What is a mortgage?
A mortgage is a loan you get from a bank, credit union, or private lender to help you buy property like a house or a condo in Toronto.
In this Chapter of our First-Time Buyer's Guide, we'll cover just about everything you need to know about mortgages from when to apply for one, how you pay the loan back, the deal with interest rates, the difference between fixed and variable rates, and how to work with mortgage brokers.
When should I get pre-approved for a mortgage?
It’s a smart move to get pre-approved for a mortgage once you feel you are ready to start your search to buy a condo. A mortgage pre-approval is when a potential lender like a bank or a credit union looks over all your finances and calculates the maximum loan you are able to afford and what interest rate they will charge you. A mortgage pre-approval helps you set your budget.
Getting pre-approved will tell you the maximum mortgage you can afford. Let’s say you were pre-approved for a $600,000 mortgage, that’s your maximum budget. So if you have a $120,000 down payment you could buy a $720,000 condo because you’d be taking out a $600,000 mortgage. But you shouldn’t do that.
There’s no guarantee you’ll receive your full pre-approval when mortgage time comes, and you don’t want to max out your finances anyway, so it’s smart to search for condos below your maximum mortgage amount. Run your numbers. The mortgage is just one of the costs of buying a condo.
Getting a mortgage pre-approval is a great way to start your search for a condo, because you can lock in your pre-approved rate for up to 120 days. If you don’t get a mortgage pre-approval, you’ll have to qualify for a mortgage once you find what you want to buy.
Two KEY mortgage terms you need to know
The amortization period:
This is a fancy way of saying how many years it will take to pay off your mortgage. Most amortization periods are 20, 25 or 30 years. Longer periods have lower monthly payments but you pay more interest over time.
The mortgage renewal period:
When you get a mortgage you also set a renewal period. Usually that's between 1 and 5 years, but it can be up to 10. When it ends you renew your mortage - you re-borrow the outstanding amount, set a new renewal period and choose a fixed rate or variable interest rate. You can also choose a new lender at this time. But heads-up! Renewals are subject to a Stress Test if you change.
What are interest rates?
A mortgage is a loan, and interest is the extra money you pay on that loan. An interest rate is the percentage of extra money you pay on your mortgage term. You don't pay that rate for the whole mortgage, just for a period of time - the mortage term . If your mortgage has a variable-rate, your interest rate can go up or down. If your mortgage is fixed, your interest rates stays the same. We cover them shortly.
If you're buying property in Canada, there are three interest rates to watch:
1) The Bank of Canada (BoC) interest rate (commonly called the overnight rate, key rate, or benchmark rate)
2) A Bank or lender’s Prime Rate - usually a few points higher than the benchmark rate
3) Mortgage Rate - whatever you negotiate and/or qualify for
The Bank of Canada changes the benchmark rate to influence and moderate the economy. Canada’s banks lend and borrow money at the BoC's rate.
Each Canadian bank sets its own Prime Rate. A bank’s Prime Rate sets the benchmark for its lending rates (not just mortgages). Canada’s five main banks tend to have a similar Prime Rate.
When the BoC policy rate goes up, banks tend to increase their Prime Rate, which could increase their available mortgage rates. A variable-rate mortgage will rise and fall in-step with the bank’s Prime Rate. A fixed-rate mortgage will be affected by changes in the bank’s Prime Rate when the mortgage comes up for renewal.
Variable vs Fixed interest rate mortgages
Fixed-rate mortgage:
A fixed-rate mortgage is a predictable choice because your monthly payment will always be the same for the length of your mortgage term. The downside is that fixed-rate mortgages often have higher interest rates which mean higher monthly mortgage payments.
Variable-rate mortgage:
A variable-rate mortgage can change (the interest rate can go up or down) based on the Bank of Canada's base rate (see above). "Variables", as they are called, offer a lower interest rate in exchange for more risk.
Choosing between a Variable or Fixed-Rate Mortgage
To make a good choice as a first-time buyer you should have a financial planner and mortgage broker paint a picture of your finances, employement, credit and what you want in the future. They should speak to what might happen with interest rates and how risk-tolerant you are. Good, informed decisions here can save you tens of thousands of dollars.
The Mortgage Approval Process
First, check your credit score and history. Lenders look at it closely. Bad credit can make it hard to rent an apartment and to get a mortgage. The lender could require you to have a cosigner with better credit, approve you for a lower amount than you’re hoping for, require a much larger down payment, or deny your application outright.
Your lender will need to look over your financial assets, your income, and your debt.
They usually want to see:
• Personal identification
• Letter of employment
• Past pay stubs or proof of your income
• If you’re self-employed or work-remotely as a freelancer, you can provide Notices of Assessments from the Canada Revenue Agency
• Credit card balances and limits
• Car payment records
• Lines of credit
• Student loans
When you meet with your lender for the pre-approval, ask them tons of questions. For instance, ask them how long they guarantee the pre-approved rate, can the pre-approval be extended, and will the guaranteed rate go down if interest rates go down.
Qualifying for a mortgage
Qualifying for a mortgage is essentially the same process as the pre-approval. The difference is you're asking for a specific amount of money -- the price of the condo or house you want to buy, less your down payment. The mortgage lender will look at the same documents, as well as the value of the property, to determine your total monthly costs and how much mortgage you can afford and if they are willing to lend you that money.
If you are qualifying for a mortgage with a government-regulated lender, like one of Canada’s big five banks, you will have to pass the mortgage stress test. For a look at how you might qualify, here’s a nifty mortgage calculator tool.
The mortgage stress test explained
The mortgage stress test was introduced to reduce the number of buyers who wouldn't be able to pay their mortgages if interest rates went up. Banks now 'test' new mortgage applications by qualifying them at a higher interest rate than the rate of the actual mortgage. To put it simply, they see if you could afford monthly higher payments.
The rate that banks use for the stress test is either:
- The Bank of Canada’s five-year fixed mortgage rate
OR - The rate negotiated with the lender + 2 basis points
The higher of these two rates is what the mortgage is tested at.
Here's an example:
We'll assume that the Bank of Canada’s five-year mortgage rate is 5.00%. Person X negotiated a mortage rate of 2.89%. The stress test would add 2 basis points to their rate, which would put them at 4.89%. That's lower than 5%, so they'd be tested (qualified) at the Bank of Canada’s rate. The higher rate is the tested rate.
Avoiding the mortgage stress test
The stress-test used to affect only buyers with less than 20% down payment, but now every buyer who gets a mortgage from a federally-regulated body needs to pass the stress test. Credit unions and some other lenders do not stress test. Before you make this decision, speak with a mortgage broker and explore your options. You'll get a better rate, avoid the stress test if you need to and will qualify for a higher mortgage.
Attend one of our First-Time Buyer Seminars to chat with a mortgage broker or financial consultant.
Should I get a mortgage from my bank or a credit union?
You can get a mortgage from several types of lenders, from government regulated banks to private credit unions. Each lender will offer different interest rates and conditions on repaying the loan, so it’s smart to explore a variety of lender options before making a decision.
One thing to note is that only government regulated mortgage lenders are subject to the federal stress-test. Private lenders may choose to put you through the stress test, but it is possible to find a private lender they will waive the stress test.
No matter what lender you choose, your down payment will be a big factor in your interest rate and the size of the mortgage you take on. If your down payment is less than 20% of the purchase price, you will have to buy mortgage loan insurance.
What is mortgage insurance?
Mortgage loan insurance is a way that banks and lenders protect themselves in case you can’t make your monthly payments. If you’re buying a condo and you have less than a 20% down payment, you have to buy mortgage loan insurance. You can purchase mortgage loan insurance through the Canadian Mortgage and Housing Corporation (CMHC). More on mortgage insurance here.
How do mortgage brokers work?
Mortgage brokers work with a variety of lenders to find you the best mortgage possible. The mortgage options they have access to might be more customized based on their relationship with the lenders, more tailored to your needs, and offer competitive interest rates.
At the end of the day, however, you are still getting your mortgage from the lender. The mortgage broker is just helping you do it.
Mortgage brokers typically offer their services for free to buyers, and then they receive a commission from the lender after they successfully set up a deal.
How do I pay my mortgage?
Most mortgages are paid monthly, like a phone bill. Each month, you pay a chunk of the original loan amount. You pay the interest first so that the lender's risk is reduced. You want to make sure you are paying enough each month to be chipping away at the principal amount and not just paying off the interest.
Can I pay my mortgage early or at least faster?
Lenders make money off the interest they charge on your mortgage, so they actually don’t want you to pay your mortgage early or faster. In your mortgage contract, you can negotiate repayment privileges allowing you to pay more than your monthly amount, but you can face repayment penalties if you pay off too much at once.
One strategy to pay off your mortgage faster and save money on interest is to negotiate for bi-weekly mortgage payments. To learn more about this strategy, speak with a mortgage broker about accelerated payments.
Can I break my mortgage contract?
You want to fully understand the terms and conditions of your mortgage agreement. If you find that your mortgage is no longer the best mortgage option out there for you, you can break your contract. You might do this if interest rates changed significantly, let’s say.
When you break your mortgage, you would either renegotiate your mortgage terms with the same lender, and fees may apply, or you could switch to a different lender. Keep in mind, however, there may be a penalty for switching to a different mortgage lender. Most often your current lender will hit you with repayment penalties.
And that's everything you need to know about mortgages (well, probably not, but almost)!
In the next chapter, we cover the rent vs buy debate and how to save for a down payment. To learn more about mortgages, we'd recommend speaking to a professional mortgage broker (attending a Condos.ca First-Time Buyer Seminar) or making an apointment with your bank to discuss getting a pre-approval.
Onwards, hopeful homebuyer!
