Your guide to mortgages
You’re probably already familiar with the fundamental concept of obtaining a loan to become a homeowner. But in reality a mortgage is a rather complex marathon of financial calculations, comparing offers, and various approval stages.
In this article we’ll explore mortgages in depth, and in simple, comprehensible terms. We’ll go over the mortgage process from start to finish, where to look for the best rates, and the vocabulary you’ll need along the way.
What is a mortgage?
A mortgage is a loan that can be used to purchase property, which in turn acts as security for the loan. A mortgage tends to be for a large sum and is usually paid off over 25 or 30 years.
When you sign up for a mortgage, you’re agreeing to make regular payments. These mortgage payments are comprised of both principal and interest. When a payment is made, it’s first used to cover the interest, then the principal. A mortgage lets the mortgage lender take possession of the property should you fail to make the agreed-upon payments on time.
The mortgage process
Once you’ve decided you’d like to buy a home, the next step is to figure out how to pay for it. Unfortunately, most of us don’t have the cash saved up to buy a home outright. That’s where a mortgage comes in handy.
Before searching for a property, it’s a good idea to get pre-approved for a mortgage. When you’re pre-approved, you’ll know exactly how much you can afford to spend on a home. You also reduce your risk since you’re a lot less likely to make an offer on a home you can’t afford. (I’ll talk about the pre-approval process in greater detail later on.)
Once you’re pre-approved for a mortgage, you can go shopping for a home. It’s helpful to make a list of needs and wants. That way you can objectively look at each home when deciding if it’s right for you.
Once you find a home you like, you’ll put in an offer. Once your offer is accepted, you’ll work with your banker or mortgage broker to get the mortgage approval. You’ll need to provide documents and information. The lender will then sign off on everything if they’re good and you can remove condition of financing from your offer (if applicable).
How do you know it’s time to get a mortgage?
When is a good time to buy a home and take out a mortgage? A good time is when you’re personally and financially ready. That means you have a steady job, you’re settled in your personal life, and you’re committed to staying put in the same place for the next five or 10 years.
When applying for a mortgage, the lender wants to make sure you can afford it on a monthly basis. The lender does this with two debt ratios: the Gross Debt Service (GDS) Ratio and the Total Debt Service (TDS) Ratio.
The GDS Ratio looks at the percentage of your gross monthly income needed to cover expenses related to the home: your mortgage payments, property taxes, heating and maintenance fees (if applicable). Most lenders are looking for a GDS Ratio below 39%.
The TDS Ratio is similar to the GDS Ratio. It looks at all the same things as the GDS Ratio, however, it also factors in any other debt that you might have. If it’s revolving debt, such as credit card debt or a line of credit, 3% of the outstanding balance is usually used for debt servicing purposes. If it’s an installment loan with a fixed payment (i.e., a car loan, car lease, or personal loan), the payment is used for debt servicing purposes. Most lenders are looking for a TDS Ratio below 44%.
It should be noted that the mortgage payments used in these calculations are higher than you’re actually paying. That’s because the payments are calculated using the inflated stress test rate (currently at 5.25%).
While the GDS and TDS Ratios include some important homeownership expenses, it’s important to also factor in any other big expenses you may have, such as childcare expenses.
Where can I get a mortgage?
There are several routes you can take when hunting for a mortgage, including going to a bank or credit union, or working with a mortgage broker.
Bank mortgages and credit union mortgages
As you shop for a mortgage, your gut instinct is probably to go to your local bank branch where you have your chequing account. Banks offer a suite of products and it might be convenient for you to hold all your important finances in the same place. And some banks will offer you extra perks for bundling your mortgage with another product.
That said, if you simply get a mortgage with the existing bank you use for chequing and savings, you might miss out on a more competitive rate that’s offered elsewhere. The mortgage market is very dynamic and it’s always a good idea to shop around. I recommend also checking out the mortgage rates offered by virtual banks (sometimes referred to as ‘direct banks’). Virtual banks don’t have physical branches, and their substantially lower overhead costs typically allow them to offer more competitive mortgage deals than traditional banks, particularly for long-term, fixed-rate mortgages.
Virtual banks will also sometimes offer bundling deals, so even if you don’t bank with a brick-and-mortar institution, there are still mortgage deals for you to jump on.
Mortgage broker
Another way to shop around is through a mortgage broker. An independent mortgage broker has access to dozens of lenders and can provide you with unbiased advice. Even if you end up choosing your local bank branch in the end, at least you’ll have peace of mind knowing you got a good deal.
Online mortgage broker
The benefit of an online mortgage broker is that they likely have access to many more lenders than your local broker would. The more options you have, the more flexibility you get. With multiple lender options, you’re also likely to find a better rate. Not only that, but if you’ve been denied a mortgage from your bank in the past, you can still search for one through online mortgage brokers.
Homewise is a digital mortgage solution that helps you find the best mortgage options from over 30 banks and lenders. You’ll get support from a personal advisor at every step of the way, including understanding the fine print of your offers. The service is free and the process is done online, 24/7, in all of five minutes.
Breezeful is an online mortgage broker that makes it quick and painless to shop around for different lenders. With an online database of over 30 lenders, Breezeful works to match you with one that best suits your particular needs. You’ll get some of the lowest rates possible, all from the comfort of your own home and faster than your normal, brick-and-mortar banks.
Important mortgage terms to know
Mortgage Pre-Qualification: This is ideal when you’re only thinking about buying a home. A lender will collect basic information about your finances and then give you an approximate figure for how much they’d potentially be willing to lend you to buy a property.
Mortgage Pre-Approval: Getting pre-approved for a mortgage is more formal than pre-qualifying. In this stage a lender will verify the financial information you provide them and run a credit check. If you’re pre-approved it indicates that the lender is committed to providing you with a loan, though the final amount they’re willing to lend you and the terms of the mortgage are subject to change based on an actual property valuation as well as market fluctuations.
The Mortgage Stress Test: This is a calculation of whether you can still afford to pay your mortgage in the event that rates increase. The results of this stress test will determine your qualifications for the mortgage you’re looking to take and applies to all home buyers, including those who make a 20% down payment on their home.
Down Payment: This is the amount of money you’re required to pay upfront when buying real estate. The bigger your down payment, the smaller the mortgage you’ll need. The size of your down payment depends on the purchase price of your home. For example, if you spend less than $500,000 on a home, you’re only required to put 5% of the purchase price down.
Mortgage Rate: This is the interest rate you’ll pay on your mortgage. This will determine how much you pay in interest over the life of your mortgage. Your mortgage rate may change depending on if it’s fixed or variable (more on that below).
Closing Costs: These are expenses that you’re required to pay out of pocket leading up to your closing date. Examples of closing costs include real estate lawyer fees, land transfer taxes, a home inspection, and movers. It’s a good idea to budget between 1.5% and 4% of a home’s purchase price towards closing costs.
Test your mortgage knowledge
What is the average new mortgage loan amount in Canada (as of Q1 2023)?
Different types of mortgages
Insured, insurable, and uninsurable
There are three main types of mortgages: insured, insurable, and uninsurable.
An insured or high-ratio mortgage is when you’re required to pay mortgage default insurance that protects the lender. Because of that, most lenders offer their lowest mortgage rates on these products (although this is offset by the mortgage default insurance you’ll pay).
An insurable or conventional mortgage is when you make at least a 20% down payment on a home. In this case, you aren’t required to pay mortgage insurance. This saves you money, but because it’s slightly riskier for lenders you’ll most often pay a higher mortgage rate than an insured mortgage.
An uninsured mortgage is a mortgage that doesn’t meet the government’s guidelines to be insured by any of the mortgage insurers. Examples include home purchases over $1 million and 30-year amortizations. Because of this, uninsurable mortgages tend to come with the highest mortgage rate.
Mortgage term vs. mortgage amortization
A mortgage term is the length of time the terms and conditions of your mortgage are guaranteed. If you have a fixed-rate mortgage, your mortgage rate will remain the same for the duration of the time.
The mortgage amortization is how long it will take you to pay off your mortgage in full. The standard length in Canada is 25 years, although there’s nothing stopping you from choosing a shorter or longer term (as long as you can pass the stress test).
Open mortgage vs. closed mortgage
An open mortgage lets you repay the mortgage in full at any point during your mortgage term. Because of this, it tends to come with a higher mortgage rate. Open mortgages only tend to make sense if you expect a huge cash windfall or intend to sell your home in the near future.
A closed mortgage has limitations on how much extra money you can put towards your mortgage beyond your regular mortgage payments. Because of that it tends to come with a lower mortgage rate than an open mortgage.
Fixed mortgage vs. variable mortgage
With a fixed-rate mortgage, your mortgage rate and payment amount remain the same during your mortgage term. With a variable rate mortgage, your mortgage rate and payment may change during your mortgage term depending on changes in a lender’s prime rate.
Fixed mortgages tend to come with a higher mortgage rate than variable mortgages since you’re paying for the stability of knowing exactly what your mortgage rate and payment will be.
What do lenders look at when approving you for a mortgage?
Lenders consider several factors when deciding whether to approve your mortgage application. They look at your income, down payment, assets, debts, credit, and the property itself.
Income
Lenders are looking for borrowers with a stable source of income. You’ll need to be able to prove that your income is sufficient to regularly make mortgage payments. If you’re a full-time salaried employee, you’ll be golden in the eyes of most lenders. If you’re an hourly employee whose hours are guaranteed, lenders like that as well. If you’re a full-time or part-time hourly employee whose hours are not guaranteed or you’re working on contract, you’ll typically need two years of income in order for a lender to consider your income (lenders will do a two-year average). For proof of income, you’ll usually need to provide a letter of employment, recent paystub, T4s, and notices of assessment for the last two years.
If you’re self-employed usually you can still get a mortgage, however, you’ll need to provide more documentation. Since the income from your own business is less stable than a full-time salaried position in the eyes of lenders, typically you’ll need to be in business for a minimum of two years and provide Personal T1 Generals, Notices of Assessment and Corporate Financial Statements (if applicable) for the two most recent years.
Down payment
If the down payment funds are from a bank account, the lender will usually want to see a 90-day transaction history. If the funds are from investments or withdrawn from RRSPs, you’ll usually need to provide three monthly statements. If it’s from the sale of another property, you’ll usually need to provide a copy of the signed purchase agreement and a recent mortgage statement (if the property you’ve sold already has a mortgage). If you’re receiving gifted funds, the lender will usually request a signed gift letter and want to see proof that the funds have been transferred to your bank account.
Assets
You’ll need to provide the lender with a summary of your assets, including chequing accounts, savings accounts, TFSAs, RRSPs, non-registered accounts, and vehicles. Although assets aren’t included in the calculation of your debt ratios, having substantial assets proves to the lender that you’re a responsible borrower. Imagine if someone has been earning $200,000 a year for 10 years, but doesn’t have any assets at all. It would raise a red flag with lenders. Has the borrower been spending every penny that they earn?
Debts and credit
Debts and credit are related to each other. A lender looks at the types of credit you have, considers the outstanding balances and the payment status and also considers your credit score and credit history when evaluating you as a borrower. This information is found on a borrower’s credit report, which a lender must obtain your written permission to access.
A lender is generally looking for a borrower with a credit score above 670 or 680 with no late or delinquent payments. However, if you have late payments, or, in some cases, if you’ve filed for bankruptcy or a consumer proposal, you may still be able to get a mortgage. A lender will usually want to know the reason why you have a credit blemish. If it’s due to life circumstances outside your control (e.g. you got sick or were laid off from work and fell behind on bills) and you can prove you’re a responsible borrower otherwise, you may still be able to get a mortgage.
The property
The last thing lenders consider is the property itself. This is done by way of an appraisal. Depending on the property and where it’s located, some lenders may use an automated valuation model (AVM) to determine the value of your property. (This is when a lender doesn’t need to visit your property to determine its value.) Other lenders may request a full appraisal. The property appraisal confirms the property is worth what you paid for it. It also lets the lender know the condition of the property.
What to consider when shopping for a mortgage
While the mortgage rate certainly matters when shopping for a mortgage, it shouldn’t be the only factor you consider.
Are you going to break your mortgage?
When you sign up for a mortgage, breaking it is probably the last thing on your mind. But a lot can happen during the standard, five-year mortgage term. If you think there’s a chance you might need to break your mortgage during your mortgage term, it’s a good idea to go with a lender and mortgage type with a lower mortgage penalty. Variable rate mortgages tend to have lower penalties than fixed rate.
How will you be penalized if you break your mortgage?
If you end up breaking your mortgage during your mortgage term to buy a new home, you may be able to avoid mortgage penalties by porting your mortgage. Porting your mortgage means moving your mortgage with you to the new property. Some lenders have more flexible portability policies than others. One lender may only give you 30 days to port your mortgage, whereas another gives you 90 days. You’ll want to ask a lender about the specifics of its portability policy if that’s important to you.
What about prepayments?
If you want to aggressively pay down your mortgage, prepayments are a must. Prepayments generally come in three forms: regular payment increases, doubling up, and lump-sum payments. Not all lenders offer the same prepayments. For example, one lender might only let you make 10% lump-sum payments and increase your mortgage payment by 10% per year, while another may let you make 15% lump-sum payments and increase your payment by 15% per year. By choosing the lender with the right prepayments for you, you can pay down your mortgage at the pace you want without incurring a penalty for making too many extra payments.
Final word
As you can see, there are a lot more things to consider when shopping for a mortgage than just the mortgage rate.
The mortgage process can be stressful, but it doesn’t have to be. After reading this article you should be better prepared the next time you apply for a mortgage. By knowing exactly what mortgage lenders will be looking at, where you should look and what you should expect, the process will go a lot smoother.
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