Mortgage 101 (The 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, here are a few ways to accomplish 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.
- Voluntarily increasing each payment.
- Additional lump sum payments.
Remember you don’t have to get your mortgage from the same place you have your savings or chequing accounts. At the end of each term you will be able to change the options of your mortgage such as the payment schedule, the term, the rate, even the mortgage lender. Be sure to consult with your broker before renewing your mortgage term.
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 any penalties.
This means you can transfer the terms and conditions of your mortgage to your next home. This may allow you to keep an existing low interest rate if you sell one house and buy another.
This allows you to assume (take over) the existing mortgage on a property. An existing mortgage may have a lower interest rate than the current market offers, so it could make sense to assume this mortgage. In turn, an assumable mortgage may be a selling feature for you when you decide to put your house on the market.
This lets you expand the principal on a first mortgage or increase your mortgage at the lenders agreed-upon rate of interest. This can be a cost-effective way to finance a home renovation or free up some of the equity in your property.
Types of Mortgages
This mortgage is for an amount which does not exceed 80% of either the appraised value of the property or the purchase price, whichever is lower. Your down payment is a minimum 20% of the purchase price.
With this type of mortgage, you contribute less than 20% of the cost of the home as a down payment and as little as 5%. A high-ratio mortgage requires mortgage loan insurance. CMHC and Genworth (GE) offer mortgage loan insurance and base the premium on the total mortgage amount. This premium can be added to your mortgage payments or paid in-full on closing.
Second mortgages usually have a higher interest rate and shorter amortization than a first mortgage. Secondary financing is often used when one does not want to break the existing term on a first mortgage. Breaking an existing first mortgage often results in large payout penalties so a second mortgage may be the solution. Taking a second mortgage on your home is typically done to free up some cash for any number of reasons. Perhaps a home renovation or landscaping project to improve the value of the property
Assuming an Existing Mortgage
In assuming a mortgage you take over the vendor’s 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 the lender who holds the mortgage.
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, to close the deal. This amount would be paid back on a monthly basis much like the mortgage.
Interest Rate Buy Down (New Constructions)
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 lump sum payment often reduces the face rate of a mortgage by as much as 2%. In turn, this increases 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.
The builder may add the amount used to buy down a rate into the price of the home and as a result you may end up paying a more for the property.
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 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 your variable mortgage to a fixed rate.
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.
The term of a mortgage is the number of years or months over which you pay a specified interest rate.
Terms usually last anywhere from six months to 10 years. At the end of the term you either pay off your mortgage in full, or, renew it. Renegotiating terms and conditions is allowed and encouraged at the time of renewal.
Generally speaking, 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.
This is the amount of time over which the entire debt will be repaid. Most mortgages are amortized over a 25 year period. The longer the amortization, the lower your scheduled mortgage payments will be but the more interest you pay in the long run.
Schedule of Payments: A mortgage loan is repaid in regular payments set up as 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.
Many experts suggest taking an open mortgage for a short term in times of high interest rates and converting to a longer term when rates fall.
A closed mortgage has a fixed interest rate that is locked for the duration of the term and usually offers the lowest interest rate available. It’s a good choice if you like the predictability of knowing your payment will not change from month to month.
Closed mortgages are not very flexible and there are often penalties or restrictions attached to prepayments or additional lump sum payments. 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. Some offer a fixed portion and a line of credit portion. To find out more, talk to your mortgage agent as there are many options available.
Where to get a mortgage
Many institutions and individuals lend money for mortgages. These include insurance companies, banks, trust companies, credit unions, finance companies and pension funds. The best option is always to speak with a mortgage broker first. Mortgage brokers know where to find mortgage funds and at the lowest rates with the best conditions available.
What a lender wants from you
Lenders will want some financial information about you and/or your co-buyers to assess your ability to repay the mortgage. 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
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, Genworth (GE), or a private insurer. The lender then approves or rejects your mortgage loan.