Let's Talk: Mortgages

Buying a home is the largest financial transaction most people will ever make in their lifetime. It's a very important decision to make and requires lots of commitment. Most homes are acquired through mortgages because people don't have hundreds of thousands of dollars to pay for it upfront. There's a lot of information regarding home-ownership but don't you worry. I already know this is gonna be a long one. I'll do my best to once again break it down so you can easily understand it.

The Right Reasons

Like I mentioned previously, this is a very important financial decision and you need to think about why you are getting into home-ownership. You have to consider whether you can afford the payments and lock-in for the next 25 years. Affordability is the most important factor to consider because why would you want to be house-rich but cash-poor? It's not like you can take a piece off your house and eat it. Heated markets in Canada like Toronto and Vancouver are stupidly overpriced compared to the rest of the country. As a general rule, if you can't afford to buy a home, THEN DON'T! Either move to a more affordable location or wait until you can afford it with a larger downpayment. Don't try to get into the housing market if you can barely make the payments. You're just asking for financial troubles down the road.

Some people choose to buy a home and live in it for life while others do it because they want to build equity and sell it when they retire or even start a rental property. A house can be both an asset and a liability depending on how you manage it. I truly, want to empathize this once again. Whatever your reasons are for home-ownership is up to you but DO NOT get into it if you are barely able to make the payments. In unforeseen events like a job loss or an increase in interest rates, you are still expected to make the agreed payments. Make sure you consider this before buying.

Requirements

In Canada, there are criterias you need to meet or qualify for before you can actually get a mortgage. Once again, they all related to whether or not you can afford the mortgage. This will keep reappearing because it's so important! You will not get a mortgage if you don't meet any of these:

• Your home needs to be located in Canada for tax reasons
• Required downpayment of 5% on the balance of the mortgage
• A downpayment of less than 20% is required to have mortgage insurance by Canada Mortgage and Housing Corporation (CMHC) and is added to your mortgage cost
• If a home is worth over $500,000 the required downpayment is 5% on the first $500,000 and 10% on the remaining amount
• Qualify for the Gross Debt Service Ratio (GDSR) - Your ratio must be below your lender's range which can vary between 35-39% 
• Qualify for the Total Debt Service Ratio (TDSR) - You ratio must be below your lender's range which can vary between 40-44%
• Minimum required credit score of 600
• You can afford closing costs and legal fees, in addition to your mortgage
• Pass a stress test if you're applying with the banks. This does not apply to credit union mortgages but they may still use the stress test to reduce their risk

GDSR/TDSR

I want to quickly go into a few of the requirements just to elaborate a bit more. These are simply ratios that include your debts and compare them to your income before taxes. It shows much much of your income is going to your debts. If your total ratio is below your lender's standard then you will be approved for a mortgage. You have to qualify for both ratios to get a mortgage and can be calculated monthly or annually. Here's the formula they use.

Stress Test

Created with the concern of current low-interest rates, this test determines whether you can continue to pay your mortgage in the future if interest rates rise in the future. The stress test applies to all new and renewing mortgages. This helps lenders reduce the risk of people defaulting on their mortgage. When you receive a rate for your mortgage, the stress test will apply a modified interest rate to see if you can afford it. This will make it harder for people to qualify because they need to either pay off their debts, have a larger down payment or qualify for a less expensive home. 

The test rate used for UNINSURED mortgages is the higher of:

• Bank of Canada's 5-year rate OR
• The rate offered by your lender + 2%

The test rate used for INSURED mortgages is the higher of:

• The weekly average 5-year rate on all insured mortgages + 2% OR
• The rate offered by your lender + 2%

Additional Costs

You can pass all the other test but if you didn't consider the closing cost, you're not going to get a mortgage. This is the annoying logistics and paperwork side of the mortgage and they don't come cheap. Some of these are optional and you may not need to perform them. You should get in touch with your lawyer to understand your full cost. They can be up to 4 % of the mortgage and include things like:

• Appraisal fee
• Legal fees
• Land Survey fee
• Land Transfer tax
• Title insurance
• Mortgage insurance
• Home inspection fee
• Water inspection fee
• Estoppel fee
• Moving cost

Pre-Approval

Getting a pre-approval for your mortgage helps immensely with the process. It means that your lender had a chance to analyze your income, expenses and credit and has given you a known set amount for your mortgage. It has the advantages of:

• Knowing the maximum mortgage amount you can apply for
• Knowing your maximum mortgage payments
• Choose to lock in interest rates for 60-120 days to secure lower rates in case rates increases
• Realtors often take you more seriously 

Being pre-approved for a mortgage does not mean you are approved for the application itself. Changes to your personal finance may affect the chances of being approved. Things like:

• A decrease in your credit score
• You acquired new debt or lost your job and no longer qualify for GDSR and TDSR
• Cannot afford your closing costs

Terms and Conditions

This is the part where you negotiate with your lender over the interest rates and decide on final agreements. There's a lot of terminologies so I'll just list it off:

• Amortization - This is the agreed length of time that you'll pay off your mortgage. The maximum is 25 years. It could be longer but only applies to uninsured mortgages.
• Term - This is how long you can lock in your interest rates. This usually ranges from 1-10 years. The most common is 5 years.
• Fixed-rate - Your interest rate is locked in for the chosen term. Your payments will stay set until your term is up.
• Variable-rate - Your interest rate will fluctuate and may increase or decrease, changing the ratio on the interest and principal of the payments.
• Open - You have the flexibility to pay off your mortgage sooner without penalty.
• Closed - You are limited to paying off your mortgage sooner.
• Portability - You have the flexibility to transfer your mortgage to a new home if you moved
• Frequency - This is how often payments will be made to your mortgage. You have the option of:
• Weekly 
• Accelerated weekly (monthly payments divided by 4)
• Bi-weekly (every 2 weeks)
• Accelerated bi-weekly (monthly payments divided by 2)
• Monthly
• Semi-monthly (2 payments each month)

Breaking the Contract

If you made a downpayment of less than 20% when buying your mortgage, you are automatically forced to purchase mortgage insurance from CMHC. In the event that you fail to make payments consecutively, your lender would be covered for the balance you owe. Your credit rating takes a huge hit and you most likely will be filing for bankruptcy. Your house would also face foreclosure. This is a process where your lender takes your home and attempts to sell it to make up the defaulted amount. In other words, they don't profit from your house. They simply recoup their losses. 

Alternatively, there is a less severe way of breaking the contract. This happens more often and it's when people want to lock in at a lower interest rate with another lender. Switching lenders will also require you to start a new mortgage application process and get approved all over again. Fortunately, lenders will allow you to exit your contract but you will be required to pay a large fee. This may or may not end up being worth the switch. The penalty is the higher of either:

• 3 months of interest
• The Interest Rate Differential (IRD)

All Done!

Congratulations! When all the paperwork is complete, the home is finally yours. Now you just have to continue renewing your term and making payments until you pay off the mortgage. Be aware that there will be constant upkeep for your home. Being a homeowner has its own rights and responsibilities. These are the ongoing costs you should be made aware of:

• Property tax
• Utilities
• Insurance
• Maintenance/Repairs
• Condo fees

Once you're done paying your mortgage, you'll be sent some papers informing you that you no longer owe a balance, which you should use to discharge your mortgage. Go to a Land Titles Office and have them remove your lender's lien on your home with the papers. You can read more about what to do here.

Tips

Here are some facts and tips about mortgages that might help you down the road:

• When you buy your first home, you're eligible for an incentive to help you with your down payment.
• When you sell your designated primary home, the growth of your home is tax-free. Upon selling your other homes, you must pay capital gain taxes.
• You can save money in interest by choosing a shorter payment frequency or by making pre-payments
• Don't take the posted rates for mortgage interest rates. They have a floor rate, which is the lowest they are willing to offer. If you have a lot of assets with your financial institution, you are more likely to get a rate lower than their posted rate.
• Use this mortgage calculator to help you see how much you'll be paying for your mortgage
• You can use brokers to help you find competitive interest rates as well as Ratehub to help you quickly compare
• You can take equity out of your mortgage as a line of credit