This week I received a question from a reader asking how much to save up before buying a house. Here is Alicia’s question:
How much money do my husband and I have to save up before buying our first home?
Thank you for asking such an important question Alicia. This is a question many people should ask but don’t.
Working out how much the down payment would be is only half the answer – you’ll also need to work out what is affordable on your budget once you’ve factored outgoings and debts into the bargain. Certain loans are available to make it easier for first time buyers in North America to own their own home and you may be able to qualify for one of these.
What Can You Afford?
How much of your income would be used to pay down your house-related debts? The TD Canada Trust recommends two calculations that can help you to assess exactly what you can afford to buy:
The Gross Debt Service (GDS) ratio – This approach looks at the cost of your house purchases, including mortgage payments, taxes and heating costs. Ideally, you should not be spending more than 32 per cent of your gross monthly income on your home. Any figure above this is considered to be on the wrong side of affordable.
Total Debt Service (TDS) ratio – This approach looks at your debt levels, including housing debts, loans, car payments and credit card repayments. Ideally, you should not be spending above 40 per cent of your gross monthly income on debt.
Both of these figures are the higher end of the scale and where possible, it’s advisable to be aiming for lower.
What Is an Affordable Mortgage?
Work out the household gross annual income and multiply by 3.4. For example, if you earn $50k, you could afford a house worth $170k. This is considered to be the absolute maximum that you can realistically afford. Aim for a house worth more than this figure and you’re unlikely to be able to afford to take it on.
Other Related Expenses
Purchase prices and mortgages aren’t the only expenses associated with buying a home. Closing costs can be as much as 20 per cent of the purchase price, for example. Don’t forget about living expenses too. After all, there’s no point moving into your dream home if you can’t afford to pay the bills or put food on the table! It’s also a good idea to know that you’ve got an emergency fund buffer in reserve for those unexpected expenses that will inevitably crop up.
What Are The Options for First Time Buyers?
Here’s some good news though – there are some loans available to help first time buyers to get on the property market in the USA and Canada. Here are some of them:
USA – FHA Loan
These loans are insured by the Federal Housing Administration (FHA) and typically have lower down payments and closing costs. Down payments can be as little as 3.5 per cent of the purchase price. Closing costs can be negotiated into the loans too.
USA – No Down Payment USDA Loan
These loans don’t require any down payment at all but you need to meet eligibility criteria. The main one is that the house must be deemed to be in a rural area according to the USDA definitions.
Canada – RSP Home Buyers’ Plan
Do you have a Registered Retirement Savings Plan (RRSP)? The RSP Home Buyers’ Plan may be an option as a first time buyer in Canada. This allows you to withdraw up to $25k from your RRSP to buy a home. This must be repaid year-on-year within the next 15 years.
High ratio mortgages
Down payments can often be anything from 5 per cent to over 20 per cent of the purchase price. To get a conventional mortgage, you’ll often need a down payment of at least 20 per cent. What if this is just too steep to be achievable for you? You may prefer a high ratio mortgage instead. These don’t require such a sizeable down payment. However, be aware that a bigger down payment means lesser mortgage expenses and lower interest payments.
Want to avoid the prospect of falling in love with a dream home only to realize that it’s way out of your price range? You might want to look at a pre-approved mortgage. This will enable you to see options that are within your budget. When we bought our house a few years ago we went through this exact process. It made searching for a home a lot easier because we knew what we could look at or consider and what was out of our price range.
As you can see, buying a home is a complex process. Hopefully this guide will help you to estimate your price range so you don’t fall in love with a home that is too expensive, which you later regret. If you ask me, it pays to take the time to do this upfront research. A house is one of the most expensive purchases you are going to make in your life so give the decision the time and consideration it deserves.
So readers, do you own a home? What process did you go through to buy your house and why? Do you have any other tips to share with Alicia?