Buying a home usually involves arranging a mortgage. That means you borrow money to finance your new home, using the home as collateral or security for the loan. Mortgages have been around for centuries because they allow people to buy and sell real estate, even when purchasers don’t have enough money to pay for the property outright. Let’s look at the fundamental components that make up a mortgage.
The amount of money you need to borrow, usually the difference between the purchase price of the property and the down payment. As you repay the loan over time, the amount of principal declines.
The cost you pay to borrow money. The interest rate is usually expressed as an annual percentage rate, compounded semi-annually.
A regular installment, usually made up of principal and interest, by which you repay the mortgage over its term to maturity.
The actual number of years it will take to repay the entire mortgage, generally a period of up to 25 years. The longer the amortization, the lower your regular payments but the more interest you pay in the long run.
The length of time that a specific mortgage contract covers, generally between six months to ten years. When the term matures or expires, you generally renegotiate the remaining balance for another term at rates and conditions in effect at that time. Generally, the longer the term the higher the rate.
A closed mortgage term means that the interest rate is locked in or closed for the duration of the term. If you want to renegotiate the rate or payoff the balance before the end of the term, you will be subject to a prepayment penalty. Interest rates for closed fixed-rate mortgages are generally lower than for open fixed-rate mortgages. Closed mortgages are available in a range of terms from six months all the way up to twenty-five years. First-time homebuyers often choose five year fixed-rate terms, feeling more secure and comfortable knowing their payments and interest rate won’t change for at least five years.
Open mortgages offer greater flexibility than closed mortgages since they can be repaid either in part or in full at any time without a prepayment penalty. Open mortgages are good options for buyers who are planning to move again in the near future, are expecting to receive a sum of funds and they want to accelerate the pay down of their principal, or believe that interest rates will be moving downward. Interest rates for open mortgages are generally higher than for closed mortgages because of the added flexibility.
If you’d prefer the security of knowing exactly what your rate and payment will be, a fixed rate mortgage is a good option to consider. Especially if you’re comfortable with rates as low as they are now and you don’t want to continually watch or worry about which direction they are going. Fixed rate mortgages are available in open or closed terms.
Variable rate mortgages
A variable rate mortgage is a rate that is variable, or fluctuates according to the rate set by the Bank of Canada. If interest rates go down, more of the payment is applied to reduce the principal; if rates go up, more of the payment is applied to interest. Variable rate mortgages have become more popular because they provide the flexibility to take advantage of falling interest rates, offer a lower rate than a fixed-rate mortgage, combined with the ability to convert to a fixed term at any time with no additional cost.
Ensure that your lender offers you a generous combination of options to accelerate the pace at which you can pay down your mortgage without penalty. Lump sum prepayments, permanently increasing your mortgage payments, and the ability to make extra payments are powerful money saving options. Anything you pay over and above your regular payment amount will go directly towards your principal.
Match the frequency of your mortgage payments with the frequency of your pay periods. Not only is it easier to budget and manage your cash flow, but more frequent payments can take years off your amortization and save thousands of dollars in interest. Biweekly payments, for example, means you’ll make 26 payments in a year, equal to 13 monthly payments instead of 12. It is this “accelerated” pace of repayment that allows you to repay your principal faster, saving you money.
If you decide to sell your home, subject to geographic restrictions, portability allows you to transfer the terms, conditions, and interest rate of your existing mortgage to your next home. For example, this may allow you to keep a low interest rate and avoid paying a prepayment penalty if you sell one house and buy another.
An assumable mortgage allows any future buyer of your home to take over the balance of your mortgage if you sell your home, assuming all your obligations and releasing you from the mortgage. This can be a particularly attractive selling feature if your existing mortgage provides a better rate than is currently available at the time of sale.
There are lots of options and features available today that let you customize your mortgage to your own unique financial goals and objectives. There are two basic principles that should always guide your mortgage strategy. By following them, the equity in your home will grow more quickly and you’ll have more money to invest or spend elsewhere
What can you afford?
Pre-approvals are the place to start, even before house hunting. A lender approves a specific mortgage amount and interest rate, providing a written mortgage commitment or a certificate so you can feel confident with the price range of the potential purchase. You’ll have a clear picture of what you can realistically afford in terms of price, down payment, fees, and other expenses. Also, real estate agents will often serve you better because they know you are a serious and committed buyer.
In British Columbia, a pre-approved mortgage guarantees your interest rate for up to 120 days for the term you select, even if rates go up. If rates go down while you’re finding your dream home, you will receive the new lower rate. This protection could save you a substantial amount of money if interest rates are fluctuating while you are house hunting. Best of all, a pre-approved mortgage puts you under no obligation and is available to you at no cost.
In order to be pre-approved, all lenders will review three basic aspects of your personal finances. First, your income, which determines your ability to make monthly payments. Second are your savings, which allow you to make a down payment and cover the closing costs, and keep some cash reserves to cover unexpected expenses. Third is how you manage other credit, such as car loans and credit cards. Your strengths and weaknesses can be gauged by looking at these components relative to one another.
Documentation you can expect to provide:
· completed application form – includes personal information, income and employment history, and a financial net worth statement
· credit history authorization – a credit check is performed
· down payment confirmation – bank statements, RRSP’s, gift letter, etc…
· income confirmation – letter of employment, current pay stubs, notice of assessments, T4’s, tax returns for last 3 years if self -employed
Benefits of pre-approval to you include:
· know how much you can afford
· peace of mind with a rate guarantee of up to 120 days
· save money by customizing your mortgage options
· conveniently shop all of the major lending institutions
· no cost and no obligation to you
· expert advice on RRSP’s, CMHC, PPST, HBP, etc…
How much do I qualify for?
In order to determine how much of a mortgage payment you can afford, financial institutions normally use the following two guidelines: (GDS) and (TDS).
Gross Debt Service ratio (GDS)
Allocate up to a maximum of 32% of your gross annual income towards the repayment of principal and interest towards your mortgage, property taxes, and heating expenses.
Let’s look at an example. Suppose a young couple who both work are looking to buy a home in the Lower Mainland. Together they make $66,000 per year, or $5,500 per month. They want to know how much they could qualify for.
Monthly income $5,500
Maximum GDS 32%
Total housing payment $1,760 per month
Less property taxes (estimate) $150
Less heating (estimate) $50
Max. mortgage payment available $1,560
The total mortgage payment that they could qualify for based on their income of $5,500 per month is $1,560 per month.
Total Debt Service ratio (TDS)
Allocate up to a maximum of 40% of your gross annual salary for all credit payments – including mortgage, car loans, and credit card payments if applicable.
Monthly income $5,500
Maximum TDS 40%
Total for all debt payments $2,200 per month
Less housing payment (from GDS*) $1,760 *
Max. payment for all other debts $440
Our couple qualifies for a housing payment of $1,760 per month, as well as $440 per month to cover any other car loans, student loans, or credit card debt that they may already have. Remember – while they may qualify for a mortgage based on these guidelines, based on their lifestyles they may decide that these payments are just too much for them to comfortably handle.
Should you have a strong beacon score, many lenders will now allocate up to a maximum of 44% of your gross annual salary for all credit payments, including your mortgage.
Very few home buyers have the cash available to buy a home outright; most will need to borrow in the form of a mortgage. The down payment (or equity) is that portion of the purchase price that you provide from your own financial resources. Many people struggle with saving for a down payment and it still remains the single biggest obstacle to home ownership.
Add up all the savings that you have available – chequing and savings accounts, GIC’s, term deposits, stocks, bonds, mutual funds, and gifts from relatives. To qualify for a conventional mortgage, you need a down payment of 20% or more.
Home Buyers’ Plan
The federal Home Buyers’ Plan (HBP) is a program that allows you to withdraw up to $20,000 from your registered retirement savings plans (RRSP’s) to buy or build a qualifying home for yourself. You do not have to include eligible withdrawals in your income, and your RRSP issuer will not withhold tax on these amounts (i.e. no tax implications). You can withdraw a single amount or make a series of withdrawals throughout the same year, provided the total of your withdrawals is not more than $20,000. If you buy a qualifying home together with your spouse or other individuals, each of you can withdraw up to $20,000.
You have to repay all withdrawals to your RRSP’s within a period of no more than 15 years. Generally, you will have to repay an amount to your RRSP each year until you have repaid the amount you withdrew. If you do not repay the amount due for a year, it will be included in your income for the year.
How do I make a withdrawal?
You need to complete Form T1036 Request to Withdraw Funds from an RRSP, for each withdrawal that you make under the HBP. Forms are available from Canada Customs & Revenue Agency or from your RRSP issuer. After completing Area 1 of Form T1036, give it to your RRSP issuer for processing. You can only withdraw funds from an RRSP under which you are the annuitant (e.g. the owner).
If your spouse contributed to your RRSP, you are still the annuitant of the RRSP, even if your spouse deducted the contributions from his/her income. Some RRSP’s, such as locked-in or group RRSP’s, do not allow you to withdraw funds from them. Check with your RRSP issuer to find the status of your RRSP’s.
A number of conditions have to be met to participate in the HBP. While some conditions have to be met before you can withdraw funds from your RRSP’s, others apply when or after you receive the funds. Regardless of the situation, you are responsible for making sure that all HBP conditions are met. If at any time during your participation period a condition is not met, your withdrawal will not be considered an eligible withdrawal and it will have to be included in income for the year you received it.
What are the conditions for participating in the HBP?
1. You have to enter into a written agreement to buy or build a qualifying home;
2. You have to intend to occupy the qualifying home as your principal residence;
3. You have to be considered a first-time buyer;
4. Your HBP balance on January 1 of the year of withdrawal has to be zero;
5. Neither you or your spouse can own the qualifying home more than 30 days before the withdrawal is made;
6. You have to be a resident of Canada;
7. You have to complete Form T1036;
8. You have to receive all withdrawals in the same year;
9. You cannot receive more than $20,000;
10. You have to buy or build the qualifying home before October 1 of the year after the year of withdrawal.
Qualifying Home – A qualifying home is a housing unit located in Canada. Existing homes or homes under construction can be qualifying homes. Single-family homes, semidetached homes, townhouse, condo, mobile homes, and apartments all qualify. Some cooperative housing corporations also qualify.
First Time Home Buyer – You are considered a first time home buyer if you have not owned a home which you occupied as your principal residence in the last 5 years. If at the time of withdrawal you have a spouse, it is possible that only one of you will be considered a first-time home buyer.
Beginning in 2000, if you previously participated in the HBP, you may be able to do so again as long as you have repaid all of the amount you originally withdrew from your RRSP’s. In addition, you must meet all the other regular HBP conditions.
Canada Customs and Revenue Agency has a web site where you can download many useful publications including the Home Buyers’ Guide at www.ccra-adrc.gc.ca
Low Down Payment Mortgages (as low as 0%)
When you need a mortgage that is more than 80% of the purchase price of your home, mortgage loan insurance is required. In Canada, mortgage insurance is provided by either CMHC, a crown corporation, or Genworth, a large publicly traded U.S. corporation. Mortgage insurance protects the lender and, by law, most Canadian lending institutions require it. Having mortgage loan insurance means that if you, the borrower, default on your mortgage, the lender is paid back by the insurer. With the risk of losing their money removed, lenders have confidence to make mortgage loans up to 100% of the purchase price of the home (subject to price ceilings). That means your down payment can be as little as 0% of the purchase price of the home.
How much does it cost?
A premium will be charged and added onto your mortgage. The premium amounts depends on the amount of your mortgage in relation to your purchase price. The larger the down payment the less the premium. Although you are permitted to pay the premium up front, most borrowers pay it back over the life of their mortgage by including it with their monthly payments.
Down payment Premium
There are specialty mortgage products available that have higher premiums. One example is Business for Self Individuals. These premiums are slightly higher as the risk to the lender is also higher due to the lack of provable income.
Down payment Premium
Criteria for qualifying
1. The home must be in Canada and must be your principal residence.
2. You must be a Canadian Citizen or have Landed Immigrant Status
3. Your mortgage payment plus the monthly portion of your property taxes, heating costs, and strata fees (if it’s a condo or townhouse), must not exceed 32% of your gross monthly household income (GDS ratio).
4. Your total debt load (mortgage, car, credit cards, etc…) must not exceed 40% of your household income (TDS ratio). **Exceptions** with high credit scores.
5. At the time of application, you must show you have sufficient funds to cover your closing costs (at least 1.5% of your purchase price even if you don’t have to pay them).
6. Both new and resale homes are eligible. Other restrictions may apply and are subject to change.
Gift down payments are acceptable as long as they are from an immediate family member of the borrower. The money must be a genuine gift and does not ever have to be repaid, and in the borrower’s possession no later than 15 days prior to the closing date. No part of the gift can be provided by any third party having any interest (direct or indirect) in the sale of the subject property. Written confirmation signed by both the borrower and donor will be used to verify the authenticity of the gift. For more information, visit the following web sites www.cmhc-schl.gc.ca or www.gemortgage.ca
I have to pay closing costs too!
Over and above your down payment, there are always last-minute costs such as taxes, legal fees, appraisal fees, moving expenses, and house insurance to pay before you are finally a new homeowner.
These are known as “closing costs,” and there are some that you simply cannot avoid or lessen, as they are legally required and often fixed at a particular rate or charge. The time to budget for those “end” expenses is now. You must be prepared to pay most, and perhaps all, of the following costs.
Property Purchase Transfer Tax
The British Columbia provincial government imposes a Property Purchase Transfer Tax (PPTT) which must be paid when a property is legally transferred to a new owner. The tax is 1% on the first $200,000 of the property value and 2% on any value over $200,000. You may be exempt from paying this tax, however you still have to show the money as if it were to be paid.
Goods and Services Tax
If you are purchasing a new home, you may be subject to 5% GST on the purchase price. However, if the home is under $350,000, a rebate will reduce the GST paid to 4.48% of the purchase price. If the price is over $350,000, the net GST to be paid increases gradually until it is a full 5% at amounts over $450,000.
The transfer of property ownership from the seller to the buyer must be recorded in the Land Title Office. In British Columbia only a lawyer or notary can act on your behalf during the completion of your purchase. Legal fees for this service typically include a registration fee, disbursements, and a fee to prepare and register the mortgage documents.
Property Tax Adjustment
If the current owners have already paid the full year’s property taxes to the municipality, you will have to reimburse them for your share of the year’s taxes.
A property inspection includes a check of all the major components of a building – roof, foundation, insulation, plumbing, heating, and electrical systems are all properly tested and examined. Not only do inspectors catch things you may have missed, but they also provide a detailed, written inspection report.
Lending institutions require an appraisal of the property before giving you the mortgage funds, it will be your responsibility to pay the appraiser’s fee.
The lending institution may also require a survey certificate to formally establish the boundaries of the property and to ensure that all buildings are within those boundaries. If the current owner/seller cannot provide a recent survey certificate, it will be your responsibility to pay the surveyor’s fee.
Mortgage Broker fee
In most cases, BC mortgage brokers are paid a finder’s fee by the financial institution who is providing you with the mortgage funds. However, if you have had difficulty in qualifying for credit in the past, or unable to prove your income, there may be a Broker Fee charged.
Mortgage default insurance
A high ratio mortgage allows borrowing more than 80% of the purchase price of the new home. In most cases, the premium is added to the mortgage amount, however if you can pay the premium upfront, do so now – it could save you even more later.
Life and disability insurance
As you take on any new debt, you should always consider your insurance protection needs, especially if you have a young family. You could purchase protection from your lender, however in most cases you would be better off to speak to an insurance agent/broker.
The mortgage lender will insist that you purchase an insurance policy which guarantees that, in the event of fire, the lender will receive the balance owing on the mortgage before you receive any insurance proceeds.
Property Purchase Tax Exemption
When buying real estate in British Columbia, the government imposes a Property Purchase Tax based on the greater of the purchase price or the fair market value of the property. The tax is calculated at 1% of the first $200,000 and 2% of any remaining balance of the purchase price. The tax is usually collected at the lawyer’s office when you “close” your purchase and legally transfer title to your name.
You may qualify for a tax exemption (up to $3,500) if you, and the property you are purchasing, meet the following guidelines:
1. The maximum purchase price to qualify for the exemption in the Lower Mainland is $425,000. In all other areas of British Columbia, the maximum is $350,000.
2. You may never have previously owned an interest in your principal residence anywhere in the world. If only one client qualifies, then only their portion of the purchase will be eligible for the exemption.
3. Purchasers must be a Canadian Citizen or Landed Immigrant and have been a resident of British Columbia for at least 12 consecutive months immediately prior to the purchase.
4. The purchasers must occupy the property as their principal residence within 92 days of completion, and reside in the home for a minimum of one year.
5. Under certain circumstances, the purchase of raw land or a building lot may qualify.
Putting Together Your Team
You’ll want to have a team of professionals at your service when buying your first home. Here’s a guide to who they are and what they do. You decide exactly who is on your team, but there are a few professionals without whom buying a home is nearly impossible. Ask neighbours, friends, family members, and coworkers for referrals in putting together your team.
When it comes to making a major decision like financing your new home, mortgage brokers are qualified professionals who can help you sort through the maze of different options and features available in today’s mortgage marketplace. They compare different lenders, do all the paperwork, and negotiate the best rate on your behalf so you don’t have to.
When a home is put on the market, the vendor (seller) is generally responsible for any real estate commissions associated with the sale. Therefore, there are many advantages to you in seeking the assistance of a qualified realtor who has experience in the area you are house hunting. A good realtor will make the home-buying process easier, helping you avoid common pitfalls and making sure you get the best value for your money. Be sure to find a real estate agent who is interested in giving great service – as defined by you the client.
A property inspection includes a check of the roof, foundation, insulation, beams, gutters, bricks, siding, and caulking of the building you are considering buying. The plumbing, heating and electrical systems should all be tested and fully examined.
Not only do inspectors catch things you may have missed, but they also provide a
detailed, written inspection report which includes an estimated cost for specific repairs and maintenance if applicable. The offer you make to the vendor should always be conditional on a satisfactory inspection. If you discover any serious defects you should renegotiate your offer or suspend negotiations altogether by withdrawing your offer.
An appraisal includes an unbiased assessment of the property’s physical and functional characteristics, an analysis of recent comparable sales and an assessment of current market conditions affecting the property. Most mortgage lenders require an appraisal to be completed prior to you receiving your mortgage funds. An appraisal report provides you with an expert second opinion as to the property’s market value, which may or may not match your purchase price.
Hiring a lawyer is the best way to ensure that your legal interests are being protected when you buy your new home. Your lawyer will review any documentation you need to sign, and perform the necessary searches to clear title from the seller so that the property can be duly registered in your name. A few days before closing, you will visit your lawyer’s office to sign the closing documents. The lawyer collects the mortgage funds from your lender, and together with your certified cheque for the remaining balance, disburses the funds to all relevant parties. At this point, you become the legal owner of the property and usually within a few days you get the keys to your new house – the possession date.
An insurance agent or broker can provide you with all your insurance needs, including property insurance and life and disability protection. Lenders insist you purchase fire insurance because your property is their collateral or security for the money they lent you. Property insurance covers the replacement cost of your home, and premiums vary depending on your coverage amounts, deductibles, and the value of your home. Life and disability insurance is offered by most lenders, but unlike fire insurance coverage, you are not required to purchase it. It may be easy and convenient to do so, but often it’s more expensive and less flexible than it could be. If you are a nonsmoker with no history of health ailments, private insurance coverage through an insurance broker is less expensive, and offers better coverage for you and your loved ones.