By Jim Yih, Edmonton Journal April 8, 2013 - Home ownership is one of the cornerstones of building wealth and the major decision around buying your first home can be stressful and really exciting all at the same time.
First-time homebuyers have a lot to think about and, to complicate matters, the rules continue to change and evolve.
The homebuyers plan was first introduced in 1992 to help homebuyers use their RRSPs as a down payment for their first home. The plan originally allowed Canadians to borrow up to $20,000 from their RRSPs tax-free. In 2009, the government increased that amount to $25,000. Here are a few basic conditions to be aware of:
- You must be a first-time homebuyer;
- You must live in the home you buy;
- If you or your spouse withdraws an amount from an RRSP where you made contributions during the 89-day period just before the withdrawal, you may not be able to deduct part or all of these contributions for any year;
- You have to repay the money to the RRSP over a 15-year period;
- If you do not repay one-fifteenth of the borrowed amount in a year, you will have to add the amount to income and pay tax on that amount.
I think this is a great plan; I used it for my first home back in 1992. According to the Canadian Real Estate Association, an estimated two million have used it to purchase a home since the plan was introduced.
Changing Mortgage Rules
When I bought my first home, I remember having to come up with a minimum down payment of 10 per cent and the longest amortization I could get was 25 years.
Over the next 15 years, the banks started to "help" Canadians buy houses with zero-down mortgage options and by extending the amortization periods on mortgages to 30, 35 and eventually 40 years. In the end, this was not financially prudent and in 2008, the government introduced new rules eliminating 40-year mortgages and requiring a minimum down payment of five per cent.
Earlier this year, the government tightened up the rules again, moving the maximum amortization period on mortgages back to 25 years.
It's true that shorter amortizations make for higher monthly payments, but they also end up saving homeowners a lot in interest. For example, if you had a $100,000 mortgage at five-per-cent interest on a 40-year amortization, your monthly payments would only be $478.81, but your total interest would be $129,819.50. If you pay the same mortgage over 25 years, your monthly payment rises to $581.61 but your total interest falls to $75,480.04.
Changes to Qualifying Ratios
When you apply for a mortgage, the lender will run a couple of debt ratios to see if you qualify. These debt ratios have changed this year.
Your Gross Debt Service Ratio (GDSR) - including total cost of housing payments (principal, interest, taxes, and heating) - should not be more than 39 per cent of gross monthly income. The Total Debt Service Ratio (TDSR) - your entire monthly debt load (which includes other debts such as credit cards) - must be less than 44 per cent.
I don't see this change being much of an issue as these ratios were more restrictive in the past, with the GDSR at 32 per cent and the TDSR at 40 per cent.
My Five Cents
Buying a house used be like a rite of passage. You had to show that you had some financial discipline to qualify. You had to save a significant down payment, and be able to handle a 25-year amortization.
Although some will argue that going back to those rules, coupled with rising house prices, make it impossible to enter the housing market, remember that buying a home should be the result of good initial financial habits.
These rules may appear to be more restrictive, but they may be needed to address the growing debt problem in Canada. And debt is the biggest cancer to financial freedom.
Jim Yih is a financial expert. Visit his award-winning blog, RetireHappyBlog.ca