Buying A House |Author: Shaheen Ahmed, RSSW, BIA, Social Worker & Credit Counsellor
Millennials represent the largest cohort of first time home buyers in Canada. However, they are also the generation known for carrying high levels of student-loan debt. If this describes you, then a pertinent question might have crossed your mind. Is buying a house while holding debt even possible? This might seem quite unattainable if you are young or a new immigrant. Homeownership can certainly be a pipe dream when starting out in your field or earning a modest living. However, you can make it happen with some discipline and planning.
COVID-19 has forced the Central Bank of Canada to keep its benchmark interest rate low. And this has lowered borrowing costs. With attractive mortgage rates on the market, it has never been a better time to borrow for large investments, like a home. Anyone presently renting may find it worthwhile going through an exercise to determine when to plunge into home-ownership. A couple buying a house together should use their combined income and debt for the calculations. You simply need to pay attention to a few pertinent financial metrics.
Debt To Income Ratio
The first one is your debt to income ratio which measures the total amount of debt you carry divided by your income. For example, if your debts amount to $2,000 per month and your monthly income is $6,000, then your debt to income ratio is 33%. Lenders like to see this number as low as possible to extend mortgage loans. Excessive levels of debt relative to income make you less resilient to a sudden financial shock. Consequently, the secret to buying a house while carrying debt lays in strategically maneuvering your finances to lower your debt to income ratio. And you have two ways to get there. Either increase your income or reduce your debt.
Buying a House: Increasing Income
Getting a higher paying job is an obvious route to increasing income. However, it may not be practical for many, especially in a tight job market. While it should remain a valid long-term goal, you might simply require small supplements to your income to optimize the ratio. Do you have extra time to engage in a side gig, like Uber, tutoring or working a second job? Other ways to supplement an income can come from subletting extra rooms in your home or purchasing a property with rental potentials, like a basement or rooms you can rent out. Remember that you must declare this income on your tax return to make it count officially towards your debt to income ratio.
Most people are better set up to optimize their debt to income ratio by focusing on reducing debt loads. Astonishingly, the recent decline in interest rates automatically offers you a leg up in this regard. You can take it further with astute budgeting to ensure you avoid taking on new debt.
If you are having trouble creating or sticking to a budget, consider a few sessions with a credit counsellor. This is an important discipline you will want to master especially if you are considering buying a house. As an impartial third party, your counsellor can present intelligent tactics to help you reduce your debt. You might be able to reach your financial goals through debt consolidation, for example. If you hold multiple debts, like student loans along with credit card balances, your counsellor could negotiate with your creditors to create a consolidated debt management plan with lower interest rates than what you presently pay.
Credit Scores and Debt To Income Ratio
When evaluating you for a mortgage lenders will also look at your credit score. In this regard, having a student loan and credit cards will work in your favour provided you have a history of making on-time payments. Credit scores trace your pattern of creditworthiness. They tell lenders how much they can trust you to repay loans on time. For large loans like mortgages, this insight to your financial reputation often precedes you and will remain critically important to the lender.
If your credit counsellor recommends debt consolidation as described above, recognize that this can have a negative impact on your credit score. However, this is still no reason to lose hope. Buying a home might take a little longer. Repairing a damaged credit score is quite achievable, even in the direst situation. You simply need to follow a few rules, remain patient and focused on sticking to your plan.
Once you have your income and debt situation under control, the next step is applying to a lender for mortgage pre-approval. Here, lenders will look at the amount of your down payment, along with your debt to income ratio and credit score. If you have already saved money specifically for buying a house, then give yourself a pat on the back. Many first-time buyers rely on the incentive offered through the federal Home Buyer’s Plan to move up to $35,000 of their retirement savings towards a down payment. For a couple, this amount doubles.
Contrary to popular belief, you can legally step into homeownership with 5% down. However, you should strive to put down as much as you can to lower the mortgage amount. Buyers with less than 20% down will incur additional cost of mortgage insurance from the Canadian Mortgage and Housing Corporation, which the lender will add to your overall mortgage amount.
You will therefore discover that your down payment threshold drives the amount of your mortgage pre-approval and budget. And this is precisely why, for most people, buying a home requires pre-planning of your finances.
Once you have received mortgage pre-approval from a lender, you are ready to start shopping for your home. If you have excellent credit scores and a decent debt to income ratio, lenders might approve you for a larger mortgage than you asked for.
Credit counsellors will always advise you to be discerning about your wants and needs. You don’t have to utilize the full amount of your loan. First of all, ensure you set aside up to 5% for closing and moving costs. Some homes may require renovating or fixing. Be open to houses below your budget and away from established neighbourhoods. And if you work remotely, then consider buying a house outside of major urban centres, where housing costs are lower.
A mortgage is usually the largest loan you will ever take on, and financial planners consider this a “good debt” because buying a house is almost always an investment. Utilizing this loan wisely will help shape your financial indebtedness for many years to come.
About The Author
Shaheen Ahmed, RSSW, BIA, is a Credit Counsellor and Social Worker at Family & Credit Counselling Services of York Region with over a decade of experience in the non-profit sector. She helps individuals & families develop lifelong money management skills with financial problem-solving, credit counselling and debt management solutions.
If you are concerned about mounting debt, contact us for a complimentary assessment. We counsel you on household budgets, credit scores, financial literacy and more.