Understanding Mortgages

One of the first steps in buying a new home or real estate property is to take a realistic look at what you can afford and how you are going to pay for it. If you are like most people, you will probably have to finance your home purchase with a mortgage loan.

What is a Mortgage?

A mortgage is a loan that uses the home you buy as security. This loan is registered as a legal document against the title of your real estate property. Here’s a quick overview of some of the most common aspects of a home mortgage that you need to understand.
- The principal is the amount of the home loan, or the cash actually borrowed.
- The interest is the amount the lender bank charges for the use of the funds, or principal. Interest rates vary according to many factors including terms and conditions of the real estate mortgage. Mortgage payments are applied towards both principal and interest.
- The amortization period is the actual number of years that it will take to repay the entire mortgage loan in full. This normally ranges from 15 to 25 years.
- The term is the length of time for which a mortgage real estate agreement exists between you and the bank lender. Typically, terms range between six months and seven years.
- The maturity date marks the end of the term, when you can either repay the balance of the principal or renegotiate the mortgage at the current interest rates.
- Options let you tailor the real estate mortgage to fit your personal needs and circumstances. Open or closed mortgages, pre-payment options, fixed or variable rates or home portable mortgages are just a few of the available options.

Types of Mortgages

There are two basic types of home mortgages:
- Conventional Mortgage: The loan amount does not exceed 75% of the real estate property value, defined as the lesser of the purchase price or the appraised value.
- High-Ratio Mortgage, or National Housing Act Mortgage: The amount is more than 75% of the real estate property value (up to 95%). By law, a high-ratio real estate home mortgage must be insured against borrower default. The home borrower pays a mortgage insurance premium (a percentage of the total loan amount) which can be added to the mortgage loan or paid in a lump sum in advance. The borrower must also pay an insurance application fee.

How much can you afford to spend on a new home?

The amount of money you can afford to spend for a new home is determined by two factors:
- Your Downpayment. This is the amount of money you have available from your own assets. You need a minimum of 5% of the total purchase price as a downpayment for your real estate property.

A larger downpayment means lower mortgage payments or, even better, that you can pay off the mortgage faster, thereby saving thousands of dollars in interest payments. Or you may be able to buy in a higher price range, if you qualify. (Be careful, though, not to stretch your budget to the limit, and to set enough money aside to cover the other expenses of buying a home or property investment).

First time home buyers can use their RRSPs towards a downpayment and closing costs. Under the federal government’s Home Buyer’s Plan, first-time buyers can borrow up to $20,000 tax-free ($40,000 for couples) from their RRSP savings. The funds must be repaid within 15 years, but you don’t have to begin repayments for two years.

- Your ability to carry mortgage debt. Bank lenders use a simple two-step method to determine the real estate mortgage amount that you can comfortably pay back on your income. As a rule, you can usen o more than 32$ of gross income on monthly paymnents to cover principal, interest, property taxes and heating (PITH) and possibly condominium fees, or 40% of your gross income on all financial obligations. The latter could include car payments, credit card instalments and other payments in addition to the “shelter” costs listed earlier.

Once your maximum monthly payment towards “shelter costs” has been established, it is easy to determine the size of loan you can handle, depending on interest rates and amortization periods.

Be Aware of the Total Costs

When you calculate how much it will cost to buy a home or property and how much you can afford, don’t forget to consider the additional costs that you may encounter. Ask your real estate builder and the sales representative for detailed estimates, and consult with your lender and lawyer for further information.

Get Pre-Approval

It is a good idea to have your bank financing in place before you begin looking for your real estate property or home. That way you can negotiate arrangements with your real estate builder in full confidence and without delay.

A pre-approved mortgage is preliminary approval by the bank lender for a mortgage up to a certain amount, usually with a guaranteed rate for a specified number of days (90 days and sometimes longer). If interest rates go down during that period, you will get the benefit of the lower rate. If they go up, your rate stays locked in.

Pre-approved mortgage financing is simple to arrange, costs nothing and does not obligate you to go ahead with the bank loan, if you choose not to. The final mortgage amount and terms will be determined once you have reached a final agreement with your real estate builder.

Information provided courtesy of the Canadian Home Builders’ Association. For more information, visit CHBA online at www.chba.ca.

For more condominium mortgage tips and home buyer checklists for pre-construction condos, click here.

Home Financing Fundamentals

Written by Kelly Wharton for the Dec 08, 2006 – Jan 05, 2007 edition of the New Home Buyers Guide for Vancouver. The real estate market is hot and so is the competition for your home mortgage business. “The past six months have seen an incredible increase in the new products and options that lenders offer,” says Joanne Thomas, a mortgage broker with Centum Capital Group Inc.

There is so much information swirling around on home financing that the thrill of buying your new house – especially your first one – can quickly be replaced with a money headache. This article will help you focus on the fundamentals of financing your new home purchase and explore some of the newest products out there.

Don’t let the down payment get you down

Issue number one on your mind will probably be the down payment. A bank or other financial institution will lend you a significant portion of the purchase price of your real estate deal. The lender secures this loan by registering a mortgage against the title of your house. “The down payment amount is calculated on the purchase price of the house only, so the home mortgage does not usually cover closing costs like taxes and survey, appraisal and lawyer’s fees,” cautions Sheree Rankin, a Royal Bank mortgage specialist. So don’t forget these additional transaction costs in your savings plan, especially Goods and Services Tax if the house or real estate property is a new or substantially renovated, and the provincial property transfer tax or PTT calculated on the value of the house. First time home buyers may be exempt from the PTT if the value of the house is under $325,000.

In a normal or conventional home mortgage loan, you will need to save 25% of the purchase price. If you have less than the 25% down payment, you may qualify for a high ratio mortgage. These home mortgage loans require as little as 5% of the purchase price down since the lender is insured against the risk of default by mortgage insurers like the Canada Mortgage and Housing Corporation (CMHC). The premium for this home insurance – which is a percentage of the amount financed – is usually added to the home mortgage amount.

Whether you are getting a conventional or high ratio house mortgage, first time real estate home buyers can use up to $20,000 of their registered retirement savings plans (RRSPs) toward the down payment. This is a Canada Revenue Agency program called the Home Buyers’ Plan or HBP. It allows withdrawals from your RRSP to buy or build your home by October of the year following the year you withdraw the money. The withdrawn amount is not taxed and if you are buying with your spouse or partner, each of you can withdraw up to the $20,000. You can use RRSP contributions made up to 89 days before the withdrawal and still claim your current RRSP contribution as a deduction. You have to repay the withdrawn amount over a period of 15 years beginning two years after withdrawal. To find out if you qualify for the HBP, visit the website at www.cra.arc.gc.ca/tax/individuals.topics/rrsp/hbp.

In this new competitive world it is possible to finance 100% of your new house price with no down payment. First National offers this type of insured mortgage. Joanne Thomas reminds us that good things come at a cost, “The insurance rates associated with these types of home mortgages are higher than for other high ratio loans.”

Freedom 25…Or 35… Or 40

Once your real estate down payment is settled, you will know how much you need to borrow or the principal amount of your house mortgage. Your focus can turn to establishing a repayment schedule that is comfortable for you. The factors that determine the monthly payment amounts are the amortization period, interest rate and principal amount. The amortization period is the number of years it will take to actually repay the mortgage loan plus interest. The common length of time was 25 years but some lenders are now using 30, 35 and even 40 year amortization periods to calculate repayment amounts. The greater the amortization period, the smaller the monthly payments, but the longer you have the debt.

The total length of a home mortgage loan on your real estate property will be made up of several terms, the period of time the lenders will agree to lend you the principal with interest. Once the term is up, you can renegotiate your home mortgage for a renewal term or repay the loan.

Cracking the Nut

The annual cost of borrowing the principal or the interest rate will also affect your monthly payments. Each of the different real estate mortgage terms – usually between six months and five years – will carry with it an applicable interest rate and certain restrictions. Depending on your taste for risk, or your ability to read crystal balls, you can chose a mortgage loan that is variable (the interest rate changes with a lender’s prime rate) or fixed (the rate stays the same for the term), open (you can prepay the loan during the term without penalty) or closed (no prepayments or with a penalty).

Some new options may help you cope with the monthly mortgage nut for your real estate property. First National has an interest only mortgage which means you pay only the interest on the principal for a period of up to 10 years. The cost for this product is a higher insurance premium and you need a 10% down payment.

Lenders also advertise cash back mortgages which give you a percentage of the loan back in cash. A higher interest rate is the price tag for these types or mortgages. Planning the financing of your new home or real estate investment ahead of time by focusing on essential issues will mean exchanging headaches for homeowner bliss.

The Facts and Breakdown of Mortgages and Pre-Approval for Mortgages

Another useful article written for the New Home Buyers Guide (HomeBase.ca magazine in the Lower Mainland), this breakdown goes through the different types of mortgages available on the market these days for home buyers, first time purchasers and how to get the best pre-approval for your home buying situation and how to secure your mortgages with banks. Originally presented in the December 08, 2006 to January 05, 2007 edition of the New Home Buyers Guide, you can read more about current real estate developments and mortgage bank information online at the www.homebase.ca HomeBase website today.

There is no such thing as “just a mortgage” these days. Today’s home owners have a special needs and widely varied financial circumstances. Because of this, there are numerous types of mortgages, mortgage pre-approvals and bank payment options designed to meet the unique requirements of every home owner. In addition to the HomeBase.ca definitions, we have also include the Real Estate Board of Greater Vancouver mortgage definitions too. The fundamental components of a bank mortgage wherever you live include:

Mortgage Principal
The amount of money you need to borrow, usually the difference between the selling price of the real estate property and the down payment. The bank mortgage is the amount initially borrowed or the portion still owing on the mortgage. Interest is calculated on the principal amount.

Interest
The amount you will pay for borrowing money for your principal real estate amount.

Mortgage Payment
A regular instalment, usually made up of principal and interest, by which you repay the mortgage over its term to maturity.

Amortization Period
The actual number of years it will take you to repay the entire mortgage, generally a period anywhere between fifteen and twenty five years. A table showing the amounts of principal and of interest comprising each level payment due at regular intervals and the outstanding principal balance of the loan after each level payment is made.

Amortized Mortgage
A bank mortgage requiring periodic payments which include both a partial repayment of the debt and interest on the outstanding balance.

Mortgage Term
The length of time which a specific mortgage agreement covers generally being between six month and twenty years (although twenty five year terms have recently been introduced). When the term matures or expires, the balance of the mortgage is generally renegotiated for another term at prevailing rates and conditions in effect at that time.

Home Equity
The value of the real estate property over and above all claims, generally being the different between market value and the outstanding principal of all mortgages relating to the property. Essentially the difference between the price of which a real estate property can be sold and the mortgage(s) on the property. Home equity is the owner’s stake in the property.

Conventional Mortgage
A mortgage loan that is seventy five per cent or less of the loan to value ratio; and does not require insurance by CMHC or other private insurer.

Debt Service Ratio
The percentage of a borrower’s income that can be sued for housing costs.

Gross Deb Service (GDS) Ratio
The amount that a lender will permit a borrower to use from his/her gross income in order to qualify for a loan for housing costs, including mortgage payment and taxes (and condominium fees, when applicable).

Total Debt Service (TDS) Ratio
The maximum percentage of a borrower’s income that a lender will consider for all debt repayment (other loans and credit cards, ect.) including a mortgage.

High-Ratio Mortgage
A bank mortgage that exceeds seventy five percent of the loan to value ratio; must be insured by either the Canada Mortgage and Housing Corporation (in Canada also known as CMHC) or a private insurer (in the United States and Canada) to protect the lender against default by the borrower who has less equity invested in the property.

Mortgage Insurance
Government backed or private-backed insurance protecting the lender against the borrower’s default on high-ratio (and other types of) mortgages.

Open Mortgage
A mortgage that can be prepaid or renegotiated at any time and in any amount, without penalty.

Variable Rate Mortgage
A bank mortgage for which payments are fixed, but whose interest rate changes in relationship to fluctuating market interest rates. If mortgage rates go up, a larger portion of th epyament goes to interest. If the rate goes down, a larger portion of the payment is applied to the principal.

These definitions and information on mortgages is brought to you by HomeBase.ca and the Real Estate Board of Greater Vancouver.