Planning on buying a house this Spring in Toronto? Then you have likely gone through your check list. Down payment? Check! Pre-approval from the bank? Check! An estimate of what land transfer tax you will need to pay out? Check! Moving costs, insurance, bills? Check, check, check! It would appear that you have everything lined up and ready to go, but there is one more thing that you should add to your checklist. And that's money for a shortfall.
"What is a shortfall?" you ask. Well, before I get into the nitty gritty of what it is, let me offer up a little backstory first.
As almost anyone who reads a newspaper or blog knows, houses in Toronto are hot again this Spring. I know, not terribly surprising. There are many more buyers than there are houses to buy. How do I know this? Well, I have been in my share of bidding wars this past few months, and I have seen it first hand, though you don't need to be a real estate salesperson to clue into this.
It seems that at this particular moment in time, we are experiencing the quick ascension of two emerging neighbourhoods, namely the Danforth Village in the east and the Junction Triangle in the west. Why? Well, they are the last two affordable places to buy a house that is close to a built subway line.
This low level of inventory is not just in these parts of Toronto. It's happening in many areas of the city, but the Junction Triangle and the Danforth Village are two good examples of where some first time buyers or first time house buyers are heading to buy their home in Toronto. Quite frankly, I think these neighbourhoods have a lot going for them, and are transforming in really cool ways. I can see why there's some demand.
With that said, anyone who would like to buy a house in a hot Toronto neighbourhood right now will need to sport their war helmets and pull out their smiting sword, for battle. Not for every property, but for many of them.
So, now that we have set the stage, let me explain a shortfall by way of example.
Let's say a couple has qualified for a mortgage that is $850,000 dollars. They have $160,000 to put down on the house after all their expenses. They find a nice big detached home for sale at $699,000. They know that houses have recently sold for a little more in the area, and in the past few months, they’ve been going for a lot more. On offer day, there are 15 offers. The buyers want the property badly enough and put in a bid of $950,000 to get the property. You may think that bidding $250,000 over the asking price is unheard of, but it's not. Though it was close, the buyers’ offer is accepted! Then the bank that is offering them the mortgage sends out an appraiser. The buyers’ financing depends on what this appraiser is going to say. The appraiser drives in from Mississauga, not really sure of the Toronto market, but with a lot of accreditations on how to do appraisals, and tells the bank that the property is only worth $750,000 according to their estimations. So, there is a SHORTFALL of $200,000 between what the buyers have paid and what the bank will cover in the mortgage.
What does that mean for the buyers? Well, it means that they have to fork over $200,000 of their own money to cover the difference between the purchase price and the appraised price PLUS they need a downpayment on the mortgage of $750,000. With $160,000, that is not enough.
I know, scary stuff. This is, however, a VERY extreme example of a shortfall. They are usually not so big, though it is always a good idea to anticipate that there could be a shortfall, even it if is as low as $10,000.
The trouble is, it is difficult to assess the shortfall because you do not know what the appraised value will be. Some appraisers come back higher than others. I have heard of appraisers appraising the same property with 20% spread in value.
There are some things you can do though to prepare for this:
1. Do the math. Know the comparable solds in the area so that you can have an idea if your offer is close to this value. If not, you need to factor a potential shortfall into your calculations. If you are tired of losing out in bidding wars, then you will know that a shortfall may be needed to win on some properties in in-demand neighbourhoods.
2. Work with an agent who knows the area where you are looking and knows what is required to win in theToronto neighbourhoods where epic battles of real estate take place.
3. If you find your appraisal to be lower, you can always try another mortgage at a different bank or you can appeal your appraisal. Remember, appraisers are not always going to come up with the same number.
Of course, if all of this is just too strange for you as a buyer, then you just need to pick another neighbourhood that has fewer bidding wars, what I call the NEXT emerging neighbourhood, or you may want to head to something less competitive, like a condo.
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