Everything You Need To Know About Mortgages
Mortgages Explained - From A To Z
What is a mortgage? A mortgage is made up of two parts: principal and interest. Principal is the actual amount borrowed. Interest is the lender's fee you are charged for borrowing. You'll have to decide on an amortization period (the length of time it will take to completely pay off the mortgage) and the term, or length of time each mortgage agreement guarantees the interest rate. Before you go to a financial institution or mortgage broker, keep in mind that there are many mortgage options available. Shop around for the best rates and the best terms. Negotiate. Everyone wants your business, but it's up to you to look after your interests. Of course, the key thing to remember is to negotiate a mortgage that fits into your lifestyle, and doesn't take over your life! Your mortgage broker can help guide you through this process and supply you with information.
Obtaining a Pre-Approved Mortgage
Pre-Approved Mortgage Features to Look For:
Applying - When applying for a mortgage, provide prospective lenders with enough information about your work history, debts and assets. They're looking at the state of your personal finances. They will look at your gross income and potential mortgage payments and property tax expenses to come up with a Gross Debt Service ratio (GDS). This is usually limited to 30-35% of your gross income. To that lenders will add all other debts to come up with a Total Debt Service ratio (TDS), which can't exceed more than 40 percent of your gross earnings.
What Lenders Look For - Lenders are looking at the risk factors from two points. First, will you be able to make your scheduled monthly payments? Second, if you default (don't make your payments) can the financial institution get enough money from the sale of the house to repay the loan?
Approval Process - You'll be asked about your net worth, the difference between the value of everything you own and the amount you owe. Lenders take into account your bank balance, any types of investments, other real estate, cars and boats, other loans, credit card balances and many other things. Remember to be as specific as possible. So if you have a coin, significant stamp or art collection, have it appraised! Your credit rating is your history of loan repayment and will be used by lenders as an indicator of your ability to repay your mortgage. It covers how you've managed past debts or if you've filed for bankruptcy. You'll be asked to sign a form allowing your financial institution to gather information from your employer, creditors and credit rating agencies.
If you've had credit problems, it may be a good idea to check and clean them up before you apply for a mortgage. You can check your own credit rating by contacting a company that compiles the information. The two companies that take sure of credit are: Trans Union and Equifax. They both have websites or you can check for their contact numbers in the yellow pages. Although your credit may not be perfect, it does not mean you are unable to purchase a home. Make sure you talk to a mortgage broker about your situation before you give up on your dream. Even if you can't buy now, your mortgage broker can help you re-establish your credit so that one day you will be able to live your dream of owning a home.
Types of Mortgages:
Conventional and High Ratio Mortgages - To qualify for a conventional mortgage, you simply have to have a 25% down payment of the purchase price, with the mortgage not exceeding 75% of the appraised value. If your down payment is less than 25%, then you qualify for a high-ratio mortgage. This type of mortgage requires loan insurance, which can cost an additional 0.5% to 3.75% of the mortgage amount. With this type of mortgage you could also be limited to a maximum house price. You’ll be paying those extra fees to the insurer – either Canada Mortgage and Housing Corporation (CMHC) and GE Capital Mortgage Insurance Canada (GEMI).
Second Mortgage - Of course, you may need to consider a second mortgage to be able to get the funding to obtain the house you desire. Each mortgage uses your home as security and gives the mortgagee the right to take your home if you default on your loan. The first mortgagee gets paid first in cases of default and has the best chance of recovering all of its money. So it only goes to figure that a second mortgage will have a higher interest rate.
Assuming an Existing Mortgage - Say the seller of the home you want has a dynamite mortgage – meaning the rate is low. By assuming the existing mortgage, you may be able to save on the usual mortgage fees such as appraisal and legal fees. You'll save time, since you don't have to negotiate to arrange financing from another lender and the existing mortgage on the home may be less than the current market rates. Unless otherwise specified, you'll still have to qualify with the lender first!
Seller Take Back - With an STB, the Seller also becomes a lender, holding all or some of the mortgage. Sometimes the seller will offer this loan at lower than bank rates.
Prepayment - This is a wonderful option if you receive regular bonuses or if your income fluctuates throughout the year. With a pre-payment privilege, you have the right to make payments toward the principal portion of your mortgage over and above the monthly payments. A mortgage with a pre-payment option is closed. An open mortgage means you can pay the entire principal sum without notice of bonus.
Portability - If you still have time remaining on that fantastic loan you negotiated, portability is one option you'll want to discuss with your lender. Quite simply, it means transferring the balance of your current mortgage at the existing rates and with the existing terms and conditions, to your new home.
Expandability - If you need additional funds down the road, will your mortgage terms allow you to increase the principal amount? Usually, your new rate will be a blended amount of the initial mortgage rate and the prevailing rates. It's a great option to discuss with your lender if you foresee large expenses in your future like renovation or education
Interest Rate - Quite simply, interest is the cost of borrowing money. There are two types of rate structures: fixed and variable.
Choosing Security or Flexibility - Mortgages are available with closed, open and convertible options, with fixed or variable rates. The options you choose will reflect your beliefs about the market -- is it going up or down? -- and your short-term goals and desire for long-term security.
Two Rate Styles of Mortgage to Choose From:
A fixed-rate mortgage will remain the same for the length of the negotiated term. Your payment schedule is established in advance. You can choose either an open or closed mortgage, depending on the term. If you are going to need a high-ratio mortgage, the mortgage broker may require that you take a longer term mortgage (usually, at least 3 years) so you don't get into trouble if rates rise in the short term. The mortgage will always be closed but with privileges. Often mortgages only come in two terms; 6 months and one year. Both are generally at higher rates than a closed contract for the same time period.
A variable-rate mortgage fluctuates with the prevailing market cycles. Your monthly payment will remain constant (usually for a year or two), but the amount allocated to your principal will vary. If the market trend is toward lower rates, this may be a good option. If rates are rising, you may choose to convert to a fixed-rate mortgage. But if you're on a tight budget, you may not like the feeling of uncertainty. You may be willing to pay more for peace of mind.
Three Payment Styles to Choose From:
Open Mortgage - This type of mortgage offers a great deal of flexibility, as it can be repaid in part or full at any time without penalty. This is a great mortgage if you believe interest rates are moving down or if you plan to move in the near future. The term may be limited to six months or one year.
Closed Mortgage - Here the interest rate is fixed for the full term of the mortgage, and you will have to pay a penalty to change the agreement conditions. This type of mortgage is ideal for buyers who suspect that interest rates will rise and who are not planning to move in the near future. This type of mortgage is usually available in a wide variety of terms.
Convertible Mortgage - With this mortgage, you'll enjoy the same peace of mind as a closed mortgage, plus the flexibility to convert to a longer closed mortgage at any time without penalty. If you think rates will drop, this will allow you to wait until you feel they have hit bottom, or if rates rise, you can lock in.
Mortgage Term - Over the course of your amortization period, you may have many different mortgages. The term is simply the length of time that interest rates, payment schedules and obligations to the lender exist. When the term comes to a close, you will have the option to renew your mortgage (taking into account current market conditions) at your current or new lending institution. You can also put a lump sum toward the principal without restriction, or pay off your entire mortgage without penalty. If you wish to change the structure of your agreement during the term you may have to pay a substantial fee to the lender.
Amortization - This is the amount of time over which the entire debt will be repaid. Most mortgages are amortized over 15-, 20-, or 25-year periods. The longer the amortization, the lower your scheduled mortgage payments, but the more interest you pay in the long run.
There Are Ways to Reduce Your Interest Payments:
1) Negotiate a shorter amortization period. (That's the number of years over which you'll pay off the total amount of the mortgage. Don't confuse this with the term of the mortgage, which can run from 6 months to 10 years and must be renegotiated.) A shorter amortization period will mean higher monthly payments, but you'll be paying more principal with each payment. Consider this:
2) Accelerating your payments. Opt for a weekly or biweekly payment schedule. More payments per month mean less overall interest.
3) Put lump sum payments toward your principal. When negotiating your mortgage, ask how frequently you can make a lump sum contribution. Most financial institutions allow a percentage of your overall mortgage to be contributed on your annual mortgage anniversary date. Depending on the type of mortgage you select, you may also be able to negotiate additional monthly, or even weekly, payments. These payments will rocket you toward mortgage freedom.
Before you calculate the amount of your down payment and determine what you can afford, it's a good idea to set aside a few thousand dollars to cover the extra costs that seem to spring out of nowhere. Here is an overview of costs you could encounter. The good news is that not all of them will apply.
Mortgage Loan Insurance Premium and Application Fee - Mortgage loan insurance will be necessary if you have a high-ratio mortgage (less that 25% down payment). The application usually costs $75 with a valid appraisal, otherwise it's $235. The actual insurance premium will range from .5% to 2.9% of the purchase price and is added onto the mortgage.
Mortgage Loan Insurance - As a first-time home buyer, chances are, you're not walking into your deal with a huge down payment. As you may have already discovered in other areas of the site, you can purchase a home with as little as 10% down, or even a 5% down payment if you qualify with CMHC's First Home Loan Insurance. Bottom line, if your down payment is less than 25% of the value of the home, you must purchase mortgage loan insurance. In Canada, most lenders are legally required to insure these high risk mortgages. This insurance means that if you default on your mortgage, your lender receives their money from the Canadian Mortgage and Housing Corporation (CMHC) or other insurer. And it's coverage like this that gives most lenders the confidence to finance up to 90% of your purchase.
What Does it Cost? The actual premium of the loan ranges between 0.5% and 2.9%, and is based on the size of the loan and value of your home. You can make your premium in two ways: as a lump sum when you make your purchase or as part of your monthly mortgage payments. But keep in mind, if you're paying it monthly, you're also paying interest on the premium!
CMHC First Home Loan Insurance - This is a special product for first-time purchasers. It allows you to mortgage up to 95% of the value of your home. Any type of home is eligible, as long as it meets the following criteria:
All housing payments - mortgage principal and interest, property taxes, heating (and if applicable, 50% of your condominium fees) can't total to more than 32% of your gross household income, or be more than 40% of your entire debt load.
So there you have it – mortgages demystified!
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