Having paid off the mortgage of our home 3 years ago, my husband and I were ready to purchase our first rental property this summer.
As the money coach, I was of course the one responsible for figuring out which price range we can afford and how it will affect our everyday finances.
One of the main mistakes people make when purchasing a home is they rely on the bank to tell them the amount they can afford.
But there’s a major limitation in this logic: Your budget is a completely different reality from the criteria the bank uses to approve you for a mortgage. The bank examines your income, savings habits, credit history and any outstanding debts you have, then they determine which amount you can afford. The bank will never ask you how much you pay for your kids’ private school or how much you spend on vacation every year, or if you have an expensive hobby that costs you thousands of dollars each year.
So to ensure that you are not getting yourself into a tight financial spot, it is crucial to draw a budget using all your current expenses and determine how a new mortgage will affect your lifestyle. Perhaps you can afford a new mortgage but only if you cut out your annual vacation or if you cancel your kids’ expensive activities. It is your responsibility to plug in the numbers and dictate to your bank which amount you can afford, not the other way around.
When it came time to do our budget, I also used the worst-case scenario: I completed it with ZERO rental income (in case we are not able to rent it to a certain period of time) and I did not take into account any employment bonus. I also checked what our mortgage payments will be if interest rates were to rise (because they will not stay that low forever!) or if condo fees were to increase. That way, I ensured that we are steady enough so we don’t go in the red if times are tougher. In other words, I performed a “stress test” to our finances.
Another important thing to consider is all the initial expenses for the new purchase, such as the notary fees, the very unwelcoming “Welcome Tax” (also called “Land Transfer Tax”), the appraisal and the inspection, among other fees. In addition, since we bought a new construction, I also had to take into account the sales taxes. And of course, one should not forget expenses such as painting, new light fixtures or kitchen appliances.
So what have I learned from my experience this summer?
1- Don’t underestimate the cost of buying a new property and make sure to take into account all the housing expenses. (I have written a guest blog post detailing the initial and recurring expenses to consider when buying a new home – I strongly encourage you to read it by clicking here)
2- Use your “worst-case” revenue in your budget, to check if you will still have financial breathing room after your new acquisition.
3- Lastly, if you did a thorough budgeting exercise and the bank approves you for a higher amount, DO NOT accept it UNTIL you re-plug the numbers and see how it will truly affect your everyday finances.
Many buyers are eager to jump into the purchase of their first home or their first rental property and they forget to plan. So avoid any unpleasant financial surprises by planning ahead and take the time to have an honest and thorough look at your finances.
Are you considering buying a new home or a rental property and you are not sure if you can afford it to not? I can certainly help you figure it out… Do not hesitate to contact me!