Navigating the mortgage process for the first time can be daunting, but with the right information, you can make informed decisions and secure the best mortgage for your needs. This guide will help you understand key terms, how to qualify, where to get mortgages, what they cover, and important considerations.
The information provided in this guide is for general informational purposes only and should not be considered financial or mortgage advice. For personalized advice and detailed information about mortgages, please consult with a qualified mortgage professional.
1. Key Terms
There are many terms that are key to understanding the mortgage process, requirements and what is expected of you. Here is a summary:Â
- Insured Mortgage/ High Ratio Mortgage: A high ratio mortgage is a mortgage loan where the borrower has a down payment of less than 20% of the purchase price. Because of the higher risk associated with a smaller down payment, these mortgages are insured to protect the lender in case of default. The insurance premium, which is a percentage of the mortgage amount, is added to the mortgage balance and paid over the loan’s term. This insurance is usually provided by agencies like the Canada Mortgage and Housing Corporation (CMHC), Genworth Financial, or Canada Guaranty. The cost of mortgage insurance is called the premium, and is based on your down payment. This premium ranges from 0.6% to 4.5% of the mortgage amount. This can either be paid upfront, or added to the mortgage principal balance.Â
- Mortgage Insurance: Differing from an insured mortgage, there’s optional insurance that protects the borrower, such as mortgage life insurance or mortgage disability insurance, which can help cover mortgage payments if the borrower loses their income or passes away. This is usually charged as a monthly premium.Â
- Downpayment: The initial payment made when buying a home, usually a percentage of the purchase price. A higher down payment can reduce the need for mortgage insurance and lower your monthly payments. In Canada, the minimum down payment for homes costing up to $500,000 is 5%. For homes priced between $500,000 and $999,999, the minimum down payment is 5% on the first $500,000 and 10% on the remaining amount. For homes priced at $1 million or more, a 20% down payment is required.
- Total Debt Service Ratio (TDSR): This is a measure of your total monthly debt payments, including your mortgage, compared to your gross monthly income. Lenders use this ratio to determine your ability to manage monthly payments. Usually, the threshold for mortgages is a TDSR under 45%.Â
- Fixed-Rate Mortgage: A mortgage with a consistent interest rate throughout the term, offering stability and predictable payments. The monthly payment, and principal payment will not change.Â
- Variable-Rate Mortgage: A mortgage with an interest rate that can fluctuate based on market conditions. This can result in lower initial payments but carries the risk of rate increases. When rates go up, the monthly payment often remains the same (depending on the lender), but a higher portion of the payment will go towards interest, reducing the amount applied to the principal balance.
- Term: The length of time your mortgage agreement covers, usually ranging from 1 to 5 years. At the end of the term, you’ll need to renew your mortgage under new terms.Â
- Amortization: The total length of time it will take to pay off your mortgage, typically 25 to 30 years. This period affects your monthly payment amounts. The maximum amortization period can depend on the mortgage type and principal amount. However, It is important to consider the interest over the life of the loan. A longer amortization can mean lower monthly payments, but the interest paid over the life of the mortgage can be considerably more.Â
- Pre-Approval: A preliminary evaluation by a lender that determines how much you can borrow. This helps you understand your budget and shows sellers you are a serious buyer.
- Gifted Downpayment: In Canada, a gifted down payment is money given to a homebuyer by a family member to help with the down payment. The gift must be a true gift, meaning it does not need to be repaid. Lenders typically require a gift letter from the family member stating that the money is a gift and does not need to be repaid. In Alberta, the rules are the same as the rest of Canada; the gift must come from a family member, and a gift letter is required.
- Principal: The amount of money you borrow to purchase your home, excluding interest. As you make mortgage payments, you pay down the principal, reducing the amount you owe on the mortgage.
- Dower Act: The Dower Act is a unique piece of legislation in Alberta designed to protect the property rights of married persons. It requires the consent of both spouses before the matrimonial home can be sold or mortgaged. The act ensures that one spouse cannot dispose of the home without the other’s agreement, providing significant protection to the non-owning spouse. It also grants a surviving spouse a life estate in the home if the other spouse passes away.
2. Types of Lenders
Choosing the right lender is a critical step in securing a mortgage. Here are the main types of lenders you might consider:
- A Lenders: These are traditional lenders such as major banks and credit unions. They offer the most competitive interest rates and terms but have stricter qualification criteria. Borrowers typically need a good credit score, stable income, and a low debt-to-income ratio to qualify.Â
- B Lenders: These lenders cater to borrowers who may not meet the strict criteria of A lenders. They include trust companies and smaller banks. B lenders offer more flexible qualification requirements but usually charge higher interest rates and fees. They are a good option for those with credit issues, self-employed individuals, or those with unstable income.
- Subprime Lenders: Also known as private lenders, these lenders provide mortgages to borrowers who cannot qualify with A or B lenders. Subprime lenders have the most flexible lending criteria but charge the highest interest rates and fees. They are often used as a last resort for borrowers with significant credit challenges or unique financial situations.
3. How to Qualify for a Mortgage
Qualifying for a mortgage involves several key factors that lenders will evaluate to determine your eligibility and the terms of your mortgage. Here’s what you need to know:
- Credit Score: Your credit score significantly impacts your mortgage eligibility and interest rate. Lenders use your credit score to assess your creditworthiness. Aim for a good score by managing your debts and making timely payments. In Canada, a score of 650 or higher is generally considered good. Check your credit report for errors and work on improving your score before applying for a mortgage.
- Income: Lenders will assess your income to ensure you can afford the mortgage payments. This includes employment income, self-employment income, and other income sources. Provide documentation such as pay stubs, tax returns, and employment verification. Stable and sufficient income increases your chances of mortgage approval. This can be a significant barrier to entry for many business owners, as the lender will look at the personal income. If the business owner does not pay themselves a set salary, and pay for things through the business, the lender may see this as a lack of income. Usually, the income reported on the individual T4 will be the main source looked at.Â
- Debts and Collections: Your existing debts and any collections will be considered. A high debt-to-income ratio can affect your ability to secure a mortgage. Lenders calculate your Total Debt Service Ratio (TDSR) to determine if you can manage your monthly payments. Pay down debts where possible and avoid taking on new debt before applying.
- Downpayment: A larger down payment can improve your chances of approval and reduce the need for mortgage insurance. Save diligently and explore programs that may assist with down payments. Remember, the minimum down payment requirements vary based on the home’s purchase price.
- Employment Stability: Having a stable employment history is crucial. Lenders prefer borrowers who have been with the same employer for at least two years. If you’re self-employed, be prepared to provide additional documentation, such as business financial statements and tax returns.
- Documentation: Gather necessary documents to support your mortgage application. This includes proof of income (pay stubs, tax returns), bank statements, employment verification, and identification documents. Having these documents ready can expedite the application process.
- Potential Red Flags: Certain factors can lead to the failure of your mortgage application. These include having unpaid collections, significant Canada Revenue Agency (CRA) debt, recent bankruptcies, or a history of late payments. Lenders view these issues as high risk, and they can significantly impact your ability to qualify for a mortgage.
4. What Mortgages Cover
Understanding what your mortgage will and won’t cover is crucial:
- Covered Costs: The mortgage will cover the purchase price of the property. This is the primary purpose of the mortgage loan.
- Excluded Costs: Closing costs, such as legal fees, inspection fees, and land transfer taxes (not applicable in Alberta), are typically not covered by the mortgage. You’ll need to budget for these separately. Other excluded costs may include home insurance, moving expenses, and initial home maintenance. It’s important to have additional funds set aside to cover these expenses, which can add up to several thousand dollars.
By knowing where you can obtain a mortgage and understanding what it will cover, you can better plan your home purchase and ensure that you are financially prepared for all associated costs.
5. Important Considerations
Several factors should influence your mortgage decisions:
- Affordability: Determine how much you can realistically afford, considering your income, debts, and lifestyle. Use mortgage calculators to estimate your monthly payments and ensure they fit within your budget. Remember to account for property taxes, home insurance, and maintenance costs.
- Interest Rates vs. House Price: Weigh the impact of interest rates against the purchase price. A higher interest rate can significantly increase your total payment over the mortgage term. Consider locking in a rate if you expect rates to rise. Compare different mortgage products to find the best combination of interest rate and terms for your situation.
- Term vs. Amortization: Understand the difference between the term and amortization period. The term is the length of your current mortgage agreement, while amortization is the total period over which the mortgage will be paid off. Shorter terms may offer lower rates but require refinancing more often. A longer amortization period results in lower monthly payments but higher overall interest costs.
- Financial Stability: Ensure you have a stable income and an emergency fund to cover unexpected expenses. This can help you manage your mortgage payments even during financial difficulties. Consider getting mortgage insurance to protect your investment in case of job loss, disability, or other unforeseen events.
- Future Planning: Many people decide what they can afford based on current interest rates, salaries and savings. However, it is important to consider how factors may change in the future. For example, interest rates were extremely low during 2020 and 2021, prompting people to buy, with mortgage rates under 3%. Now that interest rates are a lot higher, many people will find themselves having a much larger payment when they renew their term, and it is possible they are unable to make the payments.Â
6. Primary Residence vs. Investor Loan
Different types of loans apply depending on the purpose of your property:
- Primary Residence: Loans for homes where you intend to live. These often have more favorable terms and lower interest rates. Lenders may offer special programs and incentives for first-time buyers, such as lower down payment requirements or reduced interest rates.
- Investor Loan: Loans for properties purchased as investments, such as rental properties. These may have stricter qualifying criteria and higher interest rates. Lenders view investment properties as higher risk since the borrower is not living in the property. Ensure you understand the additional responsibilities and risks of owning investment properties, such as managing tenants and maintenance costs.Â
7. Timeline of the Mortgage Process
Understanding the timeline of the mortgage process can help you manage expectations and stay organized. Here’s a step-by-step breakdown from applying to receiving the funds for your new home:
Initial Research and PreparationÂ
- Assess Financial Health: Check your credit score, evaluate your budget, and gather necessary financial documents.
- Save for Down Payment: Ensure you have enough saved for the down payment and other associated costs.
- Research Lenders: Explore different lenders, mortgage brokers, and their offerings.
Getting Pre-Approved
- Pre-Approval Application: Apply for pre-approval with your chosen lender(s). Provide documentation such as income verification, credit report, and other financial information.
- Pre-Approval Decision: Receive a pre-approval letter indicating how much you can borrow. This shows sellers you are a serious buyer.
- Important Note:Â A pre-approval is NOT the same as a finalized mortgage approval. During the pre-approval period, it is crucial not to take on additional debt, make significant changes to your credit score, or miss any debt payments. These actions can jeopardize your mortgage application, as the pre-approval is based on your current financial situation. Make sure you speak to the mortgage provider before any major financial decisions.Â
House Hunting and Making an OfferÂ
- Find a Real Estate Agent: Work with a real estate agent to find homes within your budget.
- House Hunting: Visit properties, attend open houses, and narrow down your choices.
- Making an Offer: Submit an offer on your chosen property. Negotiate terms and conditions with the seller.
Offer Acceptance and Finalizing the MortgageÂ
- Offer Acceptance: Once the seller accepts your offer, sign the purchase agreement.
- Mortgage Application: Submit a formal mortgage application to your lender with the accepted offer and purchase agreement.
- Property Appraisal and Inspection: The lender may require a property appraisal and inspection to confirm the value and condition of the home.
- Mortgage Approval: Receive final mortgage approval from your lender. Review and sign the mortgage agreement.
Down Payment and Closing Preparation
- Arrange Down Payment: Transfer your down payment funds to your lawyer or notary’s trust account (instructions will come from the lender).Â
- Prepare for Closing: Review the closing disclosure, which outlines final terms and costs. Ensure all necessary documentation is ready.
- Home Insurance: Arrange for home insurance, which is often required by lenders.
Closing DayÂ
- Sign Final Documents: Meet with your lawyer or notary to sign the final mortgage and property transfer documents.
- Transfer of Funds: Your lender will advance the mortgage funds to the seller through your lawyer or notary.
We are always here to help you discuss your mortgage needs. Our extensive network of trusted brokers can provide personalized advice and find the best mortgage solution for your situation. Contact us today to start your journey towards homeownership with confidence!
Happy house hunting!
