If you’re a first-time homebuyer, or a homeowner looking to leverage your single-largest investment, you’re probably a bit perturbed with the new financing rules imposed by Finance Minister Jim Flaherty.
According to these new rules, after March 18, the longest payback period you can qualify for is 30 years, down from 35. This new rule will result in higher regular payments and will impact at least 20,000 resale home sales in 2011, according to experts. That’s because up until now, a whopping 30% of homebuyers have opted for 35-year amortization schedules.
While changes like these are always met with criticism, with many first time home buyers concerned about their ability to jump into the housing market, the question remains is this a good thing? Is Minister Flaherty helping or hurting first time homebuyers?
Helping. And I’ll tell you why.
If you had 5% as a down payment, and you’re gross family income was around $65,000—the median salary, in Canada, is $63,900—you could afford a $341,000 home. (We assume a 25-year amortization, for a fixed-rate 5-year term. These are the same assumptions the banks use for pre-approved mortgage applications. At time of writing, the posted rate for a 5-year fixed was 3.8%).
But bump the payback period up to 30 year and your maximum house price jumps to $379,000. Add another five years to your payment schedule and you can afford a $410,000 home (excluding closing costs and mortgage insurance fees).
Great news, until you realize how much increasing your payment schedule really costs you. (I assume a 5% down payment on the maximum house price you can afford and that the interest rate remains constant for the length of the loan):
• $184,000 in interest payments for a $341,000 home (25 year amortization)—or 54% of your home’s current value
• $251,000 in interest payments for a $379,000 home (30 year amortization)—66% of your home’s current value
• $324,000 in interest payments for a $410,000 home (35 year amortization)—79% of your home’s current value
Sobering stats—to say the least.
While I’m the first to acknowledge the benefits of home ownership, and real estate investments, in general, I don’t think the emotional pull to own a home—particularly your dream home—should trump sound investment acumen. And I just can’t rationalize paying an 80% premium on any investment as a sound investment strategy.