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.

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.