If you’re considering buying a home, know that it is a viable proposition. In place of paying out monthly rental cheques to your landlord, you could be paying out mortgage installments that can eventually help you build equity on the property. Years down the line, you could become a real estate owner and own your home. However, before you take that giant step forward, you may want to study the mortgage market and understand how it works.
- Take a Closer Look at the Total Costs You’ll Incur Before Buying a Home
- Understanding the Most Commonly Used Mortgage Terminology
- Types of Mortgages
- Getting Pre-Approved for the Mortgage
Take a Closer Look at the Total Costs You’ll Incur Before Buying a Home
Before going ahead with your plans of taking out a mortgage, you’ll want to take a closer look at the costs you’ll incur and match them with your financial status and budget. Expert mortgage consultants advise you that they typically use two kinds of debt ratios to evaluate the mortgage you can comfortably pay off.
Gross Debt Service Ratio (GDS)
Should you choose to take out a mortgage, you’ll incur additional ongoing expenses. The Gross Debt Service Ratio is that percentage of your income that you’ll divert towards paying them off. Take care that this percentage should not be more than 32% of your income.
- Home insurance premiums
- Costs of utilities such as heating
- Real estate taxes
- Any applicable condo fees
- Any applicable second mortgage payments
Total Debt Service Ratio (TDS)
The Total Debt Service Ratio is that section of your income that you’ll use to pay off other household expenses that are payable on a regular basis including consumer debt obligations. These costs should not be more than 40% of your total income.
- Cost of living including the GDS listed above
- Personal loan payments
- Student loan payments
- Credit card bill payments
- Car payments
- Installment payments for any other items you may have bought
To get a clear view of the exact finances you can afford for a mortgage, use any of the online mortgage affordability calculators available on the internet.
Understanding the Most Commonly Used Mortgage Terminology
These are the most commonly used mortgage terms and what they mean.
The mortgage term is the timeframe for which your mortgage provider or lender will loan you a sum of money at a specific rate of interest. Mortgage terms can range from 6 months to 25 years with the most common terms being for 5 years. On completion of the mortgage term, you have the option of clearing the balance loan entirely and become debt-free. Of course, that’s possible only if you have the necessary funds. The other option is to renew your mortgage with the same lender. Alternatively, you can check the market for lenders who can offer you loan products at lower rates of interest and/or more favorable terms and conditions.
At the time of buying a property on mortgage, the law requires that you pay off a minimum of 5% of the percentage of the price in cash. You can then take a loan or mortgage for the balance 95% and pay it off in the next 25 years or so. The initial 5% to 25% of the price that you pay is called the down payment and can sometimes take years to save up.
A useful tool that can help you save the funds you need for a down payment is the Tax-Free Savings Account (TFSA). Any funds you deposit in this account do not incur any taxes. Further, in case of emergencies, you can withdraw funds from this account without incurring any penalties. This facility is not available in any other registered savings accounts. To help your savings grow faster, you can divert the funds into a low-risk GIC within the TFSA.
In Canada, if you opt for a CMHC-backed mortgage, you can take a mortgage amortization period of 25 years. But, if you’ve opted for a conventional mortgage, the amortization interval can be 30 years. The amortization period is the time it will take you to pay off your mortgage and become entirely debt-free. This time frame depends on the payments you make each month, the prevailing rate of interest, and the frequency with which you clear payments.
First time home buyers may want to opt for longer amortization periods that allow them to make smaller payments that easily fit into their household budgets. As you continue to live in the house, you’ll develop a fair view of the actual payments you can afford to make. Changing life situations like salary hikes and multiple earning members in the family can help you make bigger payments in the future.
If you’re paying a down payment of less than 20% for the property, the mortgage provider will require you to buy mortgage default insurance. This insurance protects the lender and his investment in case you’re unable to honor your loan payments. Organizations like the Crown Corporation CMHC or private coverage providers like Genworth and Canada Guaranty offer mortgage default insurance.
When making mortgage payments, you need not necessarily make payments once a month. Depending on the availability of funds, you can make additional payments every week or every two weeks also. This system is called the accelerated payment system and allows you to clear your debt sooner. You’ll also pay less interest overall. An online mortgage payment calculator can help you calculate the total interest you can save.
At the time of evaluating your application for a mortgage, loan providers may request you to pass a stress test. This test indicates if you can afford mortgage payments even if the interest rates were to rise, and is applicable to borrowers who are offering less than 20% of the price of the property in down payment. Moving forward from January 2018, according to the new regulations laid down by the Office of the Superintendent of Financial Institutions Canada (OSFI), all applicants must take the stress test irrespective of the down payment they’re making or the kind of mortgage they’re applying for – variable rate or fixed rate.
You must prove that you can afford the higher of 2 options:
- Contractual mortgage rate plus two percentage points
- Conventional mortgage rate or the 5-year rate established by the Bank of Canada
Types of Mortgages
Before choosing a mortgage, you need to know what types of mortgages exist:
If you’re looking for a stable low rate of interest all through the mortgage term, and you don’t foresee any significant changes in your life situation, you can opt for the closed mortgage. This mortgage carries a penalty in case you want to prepay, renegotiate, or refinance the loan before it matures. However, you may have the facility of making bulk payments towards the principal. You can also increase the monthly payments you’re making, but only by a certain percentage.
In case you’re looking for a fixed rate open mortgage, you can get one with terms ranging from 6 months to 1 year. However, if you’re looking for a variable rate open mortgage, the provider may offer you terms ranging from 3 to 5 years. Open mortgages are quite flexible and are ideal for the investor who is expecting to receive large sums of money like, for instance, an inheritance, divorce settlement, or insurance claim. Such mortgages allow you to pay off the loan before maturity, or convert the open mortgage into a closed mortgage without incurring a penalty.
Taking a convertible mortgage offers you the flexibility of changing the type of mortgage without incurring a penalty, but within a specific time frame. Such mortgages also carry various other conditions so you may want to read them carefully before signing the papers.
Variable Rate Mortgages
If you opt for a variable rate mortgage, your monthly payments will depend on the prime rate fixed by the bank for that particular month. These kind of mortgages are a good option if you anticipate that interest rates will drop in coming times and you’re okay with the uncertainty of the monthly payments you may have to make.
Fixed Rate Mortgages
At the time of taking the fixed rate mortgage, the lender will fix a particular rate of interest and you’ll make the same payments each month all through the mortgage term regardless of the fluctuating interest rates. Although fixed-rate mortgages carry a higher rate of interest, they offer you the stability of fixed payments making it easier for you to budget your family expenses.
Blended rate mortgages combine the positives of the fixed rate mortgages and flexible rate mortgages. However, each lender may offer you customized terms and conditions that you can fix at the time of buying the mortgage.
Getting Pre-Approved for the Mortgage
The first step involved in taking a mortgage is to get pre-approved for the loan. This process gives you and the prospective lender a clear view of the mortgage payments you can make depending on your financial status. In this way, you know exactly how much you can invest in a home and can look for appropriate properties accordingly. Once the pre-approval process is complete, you’ll receive a ratecertificate or written confirmation issued by the lender with the facility of locking the interest rate for 120 days while you look for the property you wish to buy.
Information You’ll Provide for Pre-Approval
- Employment status and income: Proof of all income sources including alimony cheques, child support payments, pay stubs, part-time job pay cheques or any other
- Current debts: Outstanding loans and commitments including car loans, personal loans, mortgages, student loans, credit card debt, or any other
- Current assets: Investments and bonds like stocks, GICs, RRSPs, or any others
Understanding Pre-Approval and Final Approval
The pre-approval procedure gives you a fair view of the amount you can comfortably spend on the home. It also works to convince your seller that you qualify for a mortgage and intend to buy the property. However, you’re not obligated to take the pre-approval rate. Final approval is when you actually buy the mortgage and fix the rate of interest.