Mounting price pressures and a projected rise in interest rates have first-time home buyers thinking of going much bigger on their purchases. It’s in an effort to prevent being priced out of the market for their next-level home in five to seven years from now (the average time frame a new homeowner spends in their starter home).
But, what’s on the other side of overdoing your home buying budget can be home poverty. That’s basically where you can only really afford your house, and not much else. Unfortunately, this can result in not being prepared for retirement, having more stress and racking up consumer debt for any out of-the-ordinary costs, even for something as simple as a vacation or car repair.
However, if your longer-term forever home has become your vision for your now home, these tips should help you balance the higher costs of home ownership you’ll face while creating financial security for your future.
Do your own stress tests using a mock budget
The banks have stress tests to determine whether you can afford to carry the mortgage based on your income and borrowing costs. But you should do your own, too.
Set a stress test up like this.
Use a budgeting template (there are thousands online, and possibly one from your bank). Enter your income sources. Then start offsetting this with the projected costs of owning the property.
This DOES NOT MEAN you guessing what the costs are or pontificating about what your income could be if you just got that raise you know you deserve.
These numbers should be based on your financial facts and current lending conditions (interest rates, market prices and so on).
Get into lockstep with your mortgage specialist, realtor and insurance provider, who can feed you the precise calculations for the mortgage amounts, utilities, property taxes, average annual maintenance costs, insurance premiums and so on. Put these real numbers into the budget.
Then you’ll need to do a deep dive into your other costs, such as groceries, loan payments, subscriptions, child care and so on. The only way to do this is to look at actual receipts and/or purchase transactions from your credit card and bank account statements.
This is the part where, far too often, I see first-time homebuyers say things like “Oh, I can trim back on this or that,” or “Well, once that car loan is gone, it’s going to be a breeze,” which is awesome to think about doing, but you need to put it into practice first to see if it’s actually possible. If your family eats $ 1,100 of food each month, and you’re proposing to cut that to $ 700, it’s probably not realistic.
Now, what’s left over after your expenses are subtracted from your income? Is this amount satisfactory to you? Is it enough to build an emergency fund (5 per cent of take-home pay is the benchmark) and set money aside for retirement (10 per cent of take-home pay) and your kids’ future education (approximately 3 per cent of take-home pay or, to get the maximum from the RESP Canada Education Savings Grant, around $ 200 per month per child)? Can you still save for a vacation or buy shoes when you need to? Will you be able to afford the groceries you prefer? If the rates go up, which the financial community pretty much unanimously agrees will happen this year, are you prepared for a higher cost of borrowing in the future?
If the numbers staring back at you leave you feeling comfortable, then your next step is to book a proper review of your financial plan with your financial advisor for before you make a purchase. They’ll work the new details into your plan, and give you a line of sight on how the purchase could impact your retirement.
If you’re feeling a bit nauseous or like you’re cutting it too close for comfort, pause and consider the following next steps. A warning, though. Some of these will take a bit more time than others.
Upgrade your job and income
Your income plays a big role in how much you can afford to borrow. If you’ve been holding off on switching employers or applying for a higher-level role, get cracking on this. The extra income should increase your borrowing capacity, and your mortgage specialist can tell you precisely by how much. You may need to be in your new role for a certain period of time before the bank will consider “upping” your mortgage limit.
Save a lot more money really fast for your down payment
I get it. Your rate of savings might be outpaced by home price growth, especially if you are in Ontario or B.C. Try some bigger moves, like selling a car, bicycles, computers and basically anything you can live without. If you have the opportunity to work more or take a freelance contract, get on it!
Ask for early inheritance
Obviously, this only makes sense if your family can afford it. But, if they can and you can handle whatever strings are attached, ask them to give you money for the down payment. If this turns out to be a loan, make sure you have a plan to pay it back and a written agreement on exactly how the loan will be handled.
Live somewhere else
If you are dead set on living in the city, you’re going to pay higher prices. Now, in some rural areas, prices have shot up, too. But there still are less expensive places where you could buy. If you’re going to be working from home more permanently, you might be a good candidate for these more rural options.
Understand what co-signing really means
I’m seeing more people turn to their family and friends to co-sign on the mortgage, but be wary. This still means you have to pay the full gamut of costs. Yes, the bank may approve the mortgage application on the strength of your co-signer’s finances, but you’re still going to have to come up with the money each month. Note that co-signing is super common for newer small business owners, people who have too much consumer debt, and anyone with a poor credit history, as many lenders have tighter lending rules for these folks. If you want to get out of having to have a co-signer, try a combination of increasing your income, clearing up your debts and saving more, which means cutting back any unnecessary purchases.
Meridian Credit Union issued a friendly reminder this past week about people “bigging up” their purchases, suggesting that a financial reality check before signing on the dotted line is prudent. I concur. For most people, this is the biggest financial decision of their lives, and it needs careful consideration. And, there’s no shame in renting for a while, either. You can still build wealth.