The house is nearly perfect: decent condition, nice neighbourhood and while it's priced at the higher end of their budget, the young couple feels they can shoulder the cost.
The only thing standing between them and the purchase of their first home is the dreaded circa 1960s bathroom. With its cracked ceramic tile, leaky taps and old bathtub, it’s in dire need of an overhaul - an expensive deal-breaker that wasn't accounted for in the homebuyers’ original budget.
So, what are their options?
The first, of course, is to walk away until they find something they can afford. A complete bathroom renovation can cost upwards of $15,000 and if the couple doesn’t feel comfortable tacking on the additional debt, they need to think twice.
Another option is to obtain a line of credit. They’re an easy way to access low interest short-term cash quickly but they’re not necessarily the smartest way to go, at least not according to David Chilton, the Wealthy Barber himself.
“People cannot resist lines of credit,” he said in a speech at a conference of the Canadian Pension & Benefits Institute in May. “And the worst combination in the country is a line of credit and a home renovation – once they renovate one room, the other rooms pale by comparison, so they go on to the next room and it’s a never-ending cycle of renovation as they get deeper and deeper and deeper in debt.”
A third, less common route the couple could take is to apply to the purchase plus improvements program (PPIP). Also known as the improvement, renovation or high-ratio mortgage, this option covers the sale price of the home, as well as any renovations that would increase the value of the property.
The program allows homebuyers to take advantage of the historically low interest rates associated with a mortgage and pay one lump sum monthly payment. But the PPIP involves a few steps, the first being to make the purchase offer conditional on getting approval for the renovation mortgage program.
The next step is to get quotes from a contractor to determine the cost of the renovations, says Daniel Natereno, a broker with Mortgage Intelligence. The Canadian Mortgage and Housing Corporation (CMHC) will approve a loan of up to 95 per cent of the ‘as improved’ value of the home, provided the money you’re putting into the home does, in fact, improve the value.
Renovations cannot be strictly cosmetic in nature, warns Mr. Natereno, but must rather be part of a broader project like changing a bathroom, kitchen or flooring.
The bank will send an inspector to confirm that, based on the list of improvements that are requested, they’ve been done sufficiently. Then the inspector will send the report back to the bank indicating that everything’s complete and they’ll release the funds to the client.
Quotes are often required in order for the lender to release funds, though some lenders will make exceptions for small improvements. Inspection reports can cost betweens $100 to $200, says Mr. Natereno.
Depending on the homebuyers’ current situation, the PPIP can offer more benefits than a traditional line of credit.
“Most banks will give you a line of credit of up to 80 per cent of the market value of the property, whereas the PPP/CMHC-insured mortgage can go up to 95 per cent of the improved value of the property, so it provides a way for homeowners who've only got 5 per cent of the down payment to be able to buy the home they want and improve it as well,” says Tina Tehranchian CFP financial advisor at Assante Capital Management Ltd.
But there are certain disadvantages to these high-ratio mortgages, and they’re certainly not right for everyone, explains Ms. Tehranchian. Those looking to obtain up to 65 per cent of the purchase price plus improvement value must pay a 0.50-per-cent premium, whereas those wanting more than 90 per cent must pay a 2.75-per-cent premium on the total loan amount.
It may not make sense for someone looking for a loan on the lower end of the scale to pay this premium, since most financial institutions offer lines of credit of up to 75 per cent of the value of the home. “As long as that’s the maximum that they need, that would be a better option because there’s no CMHC premium,” says Ms. Tehranchian.
The PPIP also doesn’t necessarily make sense for people whose cash flow fluctuates, such as some business owners. To these borrowers, the line of credit option lets them pay down the loan more quickly than they could on a mortgage, so long as the they’re disciplined. Lines of credit are also good in the bad times, explains Ms. Tehranchian, since you can just revert to paying the minimum when things slow down.
The other caveat with the PPIP is that while they make it easier for borrowers to qualify and force them to be more disciplined with the one monthly payment, they can tempt homebuyers to bite off more than they can chew.
“Homebuyers should do their homework and make sure they’re going to be able to afford those loans, even if they went up 3 per cent from their current levels. The last thing you want to do is have a very low down payment (5 or 10 per cent) and then have the property market drop. You’ll see your down payment wiped out and you’re stuck with a mortgage that costs you way more than you expected,” says Ms. Tehranchian.