Get up to speed on mortgage basics before buying a home

When you’re starting your home buying journey, it can be hard to know where to begin. For one thing, mortgages aren’t always easy to understand, especially with regulatory changes over the past two years. If you’re looking to buy a home, it’s important to get up to speed on these rules so you can select the right mortgage for you. To help you understand these changes, let’s look at some of the basic requirements for buying a home.

The mortgage basics

Down payment requirements

Home down payments are usually expressed in percentages. They’re calculated by dividing the dollar value of the down payment by the home price. In Canada, the minimum down payment depends on the purchase price of the home:

  • Purchase price of less than $500,000 needs a 5% minimum down payment
  • Purchase price of $500,000 – $999,999 needs a 5% minimum down payment on the first $500,000, and 10% on any amount over $500,000

If you make a down payment of at least 20% of the purchase price, you’ll hold a conventional or low-ratio mortgage. Mortgage Terms & RulesIf you put down less than 20%, your mortgage is considered a high-ratio mortgage. By law, high-ratio mortgages require you to buy mortgage default insurance.

Mortgage default insurance

This type of insurance protects mortgage lenders if homeowners can’t pay their mortgage. Your mortgage lender can arrange a default insurance policy through Canada Mortgage and Housing Corporation (CMHC), Genworth Canada or Canada Guaranty. In most cases, the additional cost is factored into your mortgage payment.

Financial stability requirements

Your lender will use two ratios – gross debt service (GDS) and total debt service (TDS) – to assess your ability to make monthly payments. These are used to determine how much you can spend on housing without risking your financial stability.

  • Gross debt service is an estimate of the maximum home-related expenses you can afford each month, including mortgage payments, electricity and gas costs, property taxes and condo fees. While an acceptable number varies between lenders and the type of mortgage you hold, your monthly housing costs should be less than 30% of your gross monthly income for a non-insured, conventional mortgage.
  • Total debt service is an estimate of the maximum debt load you can afford each month. In addition to your home-related expenses, this number includes things like car loan payments, credit cards and other loan expenses. This number also varies between lenders, but in general, your monthly debt obligations shouldn’t be more than 40% of your total monthly income for a non-insured, conventional mortgage.

Regardless of where you are in your home buying journey, brushing up on mortgage basics and the current rules is a good place to start when thinking about your next move.

Recent changes to borrowing

Changes to mortgage default insurance

What is it? In October 2016, the Department of Finance implemented new stress-testing requirements for all mortgages that need mortgage default insurance. In other words, if you need mortgage default insurance, you’ll have to be able to afford a higher mortgage rate than the promotional rate for the term you selected. This helps ensure Canadians aren’t taking on bigger mortgages than they can afford.

Who’s it for? Homebuyers applying for a high-ratio mortgage that requires mortgage default insurance, or where low-ratio mortgage insurance is required.

How does it affect me? All homebuyers applying for mortgage default insurance (high- or low-ratio) must qualify at the greater of their lender’s standard rate 5-year mortgage rate and the Bank of Canada’s 5-year conventional mortgage rate, regardless of the term chosen. For an insured mortgage, the GDS can’t exceed 39% and the TDS can’t be more than 44%.

How much mortgage default insurance costs

What is it? From time to time, Canada Mortgage and Housing Corporation (CMHC) changes the cost of insurance. Under new guidelines, CMHC increased the cost on March 17, 2017.

Who’s it for? Homebuyers applying for a high-ratio mortgage that requires mortgage default insurance, or where low-ratio mortgage insurance is required.

How does it affect me? The cost of mortgage default insurance is based on the loan-to-value (LTV) ratio of the mortgage you’re applying for – it’s calculated by dividing the size of the loan you’ll need by the purchase price of the home. The higher the LTV ratio, the more insurance will cost. The cost depends on the LTV ratio. For current rates, refer to the CMHC website.

With housing price fluctuations and changing mortgage rules, it can be overwhelming to navigate the housing market. If you need a little help to get started, I can assess your financial security plan to make sure you’re on track towards your home ownership goals.

I can also put you in touch with a mortgage planning specialist who can guide you through each step of the mortgage process. Regardless of where you are in your home buying journey, brushing up on mortgage basics and current rules is a good place to start when thinking about your next move.

Did your lender talk to you about Mortgage Insurance?

Protect what matters most, not just your house

When you buy a home, you need a way to help protect yourself and your family financially, no matter what happens.

Your bank/lending institution probably talked to you about mortgage insurance (also called creditor insurance) when you bought your house. It means if you die, your mortgage is paid off.

Mortgage Insurance vs. Individual Life Insurance:

But is mortgage insurance the best option for you?

If you want to protect more than just your home, individual insurance may better suit your needs. Individual insurance generally provides more control, options and benefits to help you financially protect what matters most.

By comparing mortgage and individual life insurance, you ensure you’re giving yourself and your family the type of insurance protection that meets your needs.

I’m a trusted professional who can help you build a financial security plan to help protect your mortgage and what matters most in your life.

Should I Rent or Buy?

It’s one of the most important questions you’ll ever answer – should I rent or buy? The choice you make could have a long-term impact on your financial situation.

Keeping up with friends who’ve decided to purchase a home should not play a role in your decision. Ultimately, it’s about timing and what works best for your unique situation.

Why there’s no rush to buy a home

First, let’s shatter the myth that says you should jump into the real estate market as soon as possible. Home ownership does not automatically offer the highest returns, especially now that the market has risen so strongly over the past decade. Your decision about buying should be based on affordability and need, not expected short-term investment gains.

  • Should I rent or buy? The choice you make could have a long-term impact on your financial situation.

Some personal finance writers have debated whether you’d be better to rent for your entire life and invest the extra money you pay each month for owning a home – that includes mortgage interest, on-going maintenance and everything else. The Ontario Securities Commission funds an investor education website that includes a calculator to test out various scenarios.

In Canada’s major cities – including Vancouver, Calgary and Toronto – rental prices are not keeping pace with property prices, meaning many renters are living in neighbourhoods where they could not afford to buy a home.

Rent or Buy?

The advantages and disadvantages of “forced savings”

For most people, owning a home is both a lifestyle and a long-term investment decision. The numbers support this decision, as two in three Canadians own their homes. The reason is simple: people put a great deal of intrinsic value in owning the roof over their heads and paying down a mortgage forces them to build financial assets.

Over the years, this “forced savings” approach becomes easier as wages increase and the share of income earmarked for a mortgage steadily declines. However, during the early stages of a mortgage these financial pressures can strain lifestyles and even relationships.

Why delaying a home purchase could be a very wise move

Delaying a home purchase may be a sound option for many people because it allows you to build a larger down payment. This allows for the potential to reduce your monthly mortgage payments. And if you manage to put 20 per cent down, you avoid mortgage insurance – which can cost as much as 3.35 per cent of the value of the mortgage.

A larger down payment also puts you in a much stronger position if housing prices take a short-term drop. With a 20 per cent down payment, a 10 per cent drop in your house value would still leave you with significant equity. With only five per cent down, you’d be in negative territory.

Try out the cash flow test run

Delaying a home purchase not only creates the opportunity to build a bigger down payment, it allows you to get a feel for how your monthly cash flow will change once you’ve bought a house. At minimum, you should save the difference between rent and your expected monthly mortgage payment. Take it to the next level by adding up and banking all non-mortgage costs, including property taxes, insurance, heating and other utilities. Condo buyers also have to factor in strata/maintenance fees.

The longer you maintain this “cash flow test run,” the bigger your down payment will be. Plus, putting your estimated budget for home ownership to the test will help you establish a financial comfort zone, helping you avoid becoming “house poor” – or being unable to afford anything other than your basic living expenses. After all, your goal is to own a great home and still have enough money to enjoy the rest of your life.

Expect the unexpected

When you work out a budget for the costs of buying versus renting, mortgage payments and other ongoing expenses are easier to estimate. The big unknowns are unforeseen repairs. A common rule of thumb is to budget for one per cent of the purchase price of the home for regular maintenance.

From a renter’s perspective, squirrels are a cute feature of city living, while a sudden thundershower is a perfect way to water trees and plants. But a homeowner may feel differently after discovering a squirrel has chewed a hole in their roof, causing rainwater to flow down walls and across ceilings, eventually flooding the basement.

The Canada Mortgage and Housing Corporation (CMHC) urges homeowners to put five per cent of take-home earnings in a special fund to cover emergencies, such as major house repairs or the loss of a job. Even if you can afford to buy a brand new home in your ideal neighbourhood, you need to account for repairs and upkeep as well.

Buying can help you create your own living space

Wanting to own a home isn’t just about money – it’s also about creating a truly unique living space that fits your personality. Renters, on the other hand, have few incentives to invest anything into customizing their home and they could be forced to move if the building is sold.

If you’re planning to have children, the stability of staying in one neighbourhood for an extended period may be important. As your family grows, the math behind the buy versus rent calculations may point to a purchase.

Why buying a “starter home” may not be right for you

For many, the next step is purchasing a “starter home.” Consider, though, that buying a less expensive home with the intention of eventually trading it in for a larger one in a nicer area involves major costs – including real estate agent commissions for selling the starter home, one-time taxes on the new home, closing costs and moving expenses. Added up, they could easily overtake any increase in your starter home’s value.

Owning for a relatively short time also increases the risk that the home’s value may decrease and not have time to recover. While house prices tend to rise over time, there may be short-term dips in the market. Renting in the short term avoids these risks and could actually get you into your dream home sooner.

Go big and go home

Delaying your home purchase may give you the ability to avoid going the starter home route, opening up the opportunity to buy the “forever home” that will serve you and your family for many years.

Buying a more spacious house before starting a family allows you to grow into it. Meanwhile, you can follow the lead of many first-time homebuyers and rent a part of the house to generate extra income. Then, once your family grows, you can convert the apartment into bedrooms and bathrooms for your kids.

Buying a home can be immensely rewarding and a wise financial decision. Prudent financial security planning, which may include renting a little while longer, can help ensure you achieve your goals while also keeping your finances in great shape.

Are You Ready to Dive into a Mortgage?

All homeowners dream of burning their mortgage papers after making that final payment. Smart planning and prudent decisions will help make that day arrive sooner than you’d think.

However, before plunging into the real estate market, you should estimate how much you can afford. There are many online tools that can help you do this.

Lenders want to make sure your total monthly housing costs – including mortgage payments, taxes and utilities – do not exceed one-third of your household’s total gross income and that your total debt load (including car loans) is not above 40 per cent of your household’s total gross income. All lenders have software programs that can compute how much they’re willing to lend and how much house they expect you can afford to purchase.

That first big payment

A big down payment could be a great way to reduce the size of a mortgage. But people who don’t have a lot of money saved – and don’t want to wait to build a larger down payment – can take on a high-ratio mortgage. Borrowers in Canada with less than a 20 per cent down payment must purchase mortgage insurance, which protects the lender in case of default. This could cost up to 3.35 per cent of the value of the mortgage and typically gets tacked onto the principal.

Options to consider when choosing a mortgage

It’s important to consider these topics when choosing a mortgage:

  • Fixed or variable interest rate
  • Amortization period
  • Length of term
  • Open or closed

The fixed-versus-variable-rate decision has long been debated. A few years ago, Moshe Milevsky, a professor at York University, authored a report which suggested prospective homeowners go with a variable interest rate mortgage.1 But since variable rates could go up any time, many borrowers opt for the more stable fixed-rate mortgage.

Today, the advantage of variable rates is uncertain. Yes, they remain below fixed ones, but the gap has become razor thin – to the point where potential savings may not justify the risk of variable rates climbing.

Risks not so variable

For small increases in the variable rate, the payment size may remain the same. The only difference would be an increase in the amount going to pay the interest portion. However, if rates increase significantly, even by 1.5 per cent, the lender may increase the payments.

Before deciding on a variable rate, make sure the lender explains all of the possible scenarios. Specifically, find out what interest rate changes will trigger higher payments. You may be able to include the option to lock into a fixed-rate mortgage at any time, but keep in mind that by then the longer-term rates may have changed.

Fortunately, you can use a mortgage calculator to easily determine the savings of going variable versus fixed. You may decide that the upside isn’t enough to forgo the certainty provided by a fixed-rate mortgage.

Mortgage

Coming to terms

Mortgage terms can range from six months to 10 years. Generally, the interest rate rises with the length of the term.

The advantages of an open mortgage

Fixed-rate mortgages are generally closed. They typically allow for yearly lump-sum prepayments up to 20 per cent of the original mortgage, depending on the lender – a very important detail you ought to confirm before signing. You may also be able to increase your regular payments, as much as doubling them – perfect for people with steadily rising incomes.

Paying off the mortgage all at once or breaking it up to get a better rate often triggers financial penalties. Some lenders do offer open mortgages, which allow borrowers to pay off some, or all, of the loan at any time. However, there’s a catch: the interest rate may be significantly higher.

If there’s a chance you’ll come into some money or sell the mortgaged home before the term expires, an open mortgage could make more sense. If you plan to move before the term expires, a portable mortgage (one that can be transferred to your next home) may also be an option worth considering.

  • Of all the variables to choose from, a shorter amortization period offers the fastest route to a mortgage-burning party.

Which should you choose: A long or short amortization period?

Of all the variables to choose from, a shorter amortization period offers the fastest route to a mortgage-burning party. By law, Canadians can negotiate a mortgage that extends to 25 years. Long amortization periods are popular, especially with first-time homebuyers, since they could lower the amount of each mortgage payment. However, those lower payments could come with a price – higher interest rate costs.

Anyone taking out a mortgage ought to become very familiar with a mortgage calculator. Try plugging in shorter amortization periods and compare the increase in payments with the drop in interest costs. The sweet spot is often around 20 years, where the increase in payments isn’t so big but the savings in interest costs could be significant.

Accelerated payments could help you pay off your mortgage faster

You can pick weekly, bi-weekly and monthly payments, depending on the lender. More frequent payments will mean you’ll pay less interest over the life of the mortgage with the same interest rate.

You can also opt for “accelerated” payments that shave time off your total amortization period. While giving your lender payments a few days earlier doesn’t save much interest, accelerated payments can increase the total payments you make each year­ ­– helping you pay off your mortgage faster.

If you value simplicity, increase your total annual payments but add them up and divide by 12 to compute the equivalent monthly payment.

It’s time to get started

Once you’ve decided to purchase a home, consult with me, I can show you how and why you should build your mortgage into your financial security plan.