Mortgage Primer
Introduction
Unless you have enough cash to buy a property you will need to borrow the difference between the downpayment/deposit and the cost of the property.
This loan is called a mortgage. A lender will give you a loan in exchange for a garantee that you will pay back the loan plus interest. If you fail to pay, the lender has the right to sell the property to recover the amount of the mortage, interest and their costs in recovering these. In order to feel safe about extending a credit to you, lenders expect a buyer to put down 25% of the price of the home as a deposit/downpayment. This way if things go wrong the lenders will not be at risk of loosing the money they lent you because the property and the downpayment are worth more than the mortgage and if they have to sell the property they will get enough to cover mortgage, interest, and costs. A mortgage that is exetended with a 25% downpayment is called a normal mortgage. You can get a mortgage with as little as 5% down but this cost you more because of higher interest rates and insurance costs. These are called high ratio mortgages
Downpayment
The downpayment can come from your savings, gifts from family, wedding loot, or from cashing some of your RRSP.
Home Buyers Plan allows you to take up to 20,000 out of your RRSP to put towards a downpayment, you eventually have to repay this money but it gives you ready cash for home purchase.
Vendors and lenders like to see a large deposit/downpayment. It reassures them that you are serious about purchasing the home.
A deposit is a sum that is presented to the vendor along with the offer to purchase. A downpayment might be only the amount of the deposit or it might have other money added when the deal closes, and the mortgage is finally negotiated.
In a normal mortgage (with 25% or more down) you are in a position to negotiate the best interest rates and can shop around to various financial institutions. Competition is fierce so don't hesitate to get more than one quote.
There is no upward limit on how large a downpayment can be.
A deposit can be presented as a cheque or preferably a certified cheque. Cash is not as acceptable since any large cash transaction must be reported. This is to avoid money laundering.
How much can you borrow?
Lending institutions have devised two formulas to analyse your financial situation and determine how much they are willing to lend you. GROSS DEBT SERVICE RATIO (GDS) and TOTAL DEBT DEBT SERVICE RATIO (TDS).
For the GDS formula, a lender will total your estimated mortgage payment, property taxes and sometimes the heating costs of the home. They will then compare this total to the income that will be used to pay the mortgage. They arrive at a ratio of housing costs against total income. For most lenders this ratio can be up to 32% of your gross monthly household income. This means that your housing costs cannot add up to more than about a third of your total income.
Lenders also consider your existing debts. Too many other debts will make it hard for you to pay your mortgage. To gauge whether your debt load will still allow you to pay them back, lenders use a total debt-service ratio formula.
Your housing costs (estimated mortgage payment plus property taxes), heating costs and all the debt payments you make in a month are added up. This will include any line of credit payments, car loans and credit card payments. This total is compared to your gross income. Lenders expect the ratio of total debt to total income to be no larger than about 40%.
Some lenders will lend mortgage money with higher ratios on individual basis. This is usually negotiated with mortgage brokers and the money comes from private investors. Interest rates are usuallly higher. Estimate how much you can borrow with Nick's Maximum Mortgage Calculator
Credit Rating
Another factor in obtaining a mortgage is your credit rating. This is a rating based on your financial history. It helps the lender judge if you can be trusted to pay back a loan. Every time you borrow money including your credit card, or get a student loan, a note is made and a record is kept of the repayment. If you repaid as scheduled or, if you had problems, kept in touch with the lender and paid as best you can, then you are considered trustworthy, if you had to be chased for repaiment, you are not considered as trustworthy, and have a less satisfactory credit rating.
If you have not borrowed money in the past and have no history with your lender, and you are not putting alot of money on a downpayment lenders might be nervous about lending you money. It might be necessary to get a co-signer.
The GDS and TDS calculation above figure out if HOW MUCH the lender thinks you can afford to borrow, the credit rating assesses the LIKELYHOOD you will pay back your mortgage based on your past history.
Lower downpayements
It is possible to obtain a mortgage if you put down less than 25% down. In that case, you are required to pay insurance on the difference between a regular mortgage (at 25% downpayment and 75% mortgage) and whatever you are getting. The Lenders are then willing to lend up to 95% of the home cost. CMHC Canadian Mortgage Housing Corporation provides the insurance. They are also a good source of information for homebuyers.
No downpayment
It is also possible to buy a home with no downpayment at all. In this case the lending institution offers a mortgage that includes the downpayment and the mortgage is insured as well. The insurance premiums are included in the mortgage. These mortgages usually have a higher interest rate and are subject to more stringent requirements. Mortgages with less than 25% down are referred to as high-ratio mortgages.
It is sometimes possible to take over a mortgage existing on a property, or to get the seller to extend you credit in the form of a mortgage.
Lenders will give you a mortgage but can you afford it?
Even though the lenders formulas determine the amount of money you can afford to borrow, it may not be a very comfortable situation for you. You should carefully assess how much you are willing to devote to purchasing and maintaining a home. The bank formulas do not take into consideration your lifestyle, maintainance on the building or any other extras.
Purchasing Costs
There are many costs associated with purchasing a home and maintaining it that are not included in the calculations. For more information have a look at ( http://www.cmhc-schl.gc.ca/en/co/buho/hostst/wosh_007.cfm? ) CMHC's costs calculator, please copy and paste address into your browser.
Planning to buy or sell Immediately? Contact Nick Boothby
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