Arranging Your Mortgage
Buying a home usually means taking out a mortgage. That means you borrow money to buy a home, using that home as collateral for the loan.
The amount of mortgage you can afford depends on your income, the down payment, current mortgage rates, and the amortization period you choose. Most lenders want borrowers to keep a gross-debt-service-to-income ratio of 40 per cent or less, coupled with a housing-cost-to-income ratio of 32 per cent or less (for more information see Step 3: Calculate Your Costs)
You may be able to purchase a home with a down payment as small as 5 per cent, thanks to CMHC’s Insurance program. First-time home buyers may also be eligible to withdraw up to $20,000 tax-free from an RRSP to use as a down payment. The funds must be repaid within fifteen years. Lenders can provide you with a pre-approved mortgage that shows approximately what mortgage loan you can afford.
Make sure you have a mortgage you can live with. There are lots of options available that let you customize your mortgage to suit your financial goals and needs.
Mortgage Basics
Mortgage payments are made up of a principal sum (the amount borrowed) and interest (the cost to you of borrowing money).
The best plan for any type of mortgage is to minimize the amount of interest you pay — and lenders offer several ways to help do this:
- A larger down payment means your home ultimately costs less because a smaller mortgage means less interest.
- A shorter amortization, the period over which a loan is repaid.
- A weekly or biweekly payment schedule, instead of monthly.
- Additional lump sum payments.
You don’t have to get your mortgage from the same place you have your savings or chequing accounts. Also, at the end of each term, you may be able to change the options of your mortgage, such as the payment schedule, the term, the rate, even who holds the mortgage.
Mortgage Features
Prepayment
Ensure that you have some form of prepayment clause in your mortgage that will allow you to pay down your mortgage with a lump sum, or an extra payment, without penalty.
Portability
This means you can transfer the terms and conditions of your mortgage to your next home. For example, this may allow you to keep a low interest rate if you sell one house and buy another.
Assumability
This means you may be able to assume (take over) the existing mortgage on the property. It may have attractive features, such as a lower interest rate than the prevailing market. In turn, an assumable mortgage may be a selling feature for you when you decide to move on in the housing market.
Expandability
This lets you expand the principal on a first mortgage at the lenders agreed-upon rate of interest. This can be a cost-effective way to finance a home renovation.
Types of Mortgages
Conventional Mortgage
This mortgage is for an amount which does not exceed 75% of either the appraised value of the property or the purchase price, whichever is lower. Your down payment is a minimum 25% of the purchase price.
High-ratio Mortgage
With this type of mortgage, you contribute less than 25% of the cost of the home as a down payment and as little as 5%. A high-ratio mortgage requires mortgage loan insurance. CMHC offers Mortgage Loan Insurance for a premium of between 0.5% and 3.75% of the mortgage amount. This premium can be added to your mortgage payments or paid in full on closing.
Second Mortgage
This usually has a higher interest rate and shorter amortization than a first mortgage. Secondary financing is often used to make renovations to a home. You can achieve mortgage freedom sooner by increasing the frequency of your payments. By making payments every two weeks, instead of monthly, a 25-year mortgage can be reduced to 20 years.
Mortgage Options
Assuming an Existing Mortgage
You take over the vendors mortgage as part of the price you pay for the house. Assuming an existing mortgage is quick and saves you money on the usual mortgage arrangement fees, such as appraisals and legal fees.
When you assume a mortgage, you don’t have to arrange financing from another lender and the rate on an existing mortgage may be lower than the prevailing market rate.
Sometimes, if it is specified in the original mortgage agreement, a mortgage can be assumed automatically. If not, you may have to qualify with a lender first.
Vendor Take Back (VTB) Mortgage
This means the vendor lends you the money to purchase the home. It’s basically a second mortgage.
For example, on a home that costs $150,000, if the vendor has an existing mortgage of $70,000 that you can assume and you have $40,000 for a down payment, the vendor may lend you the outstanding $40,000, which you pay back monthly.
The vendor may be able to offer this loan at less than bank rates. Some vendors will sell this mortgage to a mortgage broker instead of holding it themselves.
Interest Rate Buy Down
A vendor — usually a new-home builder — pays the lender a lump sum to lower the mortgage interest rate by up to 3% over a fixed term, usually one to two years.
A payment of $2,000-$3,000 reduces your mortgage rate by about 2%, increasing the mortgage amount for which you qualify.
New-home builders may offer buy downs or discounts on the mortgage rate to encourage sales. But vendor financing is usually not renewable, so you have to be prepared to pay the going market rate when the mortgage is renewed.
However, the builder may add the amount into the price of the home and you may end up paying a higher mortgage principal.
Rate of Interest
Interest is the cost of borrowing money and is paid to the lender. Mortgage interest rates are affected by the prevailing market interest rates. Mortgage rates are either fixed or variable.
A fixed rate is locked in so that it will not rise for the term of the mortgage.
A variable rate will fluctuate. The rate is set each month by the lender, based on the prevailing market rates. Your monthly payment is fixed to be the same each month for the term of the loan, but the percentage of each payment that goes toward the interest, and the percentage that pays down the principal, changes.
A variable rate can be a good choice if rates are high when you arrange your mortgage and then fall afterward. But if rates rise, you may want to convert to a fixed rate. Bear in mind that this can cost you a cash payment penalty.
If you select a variable rate, your lender may restrict the mortgage amount to 70% of the purchase price of the home and require a higher down payment on either a conventional or a high-ratio mortgage.
Also, some lenders offer a protected or capped variable rate. This means your interest rate will not rise above a predetermined limit. However, you usually pay a premium for this protection. See current mortgage interest rates.
Term
The term of a mortgage is the length of time that certain factors, such as the interest rate you pay, are set at a negotiated level.
Terms usually last anywhere from six months to 10 years. At the end of the term you either pay off your mortgage or renew it, possibly renegotiating its terms and conditions.
Generally, the longer the term the higher the interest rate. Many experts suggest you select a long term if interest rates are rising. If rates are falling, you may want to select a short term and then lock in the rate when you think rates won’t go any lower.
Note: the term is not the amortization period.
Amortization
This is the amount of time over which the entire debt will be repaid. Most mortgages are amortized over 15-, 20- or 25-year periods. The longer the amortization, the lower your scheduled mortgage payments, but the more interest you pay in the long run.
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Schedule of Payments
A mortgage loan is repaid in regular payments, either monthly, biweekly or weekly. The more frequent payment schedules can save you money by increasing the amount paid toward the total mortgage each year.
The more frequently you make your payments, the more principal you repay in a year, and therefore, the lower the overall interest you pay on your mortgage.
Open Mortgage
This means you can repay the loan, in part or in full, at any time without penalty. Interest rates are usually higher on this type of loan. An open mortgage can be a good choice if you plan to sell your home in the near future. Most lenders will allow you to convert to a closed mortgage at any time.
Many experts suggest taking an open mortgage for a short term in times of high rates and converting to a longer term when rates fall.
Closed Mortgage
A closed mortgage keeps payment unchanged for the duration of the loan period, and usually offers the lowest interest rate available. It’s a good choice if you’d like to have a fixed payment to work your budget around for a few years.
However, closed mortgages are not flexible and there are often penalties or restrictive conditions attached to prepayments or additional lump sum payments. It may not be the best choice if you might move before the end of the term. Closed mortgages have terms ranging from six months to twenty years with a five year term being the most common. Generally speaking, the longer the term, the higher the interest rate.
Split or Multiple-rate Mortgage
With this mortgage, you negotiate a portion of your total mortgage loan at one rate and term, and another portion at a different rate and term. In this way you can split your mortgage into two, three or more terms.
There are many more mortgage options available, such as a convertible mortgage. To find out more, talk to your lender.
Where to Get a Mortgage
Many institutions and individuals lend money for mortgages. These include insurance companies, banks, trust companies, caisse populaires, credit unions, finance companies and pension funds. You can also check your local newspaper classified advertisements for a listing of private lenders.If you have a Self-directed RRSP, you may wish to investigate with your lender the possibility of borrowing some or all of your mortgage from your self-directed RRSP.
Mortgage brokers don’t usually lend money but can find a lender for you.
What a Lender Wants from You
Lenders want plenty of financial information about you and your co-buyers to assess your ability to repay the loan. This ability is based on your Gross Debt Service (GDS) and Total Debt Service (TDS) ratios and also on your assets, liabilities, earnings, employment history and your past record of repaying loans. Specifically, your lender may want the following:
- personal information — age, marital status, dependents
- details of employment, including proof of income (T-4 slips, personal income tax returns or a letter from your employer stating your position)
- other sources of income, for instance, pensions or rental income
- current banking information
- verification of your down payment
- consent to run a credit investigation
- a list of assets, including property and vehicles
- a list of liabilities, for example, credit card balances, car loans — the total amount you owe and your monthly payment amounts
- fees for an appraisal or for a copy of a valid appraisal report if one was recently done
- mortgage insurance fees if a high-ratio mortgage is required
- a copy of the property listing
- a copy of the Agreement of Purchase and Sale on a resale home
- plans and cost estimates on a new home
- the condominium financial statements, if applicable
- a certificate for well and septic, if applicable
Approval Process
A mortgage approval should take only a few days, but it’s probably best to allow up to two weeks. During this process, the lender will do a credit check and spot check other information you have provided. In addition, an appraisal of the value of your home may be obtained.
Whether the lender approves your loan application will be determined by an evaluation of the following:
- Capacity: Do you have enough income to repay the debt?
- Credit history: Do you pay your bills on time and do you live within your means?
- Capital: What are your current assets?
- Collateral: What assets can you pledge as security against the mortgage?
If required, a request for mortgage loan insurance is submitted to CMHC or a private insurer. The lender then approves or rejects your mortgage loan.
Pre-approval
A pre-approved mortgage is very common. With pre-approval, your lender approves the amount of your mortgage and gives you a written confirmation or certificate for a fixed time period before you start looking for a home. The pre-approval term, usually lasting from 60 to 90 days, also sets the mortgage rate the lender will offer to you. If rates go down in that period, the lender should offer you the new lower rate.
Pre-approval gives you a head start on house hunting, but your final approval is still subject to an appraisal of the value of the home and a credit review of your finances.
With the right mortgage — one that’s flexible and tailored to your financial situation — you have the luxury of owning your home. You also have the luxury of being able to relax.