Searching for a new home is exciting. But with so many things to consider, the process can quickly become overwhelming.
Here are five things to consider before you get a mortgage.
1. Can you afford to buy a home?
The first thing to consider is how much you’re willing to spend on a home. Lenders will use a formula to determine how much they’ll loan you.
The first one, called the gross debt service (GDS) ratio, suggests that potential housing costs, including mortgage payments, taxes and utilities, should not exceed 32 per cent of monthly income before taxes. The total debt service (TDS) ratio, which adds lines of credit, car and credit card payments on top of your housing expenses, shouldn’t exceed 40 per cent of your income.
2. What is the term?
Lenders provide mortgages over a specified period of time, known as the term. While the most common term is five years, they can range from as little as six months to 10 years. Once the term is up, you can renew or renegotiate your mortgage with your lender or shop around for a better rate. A shorter one- or three-year term can provide flexibility as market conditions and interest rates change.
3. Fixed or variable rate?
A fixed-rate mortgage guarantees that the interest rate stays the same over the mortgage term. Knowing exactly how much to pay over a defined period is less stressful and can be easier to incorporate into a budget.
The interest rate on a variable-rate mortgage, on the other hand, fluctuates depending on a bank’s prime lending rate. As interest rates change over the term, the amount of your payment that goes towards interest will rise or fall. If you have an adjustable payment, the amount will change if interest rates increase or decrease. While the interest rate on a variable-rate mortgage is generally lower than a fixed-rate mortgage, there’s a risk that rates could rise.
4. How long do you want to make payments?
The time it takes to pay off the entire mortgage is called the amortization period. In some cases, these extend to more than 30 years but are capped at 25 years for buyers with down payments of less than 20 per cent.
Longer amortizations result in lower payments until the entire balance is paid off. While this might seem attractive, it also means you’ll pay more interest over time. Shorter amortizations have the opposite effect.
5. How often do you want to make payments?
There are several payment schedules to choose from – monthly, semi-monthly, biweekly, accelerated biweekly, weekly or accelerated weekly. If you’re looking to pay off your mortgage quickly, more frequent payments can save on interest.
If you choose to make accelerated payments, you’ll make the equivalent of one additional monthly payment a year. This can shave years off the amortization.
The bottom line
It can be easy to get caught up in the excitement of homeownership, but such a large debt shouldn’t be taken lightly. Shop around and compare rates, and weigh the different options. Finding an affordable home coupled the right term, interest rate, amortization and payment frequency will help you save on interest and pay off the mortgage sooner.