First time buyers

Aspiring first-time home buyers, it's time to discover the lost art of saving up to buy a house.

It'll be tough. You may not be able to get the house you want as quickly as you want. But in the end, you'll save tens of thousands of dollars and have a lot more financial flexibility in your life than you would otherwise.

Saving to buy a home used to be a rite of passage for twentysomethings. But as house prices soared in the past several years and it became increasingly hard to build the necessary hoard of cash, the mortgage industry came up with solutions like zero-down payment mortgages and 40-year mortgages.

By Oct. 15, these options will pretty much have disappeared under rules just announced by the federal government. The rules apply to people who have a down payment of less than 20 per cent and thus need mortgage insurance. To be clear, this is insurance that home buyers pay for in order to protect their lender from the risk of default. The feds backstop this plan.

Both zero-down and 40-year mortgages have been very popular with first-time buyers, mortgage brokers say.

“Most people say 40 years, oh my God, what would my parents think?” said John Cocomile of GreedyMortgage.com. “But once they see the flexibility associated with the longer amortization, they say, you know what, put me down for 40 years.”

Mr. Cocomile said about 35 per cent of his clientele, which is mainly first-time buyers, have been going with zero-down mortgages.

Under the new rules, buyers requiring mortgage insurance will need a minimum down payment of 5 per cent, and the longest amortization period they can choose is 35 years.

Some first-time home buyers may jump into the market immediately to take advantage of the existing mortgage options, although a few banks have already announced plans to stop offering zero-down and 40-year loans immediately (existing deals will be honoured). But there's no getting around the fact that down payments are going to be much more of a factor than they have been.

There's more to this than simply meeting the new 5-per-cent minimum.

The bigger your down payment, the less reliant you are on mortgages that go beyond the standard 25-year amortization to keep your payments low.

One option for obtaining your mortgage startup money is to borrow it or take advantage of products that some banks have where the down payment is made for you as a kind of bonus. The big drawback: less than optimum interest rates.

Or, you can do things the old-fashioned way and save up. How? One idea would be to set up preauthorized transfers into a high-interest savings account every time you get paid. These accounts don't pay a lot right now – 3 to 3.4 per cent at best – but they're virtually risk-free. Don't even think about exposing your home savings to the stock market.

The hidden benefits of the new mortgage rules are twofold. First, you'll save a little on mortgage insurance premiums. A zero-down mortgage carries an insurance premium of 3.1 per cent, compared with 2.75 per cent for a 5-per-cent down payment and 2 per cent for a 10-per-cent amount. Going with a 40-year amortization would add an additional premium of 0.6 per cent. The extra premium for the 35-year amortization is 0.4 per cent, while a 30-year period costs 0.2 per cent.

Second, lowering your amortization from 40 years will save you a serious amount on interest over the years. Just going from 40 years down to 35 on a $250,000 mortgage could save you close to $50,000, assuming a 5-per-cent interest rate throughout.

On the flip side, the extra monthly carrying costs of going 35 years rather than 40 on the same loan amount to about $55. That's hardly ruinous.

An overlooked aspect of the new mortgage rules is that they will allow home buyers requiring mortgage insurance to carry slightly higher total debt loads. CMHC currently requires that all your various debts, including your mortgage, not amount to more than 42 to 44 per cent of your gross income. Starting in October, you'll be able to have a total debt service ratio as high as 45 per cent.

Allowing people to carry a heavier debt load is an odd move for a government that is trying to keep the housing market from a U.S.-style fall. The way people get into trouble with a mortgage is by borrowing more than they can handle. Avoiding this trap means being leery of letting total debts get as high as even 40 per cent of gross income.

Of course, tighter mortgage rules will force some people to wait longer to buy a first home. If you're bugged by this, remember that the housing market is cooling in some parts of the country. Lower prices would do wonders for affordability.

(prepared by Rob Carrick/Globe & Mail)