Welcome to CB’s personal-finance advice column, Make It Make Sense, where each month experts answer reader questions on complex investment and personal-finance topics and break them down in terms we can all understand. This month, Joseph Kindarji, an advisor at money-management platform Wealthsimple, tackles financial advice for those looking to buy their first home without breaking the bank. 

Q: I’m looking to buy a house for the first time, where should I begin?

Buying a home can be a daunting and exhilarating journey: while 88 per cent of Canadians believe that home ownership is unattainable because of high prices and a lack of homes, 73 per cent still believe it to be a strong financial investment. With interest rates gradually coming down, data suggests many Canadians are eager to get into the market in the new year. 

This is especially true for first-time home buyers, in part thanks to recent mortgage policies by the federal government that came into effect this past summer, allowing first-time buyers in the market for a newly-built home to obtain an insured mortgage of 30 years to lower their monthly payments. 

Here are some things to consider as you look to buy your first house: 

Figure out what you can afford

Banks determine their pre-approval for mortgages based on what they call the Five Cs: Character, Capacity, Capital, Collateral, and Conditions. Character looks at credit history, capacity, is an applicant’s debt-to-income ratio, while capital is the amount of money an applicant has. Collateral means any assets that can act as security for the loan in case you can’t pay, and conditions are the purpose of the loan, amount involved and prevailing interest rates.

There is a difference between a mortgage someone qualifies for and the mortgage someone is comfortable paying month-to-month. On top of the additional monthly costs of home insurance and general maintenance, many first-time homebuyers don’t realize budgeting is the best place to start when estimating an affordable mortgage that won’t leave them “house poor”: you might own a home, but the amount of cash at your disposal for other daily needs is severely limited.

I suggest the classic 50/30/20 rule where 50 per cent of after-tax income goes to housing expenses – including a mortgage, insurance and maintenance costs – followed by 30 per cent to wants and 20 per cent to savings. Given the higher cost of living that has hit many Canadians in the last few years, this ratio may not be realistic but even setting aside an extra five to 10 percent of your monthly income assures you will be able to afford your non-mortgage expenses. 

Consider the pros and cons of a fixed or variable rate

A fixed-rate mortgage has a mortgage payment that is consistent month-over-month. Even if the Bank of Canada’s interest rate changes with time and markets fluctuate, the interest rate you agreed to when you first signed is locked in for the duration of the term. Since payments are predictable, it allows for peace of mind and is ideal for those that have a tight budget or expect interest rates to rise.

On the other hand, a variable-rate mortgage fluctuates with the market: as national interest rates change, so too does your lending institution’s prime interest rate. When interest rates go down, the monthly mortgage payment follows suit and vice-versa. It best suits those who can handle fluctuating payments or have financial flexibility. 

Whether you choose a fixed or variable rate mortgage mostly depends on the risk you can tolerate and your capacity to weather fluctuations in interest rates. There’s no right or wrong answer, but when the economy is good and interest rates are on the decline, a variable rate often translates to savings for the homeowner. Whereas when interest rates are expected to rise, oftentimes when markets are volatile, a fixed rate can protect against higher monthly costs. Ultimately, a fixed rate is more conservative and predictable, whereas variable rates are more of a “game of chance.” 

Choose your mortgage term, plan for mortgage renewal 

When you get a mortgage, it’s active for a specific period of time. This is called the mortgage term. For example, if you took out a five-year fixed-rate mortgage in November 2021, your term will expire in November 2026. Unless you’re able to pay off your remaining mortgage balance at that point, you’ll need to renew to keep making payments. 

When it comes to mortgage length, most Canadians have three-to-five-year terms, but increasingly, lenders are offering seven and even 10-year options. The ideal length depends on the current state of interest rates: if they’re on the higher side, I recommend getting the shorter mortgage term and shopping around when it’s up for renewal. If they’re on the lower end, a longer mortgage term can be a good solution and protect the buyer from future inflation. 

As your renewal date approaches, it’s a good idea to start exploring your options four-to-six months in advance to secure the best rate and terms. Don’t settle for your lender’s initial offer, shop around and compare rates from banks, credit unions, and mortgage brokers. You can use competing offers to negotiate reduced rates or added flexibility with your current lender. If switching lenders offers significant savings, consider it, but make sure the transfer fees (if there are any) don’t outweigh the benefits. Sometimes lenders cover these fees to win your business. 

Decide on an amortization period

Lastly, amortization equates to “how long it takes someone to pay the bank back.” Typically, an amortization period is 25 years but in August the federal government made it such that first-time home buyers purchasing newly-constructed homes would be eligible for insured mortgages of 30-years. This extension is meant to lessen monthly payment burdens for younger generations who are feeling the crunch of today’s high cost of living. 

When deciding on mortgage terms consider this: the longer the amortization, the lower the monthly payment but also the longer it takes to pay off the home with interest (and the more interest you’ll pay in the long-run).

Paying off your mortgage more quickly can be a smart financial move if you’re paying off a high-interest mortgage, have stable excess income, and value financial security over potential investment returns. It’s particularly beneficial when mortgage rates are high, as it provides a guaranteed return by saving on interest costs, or if you’re nearing retirement and want to reduce expenses on a fixed income.

I also recommend considering to take advantage of any prepayment privileges your lender offers to make extra payments without penalties. Make sure to weigh this against the opportunity cost. For example, if your mortgage rate is 4 per cent but you could earn an 8 per cent return by investing in a well-diversified portfolio, investing may make more sense. Alternatively, if your mortgage rate is 5 per cent but expected investment returns are only 3 per cent, paying down your mortgage offers a better financial return.

Take the plunge

Once you have a mortgage, continue to reassess your financial situation to ensure your new mortgage aligns with your goals, whether that’s accelerating payments, shortening your term, or reducing monthly costs. Choosing a mortgage requires a hard look at your affordability threshold, quality of life expectations and long-term financial goals, especially for first-timers. 

Unpacking the options, and following some of the basic rules outlined, can set you up for success and on a path towards your dream home.