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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
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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.
return to the questions 
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.
return to the questions
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.
return to the questions
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.
return to the questions
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.
return to the questions
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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