Mortgage ABCs – A Beginner’s Guide To Mortgages
Few adventures in life can match up to the excitement of buying a new house; the smell of your new furniture, the stains of fresh paint and how the whole atmosphere becomes livelier because of exciting new possibilities.
However, before you set out on this journey, you need to know a bit more about mortgages.
While the term itself has gotten a bad reputation ever since the financial crisis of 2008, it is essential to understand what it means and what it can mean for your future residence.
What Does It All Mean?
Mortgage, in simple terms, means the total amount borrowed for a house or any place of residence.
It’s basically a loan for a house.
The financial jargon for this term can be broken down through various key definitions:
This refers to the period until the payment for your mortgage is up for renewal. In Canada, this is usually 1 year, 2 year, 3 years, 4 years or 5 years. At the end of each term, you must renegotiate (renew) your mortgage rate and terms. ‘Renewal’ essentially means ‘re-negotiate’ – at this point you can actually take your mortgage to a different lender if you like.
This refers to the total time over which you must pay off the mortgage. In Canada this is typically 25 years, 30 years or 35 years. You can do things to speed up the payment though – and pay off your mortgage faster.
This kind of mortgage refers to one where the person must pay the same interest rate for the rest of the term. It means that the principal payment paid per month and the interest payment paid for the month does not change. You can find more about the particulars of this option here: fixed-rate mortgage.
Variable Rate Mortgage
Also called an Adjustable Rate Mortgage (ARM), this kind of mortgage refers to one where the rate of interest depends on movements in the central interest rates, set by the banks – called the ‘Prime Rate’. The monthly payment can then either decrease or increase depending on the changes to the ‘Prime Rate’.
Qualifying For A Mortgage
Once you have decided the plan for your home buying options, it important to make sure that you are eligible for a mortgage that can cover the cost.
The following factors come into play when determining a person’s eligibility for a mortgage:
- The current income of the person(s) applying since it impacts your ability to pay back the loan. A lender is looking for a steady source of income, to ensure that you don’t default (stop paying) the mortgage. Lenders check income through income verification, letters of employment, reviewing financials – and so on.
- The credit score of the person(s) applying – since this typically measures the likelihood of you paying back the loan. It is based on past repayments of loans, the time at which it was paid back, the amount not given back, etc. The rating ranges from various degrees with under 600 being considered a ‘bad’ credit score, 600-700 being considered ‘average’ and above 700 being considered ‘good’. You can check your credit score at Experian or one of the other credit bureaus in Canada.
- The value, location and type of property you’re buying – this is crucial to the lender because this is the collateral you will be offering them if you default on your mortgage payments. This leads to the lender not agreeing to any amount more than the appraisal value of the house since any losses over and above will have to be suffered by the lender alone then, which sometimes can become a hindrance in you getting your desired house.
How Much Can You Afford?
Once you fit the bill for the mortgage, the next step is also to determine how much can you afford?
There are two ways to think about this question.
The first part is dealt from the lender’s perspective, who has to make “affordability” calculations using specific formulas based on income and debt. The bulk of this calculation will be based on your expenses and income levels; the lender not only needs to determine whether you can cover the initial charge but also your ability to do so in the future.
The second part of the question has more to do with your ability, willingness and risk-tolerance. You could push your mortgage to the very maximum level that you possibly can. But then you might end up ‘house poor’ – where all your money is going into your house each month.
So, sometimes it is a wise idea to not take the full amount that a lender tells you that you can afford.
Mortgage Down-Payments In Canada
The minimum legal requirement in Canada is to put in at least 5% for your mortgage.
It means for a house costing $350,000 you must put forward at least $17,500 initially as the down payment in cash, and the remainder will be paid through the mortgage repayment schedule.
However, it is advisable to put in 20% or more because not only does this prevent you from having to pay the mortgage insurance, but also you have a more significant financial stake in the house which leads to lower monthly repayments.
Mortgage insurance in Canada is mandatory for anyone not putting 20% as a down-payment – it can be as much as a 2-5% additional cost on your home.
For a $500,000 property that’s $10,000-$25,000 more that you have to pay for your home! For this reason, it is highly recommended to put 20% down minimum if you have it.
Your Next Steps
There are dozens of lenders in Canada who will give you a mortgage – at various rates, terms and with different levels of hidden costs.
For this reason, we highly recommend that you speak to a mortgage broker – who will know the ins and outs of the dozens of products available and will make sure that you don’t get ripped off. We highly recommend our partners at GTA Mortgage Pros.
Getting the right mortgage deal is something that not only ensures you get to have your dream house but also how your financial situation pans out in the future. Conclusively, educating yourself about mortgages is a responsibility you owe yourself and your future home.
At GTA Real Estate Pros, we make sure that you have all the expect advice and help you need when buying a home – including proper mortgage help.
We hope you enjoyed this introduction to mortgages – please leave a comment below with any questions you may have.