Mortgage Financing – How do I qualify for a mortgage?
The elements of your mortgage financing
Your mortgage rate and terms of the mortgage are crucial and essential part of the home buying process. This rate may determine your living standards and those of your family. Future mortgage payments will consist of principal sum (this is the sum that goes into your pocket upon the sale of your home) and interest (this is the payment that goes to the lender and is called cost of borrowing). Main features of your mortgage that you should pay a close attention to are: Prepayment, Portability and Assumability.
Prepayment – this mortgage feature will allow you to pay down your mortgage with a lump sum at any time within a year with the limit set in the mortgage conditions. This is done without penalties as stipulated in your mortgage financing documents. If you have no clause in your mortgage which specifies this condition, you will not be able to make any additional payments on your mortgage or pay down your mortgage with a lump sum.
Portability – this mortgage feature will enable you to transfer your terms and conditions as well as the mortgage rate from your current home to the newly purchased property. Portability is beneficial to you, assuming that you sell your home within two or three years of starting your mortgage and transfer the mortgage to another purchased property. (On 5 year fixed mortgage) You must understand the terms of your mortgage financing and discuss the portability feature upfront with your lender.
Assumability – this mortgage feature enables you to sell your home with the ability to transfer the mortgage financing rate, terms and conditions to the buyer of your property provided that it is beneficial to both parties to do so. Again, this mortgage feature must be discussed upfront with your lender before you sign the mortgage documents.
Term of a mortgage – This is the length of time that certain factors, such as your interest rate are set at a negotiated level. Terms are usually set between 6 moths and ten years with the most common being 5 years. At the end of the term you either pay your mortgage in full or renew with new terms, conditions and amortization period. The rule of thumb is that the longer the term, the more you will end up paying in interest.
Amortization – This is the amount of time over which the entire mortgage will be paid off. Most mortgages are amortized over 15, 20 or 25 year periods. The longer the amortization, the lower your scheduled mortgage payments, but the more interest you pay in the long run.
Schedule of payments – A mortgage loan is repaid in regular payments as stipulated in your mortgage financing documents: monthly, accelerated biweekly or accelerated weekly.
Open mortgage – This is a type of mortgage where you are able to repay the loan in part or in full, at any time without penalty. For open mortgages, interest rates are usually bit higher than the closed mortgage rates. In my opinion, you should most likely negotiate an open mortgage if you are planning to sell your home in the near future (1-2 years). This is because from an open mortgage you can easily convert to closed mortgage without incurring any penalty.
Closed mortgage – The closed mortgage is a good choice if you don’t like unpredictability of market rates and you are risk averse. With closed mortgage you will get same payments throughout your term. In the case that the mortgage market rates fall in the future and you wish to break your mortgage to get new preferential rate you will be penalized for breaking your closed mortgage.
The types of mortgages
A.Conventional Mortgage – 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. For conventional mortgages you are required to have a downpayment minimum of 20% to qualify. With conventional mortgages you will not have to pay the CMHC premiums.
B.High-ratio Mortgage – You automatically fall into the high-ratio mortgage category when your downpayment is less than 20% of the value of the home. This means that you will require mortgage loan insurance offered by CMHC to cover the lender in case of default. In principle, it is easier for you to walk away from a property if you only put 0%-5% down than if you put 20% of the value of the property. This premium can be rolled in into your mortgage payments or paid in full on closing at the lawyer’s office. You may read about the CMHC insurance premium rates at How Much Does CMHC Mortgage Loan Insurance Cost?
C.Second Mortgage – second mortgages have a higher interest than first mortgages and a shorter amortization period. In principal, you can have as many mortgages as you like on your home as long as you qualify for them.
Rate of Interest
The interest is the true cost of borrowing and is payable to the lender forming a part of your monthly mortgage payments. Mortgage rates can be either fixed or variable (open variable or closed variable rates). The variable rate is set by the lender each month and is based on the prevailing market conditions.
Another option for a home owner is to establish a Home Equity Line of Credit (HELOC). HELOC is a large line of credit which is secured by borrower’s home as collateral. Most banks will extend this line of credit based on 80%-90% (depending on the lender) of your home’s appraised value. For example, four years ago you bought your home for $240,000 and due to the market conditions you know that your home has increased in value. To qualify for the line of credit you know that you need to build up 10%-20% (depending on your bank) of home equity. Home equity is the remaining amount of money which you would get if you sold your home and paid off all debts and closing disbursements. Assuming that you have this much home equity, you apply for HELOC, your bank sends their appraiser and the appraiser appraises your home at $295,000. Therefore, $295,000 - $240,000 = $ 55,000 this is part your home equity. In addition, for the past four years, you were making principal payments and you partly paid off your previous mortgage. Let’s say you paid off $40,000 in four years. This means you need $200,000 dollars for your line of credit (HELOC). This is because $240,000 was the purchase price of your home 4 years ago - $40,000 paid off principal in four years. Your home equity amount plus principal paid off amount equals $95,000. This means that if you were to sell your home right now or you defaulted and the bank was to foreclose on you, there would be $95,000 – disbursements. Therefore, $95,000/$295,000 appraised value of your home equals 32%. In this case, first bank’s condition is satisfied you have more than 20% of appraised value of your home which will be used as collateral for the line of credit (HELOC).
Second condition is that the bank will give you only a line of credit on 80%-90% OF THE APPRAISED VALUE OF YOUR HOME. Therefore, 80% of $295,000 is $236,000. Your new HELOC will be extended to you for $236,000 but remember that you only needed $200,000 to cover your mortgage? You pay off your previous mortgage with your line of credit and you have a remaining $36,000 of available credit. As you pay down your line of credit the availability of funds increases on dollar per dollar basis. The interest rates on the line of credit are usually bank’s prime, but due to current market conditions all you can hope for is prime + 1%. It is great to have a HELOC, if you have the 20% down. If the rates increase substantially over the years you can always lock in and you pay no penalty, since this is a line of credit.
Step 1. You can compare interest rate trends on the Bank of Canada’s website for the monthly Bank rates and the 5 year conventional monthly mortgages rates
Step 2. You can follow the Bank of Canada’s announcements. Mortgage interest rates fluctuations are usually a response to Bank of Canada’s interest rate announcements. A schedule of dates for Bank of Canada’s policy interest rate announcements is found here.
Step 3. A good source of information on the current mortgage fixed rates is Closed term fixed rates for different institutions You can usually observe changes on this website after each of the Bank of Canada announcements. The mortgage rates go up or down dependent on the economy’s outlook provided by Bank of Canada’s economists and analysts.
Sources of mortgage or who is my mortgagee/lender?
You can get your mortgage through these institutions directly or you can go to a mortgage broker who has relations with several institutions; banks, insurance companies, trust companies, caisses populaires, credit unions, finance companies, pension funds and private lenders.
You can use part of your RRSPs towards the purchase of a home (up to $25,000 per co-buyer). More information can be found at Canada Revenue Agency’s website under Home Buyers' Plan (HBP)
How do I qualify for a mortgage?
In order to qualify you for a mortgage, the lender or mortgage broker may ask for the following information:
1. Personal information – age, marital status, dependents.
2. Details of employment, including proof of income (T-4 slips, personal
income tax returns), letter from your employer stating your salary and position.
3. Other sources of income.
4. Current banking information including a Void Check.
5. Verification of your down payment.
6. Consent to run a credit investigation; you can investigate your own credit.
7. A list of assets, including property an vehicles.
8. A list of liabilities, credit card balances, car loans, other loans.
8. Fees for appraisal or copy of an appraisal done in the recent past.
10. Mortgage insurance fees.
11. A detailed property listing information.
12. A copy of Agreement of Purchase and Sale.
13. Any other information the lender might ask of you.
Please contact me at Main Page Contact: Tom Witek 613-314-1199 or OttawaPropertyShop@gmail.com to schedule an appointment during a time most convenient to you.