Home ownership may be the biggest investment you’ll ever make, so it’s important to do your homework and take your time.
What You Need to Know:
- Home ownership is a big decision. It’s important to do your homework and take your time when deciding on a mortgage.
- Shop around for the mortgage that best meets your needs and make sure you understand the terms of the mortgage contract.
Buying a home is an important financial commitment. Home ownership may be the biggest investment you’ll ever make, so it’s important to do your homework and take your time. There’s a lot to think about when choosing a mortgage including the size of the mortgage, the down payment you’ll make, amortization period (the amount of time you’ll take to pay off your mortgage), the term of the mortgage and whether you’re most comfortable with a fixed or variable rate of interest. Banks provide consumers with the information they need to make these decisions and answer their questions throughout the term of the mortgage.
When shopping for a mortgage, keep your goals and needs in mind. There are different types of mortgages available and many interest rate options.
Types of Mortgages
- Open vs. closed mortgage – An open mortgage allows you to pay off as much of your debt as you wish, whenever you want, without being charged a prepayment charge. This option allows for flexibility, but interest rates are usually higher on open mortgages. Closed mortgages have a set term and fixed conditions. With a closed mortgage, you may be able to make some prepayments each year without charge, and, for agreeing to keep the mortgage for the full term, you may get a more favorable interest rate
- Conventional vs. collateral charge mortgage – A conventional mortgage means that your lender registers your mortgage for the actual amount of the mortgage loan – the amount you borrow.
For example, if you require a mortgage loan of $250,000 to buy a home, the lender will register the conventional charge for $250,000.
With a collateral mortgage, the lender may register the mortgage for the actual amount of the mortgage loan or for an amount that is greater than the actual amount of the mortgage loan.
For example, if you require a mortgage loan of $250,000 to buy a home, a collateral charge may be registered for $300,000.
By registering the charge for an amount that is higher than the actual loan, at a future time you may be able to borrow additional funds through other loans or other credit agreements without additional registration or mortgage discharge costs and any legal costs may be lower.
- Reverse mortgages – Designed for seniors who currently own a home, a reverse mortgage allows you to access up to 55 per cent of the equity in your home without selling it. You don’t make any payments on a reverse mortgage, but the interest on your reverse mortgage accumulates and the loan and accumulated interest are payable when you sell the house or it’s no longer your principal residence. The Financial Consumer Agency of Canada has more information about reverse mortgages on its website at www.canada.ca/fcac.
Interest Rate Considerations
- Interest is the amount added to what you have borrowed to compensate the lender for the use of its money. It is shown as an annual interest rate percentage. Interest is usually paid to the lender in regular payments along with the repayment of the principal (loan amount).
- Fixed rate vs. variable rate – A fixed rate mortgage has a set interest rate for the term of the mortgage; the rate does not fluctuate with market changes. With a variable rate mortgage, the interest rate is influenced by an external rate of interest, typically the Bank of Canada’s Overnight Rate.
About Mortgage Loan Insurance Rules
Bank mortgages with less than a 20 per cent down payment, known as high-ratio mortgages, are required by law to be insured against default. If you default on your mortgage and are not able to make your mortgage payments, mortgage loan insurance pays back the mortgage lender. Mortgage loan insurance requires the payment of a premium, which is usually added to the amount of your mortgage or can be paid in full when you buy the property.
Currently, mortgage loan insurance is only available for homes under $1 million. For a purchase price of $500,000 or less, the minimum down payment is 5%. For purchases above $500,000, the minimum down payment is 5% for the first $500,000 and 10% for the remaining portion.
Qualifying for a Mortgage
For insured mortgages, the homebuyer needs to qualify for the loan at the greater of the negotiated rate in the mortgage contract or the Bank of Canada’s five-year benchmark rate.
For uninsured mortgages (i.e. with a 20 per cent down payment or more), borrowers will need to prove that they can afford payments based on the greater of the Bank of Canada’s five-year benchmark rate or their contract mortgage rate plus two percentage points.
These minimum qualifying rates are meant to ensure homebuyers can still manage their mortgage payments should interest rates rise.
Home Buyers Plan (HBP) - This plan allows first-time home buyers to withdraw up to $35,000 per person from their Registered Retirement Savings Plans (RRSP), without tax liability, to buy a home in Canada. You don’t have to start paying back your RRSP until two years after the purchase of the home. Before cashing in your RRSP to buy a home, weigh the pros and cons carefully. To be eligible for the HBP:
- You need a written agreement to buy or build a home
- You intend to occupy the home as your principal residence
- You are a first time homebuyer
- Your HBP balance on January 1 of the year you withdraw has to be zero
To find out more about this program, contact the Canada Revenue Agency.
First-Time Home Buyers Incentive Program (FTHBI) – This plan allows first-time home buyers looking for an insured mortgage to apply for a shared-equity mortgage (similar to an interest-free loan, but where the government shares in the upside and downside of the property value) of 5% or 10% from the Canada Mortgage and Housing Corporation (CHMC). You can repay the Incentive at any time in full without a pre-payment penalty. You have to repay the Incentive after 25 years or if the property is sold, whichever happens first. To be eligible for the FTHBI:
- you need to have the minimum down payment (5%) to be eligible
- your maximum qualifying income is no more than $120,000
- your total borrowing is limited to 4 times the qualifying income
To find out more about this program visit: https://www.placetocallhome.ca/fthbi/first-time-homebuyer-incentive.
Renewing Your Mortgage
Mortgage contracts have a set term and when that term is over, you’ll have the opportunity to renew and refinance your mortgage contract (or pay it off).
If your existing mortgage is with a federally-regulated financial institution (such as a bank), they are required to mail you a renewal notice at least 21 days prior to the end of your term. This is your opportunity to shop around for the mortgage that best suits you.
Breaking Your Mortgage Contract and Understanding Prepayment Charges
If you have a closed mortgage and decide to break your mortgage contract before the end of the term, it’s important to understand that you may be charged a prepayment charge that compensates the lender for the costs it incurs to reinvest the funds.
When you sign a mortgage agreement, you are signing a contract with the lender agreeing to pay the amount borrowed at a specified interest rate over the term, or duration, of your mortgage.
There are different reasons why you may want to break the mortgage contract:
- you sell your home
- you choose to renegotiate your mortgage to take advantage of lower interest rates
- you have an opportunity to pay off your mortgage in full early, before the term ends
Information about the prepayment charge is outlined in your mortgage agreement and is typically:
- the greater of three months’ interest, or
- the interest rate differential (IRD). The IRD is the difference between the interest rate on your mortgage contract compared to the rate at which the lending institution can re-lend the money for the remaining term of your mortgage.
Banks’ commitment to providing enhanced information about mortgages ensures that you have access to information and explanations about prepayment charges. Your mortgage agreement will tell you how prepayment charges are calculated for your mortgage and will give you a formula to estimate what your prepayment charge would be. For a more exact estimate, call your lender. Please note that any estimate that your lender provides is only accurate at that time. A day or a week later, the variables used to calculate that estimate could change. For example, interest rates could change or the remaining term of the mortgage could be different. These changes affect the amount of the prepayment charge.
Paying Off Your Mortgage
The mortgage amortization period is the number of years it takes to repay the mortgage and interest in full. If your mortgage amortization period is 25 years, it will take 25 years to pay off your mortgage. The longer the amortization period, the more you pay in interest. Here are some factors you’ll want to keep in mind:
- A higher down payment will mean you’ll borrow less money overall.
- Consider the frequency of your mortgage payments. Paying weekly or biweekly instead of monthly can mean you pay less in interest over time.
- Consider increasing your payment amounts. By doing so, you can reduce the length of the amortization period and pay less interest.
- Some mortgages have annual prepayment privileges allowing you to pay a lump sum on your principal without any prepayment charges.
- Consider choosing the shortest possible amortization period you can manage to shorten the amount of time you take to pay off the loan.
Banks in Canada provide a wealth of information for consumers on home buying and mortgages. Visit their websites to learn more.