Getting Pre-Qualified for a Mortgage

Your Payment Options

Application and Approval Process


Home Inspections and Appraisals

Using Your RRSP "Home Buyers Plan"

GST Taxes on Home Purchases

Here is some valuable information on Mortgages and Financial subjects. We are providing this information as a service to you while you educate yourself in Mortgage and Financial matters. If you have a question, please don't hesitate to contact us, we are here to help.


Getting Pre-Qualified for a Mortgage

Rate Commitment
Many Lenders will guarantee an interest for a client while they are shopping for a home. The purchaser is then protected if interest rates rise during this shopping period. This can be an extremely important advantage; it will not only save the borrower money but could also save them from loosing their dream home when they finally find it.
When interest rates rise the amount of mortgage financing a borrower qualifies for can be reduced. It is possible that your maximum affordable mortgage could be thousands of dollars less after an unprotected interest rate spike. This reduction in available financing could very well require you to ante up a larger down payment. If you do not have the additional savings your maximum affordable home price could be reduced.
A rate commitment usually requires a full pre qualification of the applicant. Rate commitments vary from one mortgage lender to another. Some will guarantee the rate for 30 to 60 days or longer. If rates rise during the commitment period the borrower is assured of either the lower of the committed rate, or the rate one day before closing. Some mortgage lenders offer commitments that guarantee the lowest market rate during the commitment period, or the committed rate. Your Mortgage Consultant can pre qualify your with the right mortgage lender and insure your rate commitment meets your needs.

Pre qualification
Pre qualification means that your lender has reviewed and verified all the available financial information detailed in your application and has determined the maximum amount of financing you can afford. A pre qualification is different from a simple rate commitment. A rate commitment is where the lender guarantees that "if" you qualify for a mortgage they will offer the agreed upon interest rate. Agreeing to an interest rate does not require the lender to complete the preliminary underwriting while a pre qualification does.
In order to complete a pre qualification the lender will require all of the information contained in their mortgage application. This will mean that you will have to provide them with most of the documentation necessary for a full mortgage approval. The effort is well worth it as you will then be assured of mortgage financing in the pre qualified amount.
The benefits of being pre qualified include the comfort of shopping for a home within your price range without the risk that complications will arise in the final hour. Also, there are the benefits of being able to make a stronger purchase offer without "subject to financing" conditions. This will allow your Realtor to negotiate harder and reach an agreement before a competing purchaser makes a better cash offer.
Pre qualifications are only subject to the lenders approval of the property, usually determined by an appraisal after a purchase offer has been agreed to. The borrower's income, expenses, credit history and verification of down payment have all been considered in advance.
Pre quantification is simply a calculation of the amount of mortgage the applicant "may" qualify for. The gross income amount used is not verified, nor is the applicant's employment, credit history or net worth. Pre-quantifications are often confused with a full pre qualification and should be used as a preliminary guide only.
The calculation to determine your maximum mortgage financing is based on your income and expected expenses. Assume you and your co-applicant have a combined monthly gross income of $5,000. If the mortgage lenders maximum GDSR is 32% you can spend $1,600 on shelter costs. In this case your maximum shelter cost payment is $1,600. By subtracting the monthly heating costs, condo maintenance fees, and property tax cost from the applicants maximum payment the lender can then determine the maximum mortgage payment.
Given this maximum mortgage payment figure the lender can easily calculate the maximum amount of financing you will qualify for based on your income. The procedure is simply the reverse of calculating a mortgage payment given the payment amount, amortization and interest rate.

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Your Payment Options


Accelerated Monthly Mortgage Payment
A typical monthly mortgage consists of equal monthly payments of both principal and interest. As payments are made the principal owing is reduced, each subsequent interest payment is also lower as a result. Over time more and more of the equal payment is applied to principal reduction, until the mortgage is completely repaid. A mortgage is usually calculated to be paid off over 25 years; however any repayment period (amortization) is possible. The amount of interest paid is a result of the interest rate, the compounding frequency and length of time it takes to repay the loan in full.
Mortgages have traditionally been paid on a monthly basis, same as rent. In recent years financial institutions have offered flexible payment options. These include the availability of Weekly, Semi Monthly, and Bi Weekly payment plans in addition to the conventional Monthly option.
There are no great savings in the amount of interest paid between the various payment plans, except for the accelerated options. When choosing a payment plan you should consider convenience and practicality. If your salary is paid on a monthly basis, a monthly payment is probably the way to go. If you are paid semi monthly or every second Friday, the Semi Monthly or Bi Weekly options may be best.

Accelerated Payment Plans.
An Accelerated Payment Plan is a great way to save thousands of dollars of interest and be mortgage free years earlier. The savings are a result of the additional principal amounts paid each month. Any payment plan can be accelerated, simply by pre-paying an amount each month or decreasing your amortization. The most common accelerated plan is the Bi Weekly payment option due to the easy payment increase.
Accelerated Bi Weekly Payments. The above chart shows that the "Monthly" option requires a monthly payment of exactly $1,000. The annual sum of these payments is $12,000, calculated as twelve multiplied by $1,000. When choosing an Accelerated Bi Weekly payment plan the borrower agrees to pay one half (1/2) of the monthly payment 26 times per year. With the accelerated Bi Weekly plan the borrower will be paying the equivalent of one extra monthly payment, $1,000, each year. The result is faster repayment of the mortgage, "accelerated", and the consequent interest savings.

Here is why.
There are 26 Bi Weekly payment periods in a year. The borrower agrees to pay $500, half the monthly payment, 26 times per year. As such their annual sum of payments is $13,000 (26 payments x $500 = $13,000). This is $1,000 more than the annual sum of monthly payments. This additional payment of principal is the reason for the spectacular savings in interest of $55,217 and the luxury of being mortgage free - faster.

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Application and Approval Process


The first stage of the mortgage lending process involves filling out the application, verifying the information on this application, and confirming the value of the property. The process of determining the risk of an application, and whether to approve it, is called underwriting.
The underwriter considers three primary components of each application. The task of underwriting is to determine the borrowers ability to repay the funds under the agreed upon terms, their willingness to repay, and the adequacy of the real property as security for the mortgage loan.

1. The current financial position of the applicant.

Net Worth
The applicant's net worth is determined to decide their overall financial well being. Of particular concern is the verification of available net worth for the purpose of down payment. The accumulation of assets beyond liabilities can be used as a general test of the applicant's personal finances and income management in prior years.

Gross Income
One of the most important components of the loan underwriting process is determining the borrower's gross income. The income of all borrowers and co-borrowers is included in the calculation. The income can be derived from several sources, but it must be supported by historical documentation and have a high likelihood of continuation in the future. The underwriter is concerned with the quantity of income earned in order to determine the maximum mortgage allowable, and also the durability of these earnings to insure that the borrower will be able to make their mortgage payments for the full term of the mortgage.
The following outlines the types of income that may qualify as well as the verifications required to confirm them:

Salary: Income derived from any kind of salary, whether monthly, weekly or hourly is acceptable. Two or three year's employment history is usually required.

Commission and bonus: Commissions and bonuses may be qualifying income if it is an ongoing and persistent component of overall earnings. To verify this the underwriter will average the last two or three years of income shown on your income tax returns and the year-to-date earnings from the written verification of employment or pay stubs. The task is to determine if this income is likely to continue in the future, and at what levels given the employment type.

Self-employment income: Generally, the underwriter will average the income earned through self-employment for the last three years from the applicant's income tax returns and the year-to-date earnings from a profit and loss statement of the business. Self employment can take many different forms so the underwriter will require as much supporting evidence as possible to determine and verify qualifying income. In determining the current amount of qualifying income generated by self employment the underwriter will take into consideration the trends in your business or industry in an effort to forecast future prospects.

Other Income: Income earned from rental properties, interest, dividends, pensions, and social security can be used, as long as it can be verified and will persist long into the future. Some incomes are discounted, or do not qualify at all, for the purposes of mortgage loan application. One time gifts or windfalls are not income nor is occasional overtime or a single bonus from your employer if it is not likely to be received again. In general, unemployment benefits or other insurance's with a finite disbursement period are not considered.

Funds to Close: When the proposed loan is being used to finance the purchase of a home, the lender will determine the source of funds for the down payment as well as closing costs. The mortgage lender is verifying that closing costs and down payment amounts are not also going to be borrowed and have been accumulated over time from the borrowers own resources.
The following are acceptable sources of funds for closing:
Funds on deposit: Money that has been on deposit for at least 60 days in checking or savings accounts at any depository institution or investment company is acceptable, so long as it can be verified on bank statements for the past two months.

Stocks, Bonds, Mutual Funds, etc.:
Cash equivalent investments are acceptable forms of funds. They can be validated through statements from investment companies for the last two months.

Sale of existing property: Many times the source of funds for the down payment on a home comes from the equity in a property that will be sold. The sales price of the property being sold is indicated on the loan application and any existing loan is verified on the credit report or through a verification of previous mortgage. The contracts of purchase and sale must be submitted to the mortgage lender in order to verify that the proceeds of disposition are sufficient and closing dates are in order.

Gifts from family members: Gifts from family members for the down payment and/or closing costs are acceptable so long as there is no requirement for repayment. CMHC will require the execution of a gift letter as proof that the gift is bona fide.
CMHC requires the borrower to demonstrate their ability to cover closing costs in the amount of 1.5% of the value of the property. Closing costs can be equal to as high as 3% of the value of the property being purchased and can vary widely depending on the property being purchased, services required, taxes and insurance's applicable, whether the home is new or old, closing dates affecting interest adjustments, and the balances of any prepaid expenses.
Closing cost are typically one time fees that must be paid as a result of the purchase transaction. Other immediate costs are also incurred as a result of a home purchase. These include moving costs, costs to ready the home for your family, insurance coverage, lock smith and security costs, renovation costs, household affects such as drapes, appliances, and furnishings, and the installation of telephone - cable and internet access etc.

2. How Much Home Can You Afford

Once the lender has determined the applicants qualifying gross income and expenses they will calculate whether the applicant can afford the mortgage loan based on their ability to carry the shelter costs. Lenders use a ratios approach to determine this ability by setting maximum expenditure amounts.
Shelter costs include:
· The Mortgage Payment
· Property Taxes
· Condominium Maintenance Fees
· Heating Costs
While these are not the entire costs of home ownership, they are the most quantifiable ongoing expenses that will have to be paid.


Gross Debt Service Ratios (GDSR)

The GDSR is the ratio between gross income and shelter costs. The lender will set an upper limit on this ratio. As a general rule mortgage lenders will not allow you to spend more than 30% to 32% of your gross income on shelter costs. If the sum of the mortgage payment, property taxes, condo fees and heating costs exceeds the lenders stipulated Gross Debt Service Ratio, the mortgage will likely be declined, or a revised loan amount offered.

Assume the applicant's monthly gross income is $5,000 and they are applying for a mortgage of $200,000 at an annual rate of 8% to be repaid over 25 years. The monthly mortgage payments would be $1,526. The lenders maximum GDSR is 32%.

The lender will add up the shelter costs related to the purchase of the subject property. In this case it is a single family dwelling with property taxes of $100 per month and $50 per month heating costs.

The Shelter Payments amount to 33.5% of the applicant's gross income, higher than the maximum allowed by the lender. As such the lender will reduce the financing available to the applicant in line with the 32% GDSR maximum.

With Gross Income of $5,000 per month and a maximum GDSR of 32% the lender will only permit the applicant to have a maximum shelter payment of $1,600 (32% of $5,000)
By subtracting the property taxes of $100 and the Heating Costs of $50 we are left with the maximum gross income available for mortgage repayment. In this case $1,450. This is the applicants maximum mortgage payment.

The $200,000 mortgage the applicant has requested results in a mortgage payment of $1,526 at current interest rates of 8 %, exceeding the applicant's maximum mortgage payment and pushing their GDSR above the limit.

The lender will calculate the maximum loan amount using the applicant's maximum mortgage payment of $1,450. This results in a maximum mortgage of $189,986, given the current interest rate.
The applicant will have to provide a larger down payment in order to proceed with the purchase of the subject property. Given that their maximum mortgage is $10,014 less than they had anticipated they will have to provide these funds from savings or they will be forced to look for a more affordable home.


Total Debt Service Ratios (TDSR)

The TDSR is the ratio between the sum of both shelter and non shelter financial obligations combined and gross income.
The lender is concerned with the applicant's ability to carry costs other than simply the shelter payments. The maximum the applicant will be allowed to spend on both shelter and non shelter financial obligations combined is usually set at 40% to 42%. Total Debt Service Ratios above 42% result in payments that are likely to be unmanageable for the borrower in the long term.

Disregarding the applicants other financial obligations could mean approval of a loan to a borrower that has substantial non shelter financial obligations and may increase the risk of mortgage payment default.

Non Shelter Financial Obligations include:
· Car Payments
· Credit & Charge Card Payments
· Personal Loans
· Lines of Credit
· Finance Company Loans
· Long Term Leases (more than 1 year)
· Tax loans
· Long term RRSP catch up loans (more than 1 year)

Let's assume that the applicant agrees to a reduction of the mortgage amount to $189,986 in order to bring their GDSR within the allowable 32% limits. The next step is to determine if the borrowers other financial obligations are within the allowable Total Debt Service Ratio limits. Again the shelter costs are summed and any additional costs are also added. If these combined costs do not exceed the 42% maximum the borrower will be past the first step.

If the applicants GDSR is at the 32% maximum they will must not have more than 8% of their gross income committed to non shelter financial obligations, 42% in total.

How Personal Debts Can Affect Housing Affordability

If the applicants existing non shelter financial obligations are, say 18% of their gross income, the income available for shelter financing is squeezed and reduced to 24% of their gross income. 24% of the applicant's $5,000 grosses income results in a maximum shelter payment of $1,200. If we subtract the heating cost of $50 and the property tax costs of $100, the resulting maximum mortgage payment is now $1,050.

$1,050 will finance a mortgage in the amount of $137,576 at 8% per annum. This is substantially lower than the $189,986 the applicant would qualify for based solely on the GDSR. The applicant's non shelter financial obligations are having a negative impact on housing affordability by reducing their available financing and consequently the applicant's purchasing power.

In the graph below the applicant has a credit card payment of 7% of gross income and car payments of 6% of gross income. The combined non shelter financial obligations of the applicant equal 18%.

After Taxes Ratios

The debt service ratio above may appear to leave a good deal of income for all other expenditures. However these ratios are based on gross income and not after tax income. A look at the applicants remaining income after taxes reveals a different picture.
The graph below displays a maximum GDSR of 32%. After taxes these shelter costs constitute 49% of their disposable income.

The remaining 35% of after tax income does not leave the borrower with much room. In the case of our applicant with a gross income of $5,000 the remaining after tax income they will have is only $1,150 per month. These remaining funds must pay for all other expenses such as food, clothing, medical and dental, vehicle maintenance and operating costs, entertainment, personal property, and savings.
Gross Debt Service Ratios and Total Debt Service Ratios are the maximums set by mortgage lenders.
Purchasers may consider opting for longer mortgage terms in order to avoid the risk of rate increases. In addition, many purchasers are wisely advised to pay down their mortgage, particularly if a renewal at lower interest rates has resulted in a lower mortgage payment.

Set Your Own Debt Service Maximums

While these maximums set risk guidelines for mortgage lenders, the applicant should also calculate their own maximum GDSR and TDSR. In many cases the lenders maximums are too high for an applicant who wishes to have a little more spending money in their pocket each month. Applicants know their lifestyle priorities and spending habits far better than the mortgage lender. The maximum shelter costs a borrower can handle should be carefully determined by the family regardless of what the lenders maximums are.


3. Creditworthiness


Credit Analysis: Another very important part of the underwriting process is determining the creditworthiness of the borrower. Loan underwriters review the borrower's credit report to find evidence of debt repayment behavior. Some of the important areas that are reviewed are:

Past and existing mortgage debt: The past repayment history on mortgage debt can be a good indication of a borrowers attitude toward mortgage obligations. A good payment history on mortgage debt is very important in the credit analysis. Generally, payments received 30 days past the due date are reflected in the credit report as late. Lenders vary in strictness, and some may not allow any late mortgage payments, while others will allow 1 or 2 in the last two years if there is a good explanation.

Installment and revolving credit: Other items on the credit report can also indicate a borrower's attitude toward their financial obligations. Credit reports indicate the outstanding balance, payment amount, and terms of payment on the borrower's revolving and installment debts. Underwriters review these credit obligations to determine the borrower's patterns of credit use and repayment behavior. Revolving credit refers to department store credit and bank credit cards. Installment credit refers to longer term credit with structured payment plans, such as car loans. Generally, underwriters are not concerned over isolated and minor slow payments indicated on the credit report. They look for an overall profile of the applicant's attitude towards their financial obligations.

Collections, repossession, foreclosures and bankruptcies: Credit reports also indicate public records such as collections, repossessions, foreclosures, and bankruptcies. Though these items may indicate past credit problems, they sometimes have valid explanations. Underwriters may require a letter of explanation on items noted in the public records. Many times consumers have re-established credit and have an excellent payment history on their current obligations. It is important to forewarn the lender if there is an item on your credit report that requires explanation. Provide that explanation in detail so that the underwriter is comfortable with it.

Some lenders will approve applicants that have previously been bankrupt provided they have since re-established a good credit history and the cause of the bankruptcy was reasonably not the fault of poor credit management on the part of the bankrupt.
CMHC will, on a case by case basis, approve applicants that have been bankrupt provided two years has passed since they were discharged.

4. The Property

The home is the collateral for the mortgage loan. The lender must determine that the property offers adequate value as security in relation to the mortgage loan amount. In addition they must determine whether it is likely that there will be any capital or maintenance costs that would put a drain on the applicant's financial resources and could affect their ability to manage their mortgage payment obligations in the future. In order to make this decision the underwriter hires a professional real estate appraiser. The appraiser will submit a report detailing their estimate of the value of the residence based on the recent sale of comparable properties in the area.
The underwriter will be particularly interested in the overall value of the property to ensure that it sufficiently covers the mortgage loan within the required loan to value ratio limits, usually 75%. The age and condition of the property determines its' remaining economic life. No mortgage amortization should exceed the economic life of the property. Properties in poor repair will likely cost more in maintenance or renovation in years to come. These costs are factored into the analysis.

Loan to Value Ratios (LVR)
The loan to value ratio is calculated by dividing the mortgage (s) by the property value or purchase price. This ratio sets another upper limit on the amount of financing a lender will provide to a qualified purchaser.
Mortgage lenders typically lend based on the borrowers ability to afford the costs associated with the property and financing. The amount of mortgage an applicant receives is determined by the borrower's debt service ratios and the value of the property. If the subject property has a lending value of $200,000 the maximum mortgage loan the lender will provide is usually 75% of this value, regardless of whether the applicant qualifies, from an income perspective, for a mortgage of $200,00. The lender will only approve a mortgage of $150,000 on this property unless the added risk of the high ratio loan is insured away by mortgage default insurance.
Mortgage lenders want to ensure that the applicant will have a sufficient stake in the property. In addition their equity contribution must be adequate enough to cover all costs and balances owed in the event that the lender has to take possession or sell the property. These costs can include legal proceedings, accrued interest, property repairs, insurance's, and marketing expenses and Realtors fees as well as added administration costs. The equity also acts a safety buffer in the event that property values decline in a slower market.

Conventional Mortgage
Mortgages with a loan to value ratio of 75% or less are termed Conventional Mortgages. 75% is the maximum a lender can advance. If the applicant requires more financing they will have to purchase mortgage insurance.

High Ratio Mortgage
High Ratio Mortgages have a LVR above 75%. The risk of these loans is substantially increased due to the lower amount of owner equity. Mortgage lenders will only allow an applicant to have a high ratio purchase mortgage if the applicant insures the mortgage through one of Canada's mortgage insurers, GE Capital Mortgage Insurance Services Canada or Canada Mortgage and Housing Corporation. By insuring the mortgage the applicant will be able to receive financing up to 95% of the value of the property. This substantially reduces the down payment requirement and allows more families to buy a home earlier.

Underwriting Conclusion:
After the underwriter has reviewed the entire loan package, there can be four outcomes:

Approval:
If the loan is "picture perfect" and the underwriter has no questions, the loan will be approved with no conditions.

Approved with conditions (the most common response):

(a) If the underwriter needs additional documentation before a final credit decision can be made, a conditional approval will be given. In essence, the loan documents will not be prepared until the condition has been satisfactorily met. An example of a condition could be a pay stub to validate the borrower's income.
(b) If the loan can be approved, but a condition must be met prior to closing, a "prior-to-funding" conditional approval will be given. In this case, the loan documents will be prepared and sent to the lawyer, but the lender will not fund the loan until the condition has been met. An example of a "prior to closing" conditional approval could be proof of sale of existing home where the equity will be used as the down payment.

Suspended:
In this case there is insufficient documentation of verification to decide whether or not to approve or decline the applicant. The mortgage lender will request the information and will set the file aside until these items are delivered.

Denial:
Underwriters will be unable to approve a loan if the loan file has substantial deficiencies and does not meet the minimum standards of the lender or the lender's secondary market investors. Some lenders require that a second underwriter review the loan package before a final denial is communicated to the borrower. Underwriting criteria can be different among lenders and a borrower may be able to find other acceptable financing alternatives in the market place.

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Home Inspections and Appraisals



When you are buying a home you will want to know two things, if you are paying the right price, and if the condition of the home is as promised. To determine the value of the home you may need a professional appraisal. If you are taking out a mortgage loan the lender usually requires a professional third party appraisal of the home to determine the lending value.

Appraisal

A real estate appraisal is quite different from a property inspection, although they do overlap in their scope and procedure. A real estate appraiser's job is to determine the value of the property. Usually the appraiser is estimating the market value of the land and building for mortgage lending purposes. Often the scope of the appraisal does not include a detailed property inspection, in many cases an estimate of the value can be reached without a comprehensive inspection of a residential property, particularly if most of the value is in the land and not the building. For mortgage lending purposes the financial institution may only require a determination that the property is sufficient security for the mortgage. Mortgage lenders are also concerned that the condition of the property is such that costly expenditures on repairs or renovations will not cause an unmanageable financial drain on the borrower. Home buyers are increasingly turning to property inspectors to insure that the home not only represents good value for the purchase price but is also in good shape.

Inspection

The home inspector offers no opinion on the value of the property. Their function is to inspect the adequacy and condition of the building and all major systems. A home may be of sufficient "appraised" value to get the mortgage, but a closer look at the building and systems may reveal that costly repairs are on the horizon. Your inspection will point out any red flags and areas of concern. Many inspectors will supply you with a schedule outlining the estimated cost to remedy or repair the problems noted. In addition most inspections will estimate the timing of any suggested repairs and prioritize the seriousness of any adverse findings. Armed with this information the purchaser can then make an informed decision on whether or not to proceed with a purchase offer.
It is important to hire a qualified and experienced home inspector. In Canada the home inspection industry is, for the most part, self regulated by a number of trade organizations. Contact one of these organizations to refer you to a home inspector.

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Using Your RRSP "Home Buyers Plan"



The Federal Home Buyers Plan allows first time home buyers to withdraw up to $20,000 from their RRSP for the purpose of buying or building a qualifying home. The primary benefits are that the RRSP issuer will not withhold tax on the amount nor will you have to claim the amount as income. The amount must be repaid to the RRSP within 15 years with a minimum annual payment of 1/15th of the amount withdrawn. If a repayment is not made for a given year the minimum repayment is included as taxable income for that year.

Participation

To participate you have to withdraw the amount from your RRSP using form T1036 Applying to Withdraw an Amount under the Home Buyers Plan. Give the completed form to the RRSP issuer along with the certification that you meet or intend to meet certain conditions as follows:

Conditions


· You have to make your withdrawal request in the same year you wish to participate in the Home Buyers Plan
· You cannot have previously participated in the plan in previous years.
· You have to be a resident of Canada
· You have to enter into a written agreement to buy or build a qualifying home
· You can withdraw a total of $20,000. Multiple withdrawals are allowed. Each of you and your Spouse can participate in the Plan and withdraw $20,000 from your own RRSPs.
· You have to be considered a First Time Home Buyer
A qualifying home is a housing unit located in Canada. Existing homes and homes under construction are both qualifying homes and can be either:
· Single Detached Family Homes
· Semi Detached
· Town Home
· Mobile Home
· Condominium Unit
· Apartment in a Duplex, Triplex, Four-plex or apartment building.
· A Share in a Cooperative Housing Corporation provided the share entitles you to posses, and gives an equity stake in, a housing unit.

First Time Home Buyer

You are considered a first time home buyer if you have not owned a home while you occupied it as your principal place of residence for five years. At any time in the fifth calendar year since you last owned a home you can qualify.

Recent Improvements

The 1998 budget now allows Canadians to use the homebuyers plan again. The applicant must have no outstanding balance on any previous Home Buyer Plan loans and must re-qualify for the program again. This means the home owner must re-qualify as a first time home buyer by not owning for the prescribed period. The effective date of the changes is 1999.

Should You Take Money Out of Your RRSP For A Home Purchase?

Withdrawing $20,000 from your RRSP under the "Home Buyers Plan" can be viewed as a loan from your RRSP to yourself. Some call this a zero interest loan but of course the actual cost of the loan is exactly what the funds would have earned if they had remained in your RRSP. You will forego these earning if you take the funds out and use them for a down payment. On the other hand if you don't withdraw these funds you will be forced to borrow the required down payment.

Lets assume you have $20,000 in your RRSP at an average annual rate of return over the next 15 years of, say 8%. In 15 years your $20,000 will have grown to $63,443, an increase of $43,443. As such if you withdraw these funds under The Home Buyers Plan, while you won't suffer taxes, you will forego these earnings.

Most financial advisors will counsel you to borrow to invest in your RRSP because the "overall" rate of return from your RRSP is greater than the cost of borrowing the money. The cost of borrowing $20,000 in a catch up loan over 15 years is usually in the neighborhood of Prime, plus or minus a percentage point, depending on the risk of the RRSP investment. Assume a cost of 7.5% over the 15 year amortization of the loan. The interest paid to borrow $20,000 would be $13,372. If we also assume a 35% tax rate, you would have to earn $20,572 of gross income in order to net out these interest costs.

We can now compare the before tax cost of borrowing - around $20,572 - with the before tax return this $20,000 would earn in your RRSP - around $43,443. Clearly it makes sense to borrow to invest in your RRSP. Conversely, it should also make sense to leave the money in your RRSP and borrow your down payment, one being the same as the other.
In reality, no mortgage lender will finance 100% of your purchase price. In addition, your lender will qualify you for a larger mortgage, based on gross income, if your debts are lower and don't include a large personal loan for the down payment. A personal loan or second mortgage is a debt that squeezes the maximum mortgage amount you will qualify for if it puts you above the lenders target debt service ratios.

In addition withdrawal under the Home Buyers Plan may be more cost effective than borrowing if this borrowing cost also includes a CMHC fee. This fee can dramatically push up your effective interest rate. If you're just shy of a conventional down payment of 25% it may be wise to withdraw the remainder from your RRSP to avoid paying mortgage insurance fees.
The best approach is to withdraw from your RRSP under the Home Buyers Plan, get all the financing you qualify for, and then once the mortgage is funded borrow to replenish the RRSP if you can afford the payments. Remember you'll also have to pay back your RRSP 1/15th each year.

Tips

Pay back the minimum 1/15th required each year if you borrow through the home buyers plan. Repayments do not trigger another tax savings. All savings above the minimum 1/15th repayment should be designated 'contributions ', rather than repayments, and invested into your RRSP. You'll receive the tax savings on these amounts each year.
Always invest as much as you can in your RRSP, even if you have to borrow, but be sure you can afford to carry the loan.
Withdraw the money from your RRSP only if you have no other source of non RRSP savings.

Saving Your Down Payment Using your RRSP

To accumulate $20,000 in a non RRSP savings plan, assuming an 8% return and a marginal tax rate of 35%, you would have to invest $3,605 each year for the next five years. This would mean earning $5,546 in gross income each year in order to net out this $3,600 in after tax savings.

Rather than spending this $5,546 in gross income each year on a non RRSP investment, you could invest this same amount into your RRSP. With yearly RRSP contributions of $5,546, you will accumulate about $32,536 in five years. You will also receive tax savings each year in the amount of $1,941. Another way to look at it is that you could accumulate the required $20,000 down payment in about 3 1/3 years by choosing the RRSP savings approach. IT ALWAYS MAKES SENSE to save through an RRSP, whether the savings will be for a house or retirement.

Other Plans

Tax-Free RRSP Withdrawals for Lifelong Learning
Canadians will be eligible to make tax-free withdrawals from their RRSP's to support lifelong learning. Individuals will be able to withdraw tax free up to $10,000 per year from their RRSP's, with a maximum of $20,000 over a four-year period. To preserve retirement incomes, these withdrawals will be repayable over 10 years.

More tips:

What if I want to sell my home before I have paid off the RRSP loan?

You do not have to repay the remaining balance if you sell your home before your scheduled payments are complete. And you are not required to continue to own the home until the amount borrowed is repaid.
In some situations, outstanding repayment installments have to be reported as income by the borrower:

When you leave the country. If a taxpayer ceases to be a resident of Canada, "the balance of withdrawals made under the plan and not yet repaid must be repaid within 60 days of ceasing residency, or must be included in the individual's income for that year."

If you die. When an individual dies with an outstanding Home Buyer's Plan repayment balance, "the outstanding amount must be included in the deceased's income for the year. There is an election that may be made in certain circumstances to allow a spouse of the deceased to effectively take over the deceased's obligations with respect to repayment installments."

When your RRSP matures. If you have an outstanding Home Buyer's Plan repayment balance at the end of the year in which you turn 69 - the deadline for collapsing an RRSP - this outstanding amount must be repaid before year end or be reported as income on your tax return.

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GST Taxes on Home Purchases


The goods and Services Tax replaced Federal Sales Tax in 1991. Although the tax is collected at a rate of 7% on the sale price of goods and services, it doesn't apply to every type of home or every form of real estate service.

New home purchases are subject to GST but may qualify for a GST rebate. Resale homes are sold exempt from GST.

GST and New Homes

When you buy a newly constructed home, condominium or townhouse, the entire purchase price including land is taxable. If the property is to be rented to tenants, the full 7% GST is charged on the purchase price. However, if the home is gong to be your primary place of residence, it may qualify for a partial GST rebate, depending upon the sale price.
For primary residences costing $350,000 or less, you will receive a rebate of 36% of the GST paid, to a maximum of $8,750. That means you pay approximately 4.5% GST (not 7%) on the purchase price.

Example #1

· You buy a new home for $200,000. The 7% GST is $14,000, less a 36% rebate of $5,040. So, you pay $8,960 in GST
· The maximum rebate is $8,750. The rebate for new homes costing between $350,000 and $450,000 declines to zero on a proportional basis. Here is how it works
· For each $1,000 of purchase price above $350,000 the maximum rebate of $8,750 is reduced by 1%
· Therefore if your purchase price is $370,000 you are $20,000 over and must reduce the maximum rebate by 20%. As such the maximum rebate of $8,750 reduced by 20% equals $7,000.
· For a home priced at $370,000 the GST payable, at 7%, is $25,900
· The adjusted maximum rebate is $7,000 so the GST payable is $18,900.
· Adjusting the maximum rebate continues until the rebate is reduced by 100%, there is no rebate, which occurs at homes priced at or above $450,000. New homes selling for $450,000 or more do not qualify for a GST rebate.

GST and the Resale Home.

You don't have to pay GST on the purchase price of a used residential home. In other words, the purchase is "exempt" from GST.
Revenue Canada defines "used residential property" to include an owner-occupied house, condominium, apartment, summer cottage, vacation property or non-commercial hobby farm. They refer to "used" as residential property that has been occupied as a residence before you bought it.
Used property can also mean a recently built house that is substantially complete and has been sold at least once before you buy it. For example, if a new house is purchased and resold before being occupied, the home's resale price will normally be exempt from GST.

GST and the Real Estate Transaction

GST apply to most of the services provided in completing the real estate transaction. For example 7% GST is applied to the commission a Realtor charges for facilitating a sale. The tax is paid by the person responsible for paying the commission- usually the seller.

Realtor commissions are taxable even if the total GST owed is reduced by a rebate, or the sale of the property is exempt from GST. For example, if you sell a used home, the sale price is exempt from GST but the Realtor's commission is still taxable.

GST applies to many other services involved in the real estate transaction. These include legal fees, appraisals, surveys and legal assistance. Again, GST is charged on these fees regardless of whether the house you purchase is exempt from the tax.

GST and Rent

No GST is payable on residential rents. However, if you employ a Realtor or another professional to find and arrange a tenant for your rental property, GST applies to the fees and commissions they charge for providing this service. GST also applies to the fees charged to the landlord for property management, as well as repair and maintenance services. Monthly fees charged by condominium associations are not subject to GST.

Land Transfer Taxes  

Along with the GST there are also other taxes that a purchaser must pay. Included is the Ontario Land Transfer Tax and the BC Property Transfer Tax. These are Provincial taxes levied on the purchase of property.

BC Property Transfer Tax

Property Transfer Tax is a provincial tax that is payable upon the purchase of real estate in British Columbia. The tax is equal to one percent on the first $200,000 in value and two percent on the balance. There currently is an exemption for first time buyers but there are a number of requirements to qualify, including:

(a) Must be the purchase of a principal residence;
(b) The purchaser must be a Canadian citizen or permanent resident of Canada;
(c) The purchaser must have resided in the province of British Columbia for at least one year immediately prior to the application to register the purchase of the principal residence;
(d) The purchaser must not have previously owned an interest in a principal residence anywhere in the world;
(e) The fair market value of the land and improvements must not exceed $275,000 within the Capital Regional District, Greater Vancouver, Central Fraser Valley, Dewdney-Allouette and Fraser Cheam and $225,000 if the property is located elsewhere in the province;
(f) The amount borrowed to finance the purchase, and registered against title, must be 70% or greater of the fair market value; and
(g) The amount borrowed must have a term of at least one year.

These are major requirements which should be reviewed with your realtor, lender or lawyer to ensure that you qualify.

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