Financing basics for first-time home buyers

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Navigating the financial system in a new country can be overwhelming. But unless you intend to buy a house by paying it in full, you would need to know about how financing and mortgages work. As a soon-to-be home buyer, it is essential that you know the basics to get the best deal. It can also prevent you from making costly mistakes that could trouble you for years.

In Canada, you will need to start by establishing a good credit history.

What is a credit history?

A credit history is “a record of a consumer’s ability to repay debts and demonstrated responsibility in repaying debts” (Investopedia). It contains information about a person’s credit accounts, details of bill payments, and how he or she uses money to deal with loans and credits (borrowing habits). It is important for newcomers to learn about building a good credit history and how the credit bureau works because lenders base their decisions from what they find out from the bureau.

Your credit history is composed of a credit report and credit score. In Canada, these are reported by two credit bureaus, Equifax and TransUnion. Credit scores run from 300 (lowest) and 900 (highest). A score of above 680 is considered good if you are applying for financing. Your credit score also determines the percentage of down payment you need to pay. If it is 500 below, a down payment of 20% + of the house price may be required. However, a score of 680+ allows you to pay five per cent or no down payment at all.

Tips on establishing a good credit history

Here are a few practical tips from accredited mortgage professional Viktor Schaefer:

1. When you come to Canada, get at least two credit and loan financial products. It can be two credit cards (from different institutions) or a credit card and a credit line. Build your credit limit to reach at least $2,500.
2. Use your credit card at least once a month to show that your credit card is active.
3. Pay on time, ideally one day before the due date. If you can’t pay the entire balance, at least pay the minimum. However, pay the full balance when it is due when you can. This prevents you from getting into bigger debt. Interest added to your outstanding balance can be considerable.
4. Don’t max out your credit limit. It is recommended that you don’t go beyond 50-70 per cent of your credit limit.
5. Don’t terminate your old credit cards. Your credit score takes into account how long you’ve had credit (15% of the score is length of credit history).
6. Pay your hydro, Rogers, MTS, etc. bills on time. These companies report delinquent customers to the credit bureaus. Take note that payment of phone bills and mortgages are now also reported.
7. If you are disputing a utility bill (for instance, you were wrongly billed for a service), pay it first and then resume your complaint so that your credit history will not be affected. Record of a missed payment stays in your credit history for seven years.
8. Don’t apply for too many credit cards or shop around for too many car loans at the same time. The bureau will assume that you are in financial trouble or are deep in debt.
9. A declaration of bankruptcy stays on your credit history for seven years. However, this will be on public record forever. This record is open to checks by employers or lenders.
10. While it is important to have a good credit score to get a good deal, having no credit score is still better than having a bad one.

Credit card traps:

While building a good credit history is important, you should be careful about credit card use. Financial institutions provide many incentives to encourage you to use your credit card often; they may also allow you to increase your credit limit every year. But remember, your credit limit is not free money. Whatever you borrow, you will need to return.

Here are a few other traps you should avoid:

1. Don’t have too many credit cards. It will be hard to manage them.
2. Don’t get a card or use it just because you want to earn air miles or rewards. Nobody has ever grown rich because of these points.
3. Don’t get cash advance from credit cards. Banks charge very high interest rates and they start from the day you get the cash advance from the bank.
4. If you cannot afford it today, don’t buy it at all. Special offers like “no interest for a year schemes” are very tempting. But if you go beyond the no interest period, you will have to pay a very high interest. These are computed from the day that you bought the item, not after the “no interest” period.
5. Never get into the habit of paying just the minimum amount due on your credit card. It is a trap that could keep you in debt forever. Check the repayment calculation at the bottom of your credit card bill to see how long it will take you to pay off your debt if you pay only the minimum. This will put things in perspective.
6. Remember that credit card fees and rates are negotiable. If you are having a hard time managing your credit balance, ask your bank to give you a better rate.

What is a mortgage?

Simply put, a mortgage is a loan to finance the purchase of a home. This loan has interest and requires a collateral (something pledged as a security for repayment of the loan). The house that you will buy is considered the collateral. If you don’t pay back the loan, the lender has the right to take the property and sell it to cover the debt.

Mortgage facts:

1. Residency or the amount of time you have stayed in Canada is considered for down payment options. How long you have been employed is also a factor. For instance, for a 10% down payment option, you are required to have stayed a minimum of six months in Canada (five years maximum stay), provide six months of account statements or a reference letter from your home country, and you must be employed in Canada for at least three months.
2. The most common interest rate options for mortgages for first-time buyers are:
   • Fixed rate – This is an unchanging rate usually for one to 10 years. Many people choose this because it is less stressful. You can expect to pay the same amount for monthly payments throughout your mortgage term.
   • Variable rate – This is usually lower than a fixed rate. However, there is a risk that the rates in the market may go up. And with this, your mortgage payments go up as well.
3. The Office of the Superintendent of Financial Institutions (OSFI) regulates financial institutions where you get your mortgage in Canada.
4. In Canada, the government institution Canada Mortgage and Housing Corporation (CMHC) protects the lender through mortgage insurance. Insurance allows buyers to pay a low down payment on a house and still get the best rates.
5. Here’s a tip: Before you decide to choose a lender, check their penalty structures. If in case you are forced to sell your property (and therefore break your mortgage agreement) due to sickness, job loss, or divorce, you will be charged a penalty. This can add to your financial difficulties especially if the penalty interest agreed upon is high.

Adapted from English Online’s Expert Opinion webinar series: Financing. Information you can’t afford to miss by Viktor Schaefer, owner VS Solutions (mortgage, insurance and investments). You can access the webinar recording and the PowerPoint presentation from this link: Financing. Information you can’t afford to miss.