It's a worst-case scenario: you have unexpectedly lost your job - and your ability to pay your regular mortgage payments. Could you withstand such a financial crisis? Four in 10 homeowners wouldn't last more than three months, according to a recent Manulife study.
For the average family, shelter – mortgage or rent – is the highest monthly household expense. According to the Canada Mortgage and Housing Corporation (CMHC), your monthly housing costs shouldn't be more than 32% of your gross monthly income. It’s important to give yourself some financial wiggle room, otherwise you can find yourself house rich, cash poor.
How to Protect Your Ability to Pay
Being ready for a financial crisis like job loss is about preparing ahead of time. A lot of homeowners, especially in pricey real estate markets like Calgary, Toronto and Vancouver, make the mistake of purchasing a home at their maximum purchase price.
“It's important not to over extend yourself to begin with,” says Sean Schumacher, a mortgage agent at Safebridge Financial Group. “Just because you qualify for a certain mortgage amount, doesn't mean you can afford it. Mortgage qualification ratios don't take in to account many costs associated with day-to-day life, or leave any room for savings. It's important to take on a mortgage that you know you can personally budget for.”
Make An Emergency Payment Plan
With home ownership comes great responsibility. When you own a property, it’s important to have an emergency or rainy day fund to deal with unforeseen financial circumstances.
“Connect with a financial planner to help assess your short and long term financial goals,” advises Schumacher. “Within that process it's important to create a savings plan that will provide you with a cash buffer you can easily access during an unforeseen financial crisis.
If you lose your job, it helps to have an in-law basement apartment or duplex to bring in some much needed income until you land a new job.
“Purchase or convert your existing home in to an owner occupied rental,” says Schumacher. “You may be able to pay for half of your mortgage with the rent collected from a basement apartment.”
Should You Take a Mortgage Payment Vacation?
Some banks offer a payment "vacation" of up to four months if you've previously made enough prepayments equal to four months of mortgage payments. “During financial hardship, this is a good way to significantly reduce your monthly expenses by skipping your mortgage payment entirely. However, this option is anything but a ‘vacation.’ The skipped payments are added back to your principal which you are charged interest on for the life of your mortgage,” warns Schumacher.
Mortgage Protection Insurance
Another way to protect yourself is mortgage protection insurance. Similar to mortgage vacations, it has its pros and cons.
“Mortgage protection insurance is an easy, relatively inexpensive way to protect your mortgage through life and disability insurance. If you die, the mortgage is paid out in full and if you become disabled your mortgage payments are covered. The application process is very simple - just fill out a one page questionnaire and provide your credit card information,” says Schumacher.
“The policy is tied to your mortgage. If you cancel your mortgage or need to get a new mortgage, your policy is canceled and you would need to reapply.
However, unlike a personal life insurance policy, the bank is the main beneficiary - which isn't always the best solution. “When there is loss of life, the policy automatically pays off the mortgage. The next of kin doesn't get to choose what to do with the money (maybe keeping the mortgage, or only paying off a portion makes the most sense financially), says Schumacher. “Term life insurance may provide more comprehensive coverage, for a slightly lower price.”
Sean Cooper is a Financial Journalist and Personal Finance Expert, living in Toronto, Ontario. He offers Unbiased Fee-Only Financial Advice, specializing in pensions and the decumulation of financial wealth in retirement. Follow him on Twitter @SeanCooperWrite and read his blogs and request his writing services on his personal website: http://www.seancooperwriter.com/