 (this way, with a 2.79% interest rate the two of you will pay around $22,236 a year on your mortgage, or about 28 percent of your income).
Ok, these are insane amounts of money we’re talking about.
Yep. That’s why it typically takes people 30-35 years to pay off a mortgage. Each month, you’ll be paying off your balance and interest in manageable chunks. The process of fully paying off your loan over a period of time is called “amortization.”
Amortization is a weird word.
Sure is . Let’s look at it in action. [graphic]
Loan amount: $400,000. Assuming you’ve got $50k for a down payment, a $400k mortgage could get you a decent sized home in Hamilton, a 600 square-foot-condo in Toronto, or a scenic parking spot in Vancouver!
Interest rate: 2.79%
Amortization period: 30 years, five-year fixed term.
Monthly Principal & Interest: $1,638.04
Number of Payments: 360
Total Payments: $589,693.38
Original Loan Amount: $400,000
Your payments are going to skew heavily towards the interest in the early days of your amortization period since your balance is so high. Heads up, this will be infuriating to watch. But once you’ve got a few year’s worth of payments under your belt, the balance will go down and you’ll be moving towards outright ownership a lot quicker.
Why am I paying $589,693.38 for a $400k mortgage?
In a word, interest. Interest rates have run between 2.6 percent to 6 percent, historically. Calculated over 30 years, this really adds up.
What’s with the wide range of these interest rates?
They tend to rise and fall with the market. When you pick a mortgage lender, you’ll have your choice of a fixed-rate or variable rate mortgage.
“When you lock into a fixed term, then you are guaranteeing that you are going to pay a particular amount for a period of time,” explains Paul Taylor, President and CEO of Mortgage Professionals Canada. “The interest rates can go up or down, but you’re protected from the movement of the market. In Canada, about 75 percent of people go for a five-year fixed term mortgage.”
“At the end of your term, you’ll also have to recommit at whatever the interest rate is then,” notes Taylor. “So you’ll have to be mindful. Is my income going to change? Am I still going to manage the payments at what might be higher rate?”
Variable rates tend to be lower in the short term, but you’re taking the market as it comes. Is that a risk you’re prepared to take? It’s really a judgement call.
Got it. So after I pick my rate, I’m paying for interest and the balance of my mortgage.
Well, it’s a bit more complicated than that. Mortgage payments follow the PITI* formula:
Principal: The original amount of your loan.
Interest: The fees you’re charged until you return the money.
Taxes: Paid to the local government based on your property value and the area’s tax rate.
Homeowner’s Insurance: Varies from province to province, and on your deductible, but on average, Canadians pay $840 annually.
*Plus a few other expenses that might factor in—like maintenance fees if you bought a condo, closing costs on the purchase, land transfer taxes, etc. These can range anywhere from 2-5% of your home’s value.**
**Oh, and one more thing. When you buy a home, you’re your own landlord. Budget 1-3 percent of the purchase price of per year for repair and maintenance costs.
I’d really prefer to pay less than this.
Wouldn’t we all. The best way to reduce your payments is to cobble together a bigger down payment. The more money you can put down, the less you’ll have to borrow, and the less interest you’ll pay over the long run. Maybe you can ask your folks? A recent BMO study found that 44 percent of Canadian millennials expected a little help from their parents when buying their first home.
Isn’t there any other way to pay things off faster?
Splitting your monthly payment in two and instead paying it biweekly can shave a few thousands off your balance in the long run. Other than that, it really just comes to down to contributing as much as you can, when you can.
But hey, if the housing market keeps up with the way it’s been going, in 30 years you can sell your suburban townhouse for eight figures. Score!
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