Mortgage Financing for Your Home – Your Options
Mortgage financing for your home – Getting approved for a mortgage is a crucial step in purchasing your first home, and there are several factors for choosing the most appropriate mortgage. While the multitude of financing options available for first-time homebuyers can seem overwhelming, taking the time to research and understand the basics of home financing can save you a lot of time and money.
When you buy a home, you may only be able to pay for part of the purchase price. The amount you pay is a down payment. To cover the remaining costs of the home purchase, you may need help from a lender. The loan you get from a lender to help pay for your home is a mortgage.
A mortgage is a legal contract between you and your lender. It specifies the details of your loan and it’s secured on a property, like a house or a condo.
With a secured loan, the lender has a legal right to take your property. They can do so if you don’t respect the conditions of your mortgage. This includes paying on time and maintaining your home.
Mortgage Financing Information
- your loan is secured by a property
- you may have a balance owing at the end of your contract
- you normally need to renew your contract multiple times until you finish paying your balance in full
- you may have to meet qualification requirements including passing a stress test
- you need a down payment
- you may need to break your contract and pay a penalty
- your loan is typically for an amount in the hundreds of thousands of dollars
When shopping for a new home even your Realtor will tell you getting a pre-approval is one of the best things you can do to simplify the process and give yourself a budget on how much you can spend on your new home. A pre-approval lets you know how much you are able to borrow. You basically go through the mortgage application process and your lender will give you a maximum lending amount and the required down payment. Beware as there is always the possibility in a hot real estate market bank lending policies may change, or the government may impose stricter guidelines for banks. ( such as the stress test )
Mortgage Financing – Stress Test
Canadian buyers who are applying for a mortgage from a federally-regulated lender are now required to undergo the OSFI Mortgage Stress Test, including those who put at least 20% as a down payment. This certainly affects homebuyer hopes, as their finances are even more closely scrutinized before gaining mortgage approval. Basically, borrowers are required to prove their ability to make mortgage payments, even in times when interest rates go up.
In order to pass the mortgage stress test, you’ll need to qualify at your contracted mortgage interest rate plus 2% or the Bank of Canada’s current five-year benchmark rate, whichever of the two is greater. As of this writing, the Bank of Canada’s five-year benchmark rate is 5.19% (which was lowered in mid-2019). For example, if you are applying for a mortgage at a rate of 3.65%, then your lender will assess you as if you were paying your home loan at 5.65% (3.65% + 2%) since 5.65% is greater than the Bank of Canada’s five-year benchmark rate.
Mortgage Financing – Types of Mortgages
A closed mortgage is a commitment with a pre-determined interest rate, over a pre-determined period of time. A buyer who uses a closed mortgage will likely have to pay the lender a penalty if the loan is fully paid before the end of the closed term. With a closed mortgage, the borrower may select a fixed rate or variable/adjustable rate depending upon their needs or preference. See “Rates” for more information on the types of rates.
Closed mortgages generally have lower interest rates than open mortgages. Most lenders will allow borrowers with closed mortgages to make a lump sum payment of up to 10, 15 or 20% of the original mortgage amount once a year without penalty. This payment goes directly toward paying down the principal of the amount owing. Many lenders will also allow a borrower to increase the mortgage payment by up to 10, 15 or 20% as well as allowing the lump sum payment.
Open mortgages will give you flexibility if you want to make large payments on your mortgage or pay off the entire mortgage without penalty, then an open mortgage is your best option. An open mortgage offers maximum flexibility. These homeowners are willing to accept some fluctuation in the interest rate for the flexibility of paying off part or the entire mortgage before the term is complete.
A convertible mortgage is an agreement made at the beginning of a term that allows homeowners to change the type of mortgage they hold during its term. If a homeowner wants to start with an open mortgage and then lock into a closed mortgage, a convertible mortgage is the right choice. It offers lower rates than an open mortgage and has the option of switching to a closed term. A conversion to a fixed rate mortgage can also be done by most lenders when the borrower has originally selected a variable rate mortgage and now wishes to move to a fixed rate before the end of the term.
Mortgage Lenders – A and B Lenders
When you’re shopping for a mortgage, there’s a lot of different lenders out there. “A lenders,” or traditional lenders, refer to banks and credit unions that cater to customers with good credit scores and a reliable income — these are considered an “A” clientele. The majority of people looking for mortgages have traditionally gone to these lenders.
Institutions servicing an “A” clientele include Canada’s major banks — e.g., BMO, CIBC, National Bank of Canada, Scotiabank, RBC, and TD. These banks are subject to federal regulation, which means that you’ll be stress tested when you apply for a mortgage.
There are more than six banks in Canada, obviously. Equitable Bank and Home Capital are examples of institutions that offer options for a “B” clientele.
These institutions offer a lower barrier of entry to qualifying for their products, but can offset that with higher interest rates. In short, they cater to people who may not qualify for say, a mortgage or a credit card at one of Canada’s six big banks, because they lack either a strong credit history, or a guaranteed income (recent immigrants, or the self employed, for instance).
But when it comes to mortgages, the deal might be worse. A mortgage is a loan that is given to you under specific conditions, and it’s necessary to take a good look at the conditions that B lenders are offering you to ensure that you won’t get trapped with high interest rates you can’t afford.
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