A home is the largest purchase most people will make in their lives.
That should reinforce the importance of planning ahead, doing your research, relying on the advice of experts and not rushing through the process.
With nearly 700,000 homes purchased in Canada each year, there’s no shortage of anecdotes about the issues and surprises that can arise.
While a mortgage broker can help you avoid many of the pitfalls commonly encountered during the home buying process, it’s still important to be informed even before you start looking for that perfect home. Here are just a few examples:
1. Not checking your credit report before applying for a mortgage
Put simply, not knowing your credit score prior to applying for a mortgage is akin to not brushing your teeth before visiting the dentist.
Your credit score can have a huge impact on the best rate you’ll be able to secure. For example, some lenders will offer a borrower with a 640 credit score rates that are a full 0.25% worse than someone with a score of 750, as we’ve written about previously on these pages. For conventional mortgages (those with down payments of less than 20%), the ideal target score is around 720.
You don’t want to discover your credit score is sub-par in the middle of a mortgage application. Knowing this information beforehand gives you time to improve your score, or address any errors that may appear on your report. You can easily check your score through Equifax or TransUnion.
Anyone with a credit score less than 680 (the minimum credit score to get the best rates) should be prepared to pony up for a higher interest rate and will likely qualify for a smaller mortgage.
2. Thinking it’s all about the rate
Let’s be honest, who doesn’t want the cheapest mortgage rate possible? And indeed it is important to find the best deal that meets your needs. After all, a few percentage points can make a not-insignificant difference to your interest costs over your mortgage term.
But don’t be too quick to jump at the cheapest rate without making sure it has all of the features you need/want, and that it doesn’t stick you with higher-than-normal penalties should you need to break your mortgage early. Some people are OK with a large penalty if it saves them money upfront on the rate. Just remember that penalties on certain “no-frills” mortgages can end up costing many thousands of dollars, nullifying any rate savings.
3. Not understanding the importance of the down payment
Many first-time buyers see a down payment as a big, almost-insurmountable obstacle to home ownership, particularly in regions where prices have skyrocketed into the stratosphere.
But when you get into the nitty-gritty of it all, there are many more considerations beyond simply coming up with the money.
Things to consider:
- How big of a down payment will you/can you make? Of course you must meet the federally mandated minimum down payment: 5% for all mortgages up to $500,000, and 10% on any portion above $500,000 up to $1 million (CMHC-insured mortgage loans are only available on properties valued under $1 million). It goes without saying that as you increase the size of the down payment, you reduce the amount of interest over the lifetime of the mortgage. But you also reduce the size of the CMHC mortgage insurance premium, which runs from 0.60% on loan-to-values up to 65%, all the way up to 4% for loan-to-values of 95% (i.e. 5% down). CMHC says the average down payment in 2016 was 8%, while the average CMHC-insured loan was $245,000. Based on those figures, the average premium was $9,016. Remember, this premium is normally rolled into the mortgage, and gets paid off (with interest) over the life of the mortgage.
- The source of your down payment funds. According to Mortgage Professionals Canada, about 10% of first-time buyers use the federal government’s Home Buyer’s Plan to withdraw up to $25,000 tax free from their Registered Retirement Savings Plan (RRSP). This can be a great tool for supplementing a down payment, so long as you’re aware of the rules and the payback requirements.
- Transferring the funds. No matter where your down payment funds are coming from (savings, investments, RRSP, proceeds from a prior sale), be sure to leave yourself plenty of time for the funds to clear and for a certified or cashier’s cheque to be produced before the closing. It’s easy to underestimate the time it may take for wire transfers to finalize, so be sure to confirm with your bank or financial institution in the event of a tight deadline.
4. Not setting (and sticking to) a budget
You’re probably thinking, “but budgets can be boring and tedious.” This is not entirely incorrect, but on the other hand a budget paints a clear picture of your financial situation and lays the framework for ensuring you can afford all of the hidden (and not so hidden) costs associated with buying a home—not to mention all of the costs that follow after the closing.
It’s important to plan for both the short and long term. Short-term costs include everything from:
- Land transfer taxes
- Legal fees
- Home inspection/appraisal fees
- Down payment (this is kind of a big one)
- Mortgage insurance (remember, the provincial tax on your insurance premium can’t be rolled into the mortgage like the premium itself, so expect this hefty expense at closing time)
Then there are the ongoing costs of home ownership. Previous owners will know what to expect, but first-time buyers may be caught off guard with sudden expenses after moving in, such as:
- Appliances and furniture
- Condo fees/Property taxes/Property insurance
- Utility costs
- Renovations/repairs (furnace replacement, new shingles, etc.)
- And everything else, down to tools, and yes, even a dehumidifier. These expenses can add up
As for long-term planning—and this applies especially to today’s buyers—just because you scored a great rate for your purchase, be prepared for the possibility that rates will rise and that you may need to renew into a higher rate in the future.
For every 25 bps or rate increases, adjustable-rate holders can expect to pay approximately $25 more in interest each month based on a $200,000 mortgage.
5. Not Shopping Around
Whether you plan to find your own mortgage or enlist the help of a broker, it’s still important to shop around in both cases.
Most people don’t buy the first car they test drive. They give themselves adequate time to research and compare their options. So why would a purchase worth many times the cost of your vehicle be any different?
As mentioned above, a mortgage broker can help you wade through these issues, plus much more. If you need help finding a qualified broker near you, Mortgage Professionals Canada offers a national listing of certified brokers.
Variable mortgage rate likely to go up – what should you do?
There is speculation that the Bank of Canada (BOC) will increase interest rates on July 12th when it once again meets to assess what to do with their Key Overnight rate. The BOC’s key overnight rate influences the Prime rate which is what financial institutions like the big banks, credit unions, and non-bank lenders use to charge consumers for various loans, including Variable rate mortgages.
So if there is a rate increase on July 12th, which would be the first increase in nearly seven years, what should holders of Variable rate mortgages do? With a rate increase of 0.25%, this will translate to approximately $13/month extra interest per 100K in mortgage owing.
The answer is…it’s really a personal decision that depends on your own situation (financially at the moment as well as your future plans). It also depends if the property is a rental property or your primary residence. It also depends on which lender you have your mortgage with now. Here are few options to consider if the cost of carrying your variable rate mortgage goes up.
If you have enough discretionary income and a bump in monthly payment of say $50/month for a typical mortgage of 400K will not break the bank for you and change your lifestyle in any way then you might want to consider doing nothing and just riding out the term of your variable rate mortgage. Depending on how much longer you have on your variable rate term, you may have already saved enough to this point to still come out ahead at the end of the term even if there are a few more rate increases down the road.
Convert to a fixed rate mortgage:
If the thought of having to continually monitor interest rate is not at all appealing to you, you may want to convert to a fixed rate mortgage. It should be free to do this. Depending on your risk tolerance and depending on the length remaining on your current variable rate mortgage and the spread between your current variable rate mortgage (ie. 2.30%) compared to for example the current 2 year or 5 year fixed rate which could range between 2.44 – 2.89% right now, it may make sense for you to consider converting to a fixed rate now for some peace of mind for the remainder of your term. For those who are more budget oriented where you have some financial goals in mind (saving for children’s education), having more certainty with your monthly mortgage payment may be preferable to riding the roller coaster of a variable rate mortgage. However, keep in mind what your future plans are if you convert to a fixed rate mortgage. Are you planning to sell your home before the end of the term perhaps? This could affect the penalty amount you have to pay if you convert to a fixed rate mortgage and then breaking the contract early shortly thereafter.
Is your property a rental property?
Your decision to act or not also should factor in what type of a property you own. If you own a rental property with a Variable rate mortgage – a rate increase will affect your monthly cash flow negatively. However, if you are still in a positive cash flow overall and since interest expense incurred for investment properties are tax-deductible, you could just write off more interest at the end of the year and do nothing instead of converting to a fixed rate right now.
Which lender is you current variable rate mortgage with?
If you have a Variable rate mortgage with TD Bank or a few select credit unions, they do not automatically adjust the monthly payments to reflect the new higher variable rate. Your monthly payment stays the same which some people really like, but the result of that is it stretches out the expected life of your mortgage (ie from 25 years to 27 years). This is because more of your monthly payment now goes towards interest than before and less goes towards principal.
Maybe even switch lenders for a deeper discounted Variable rate mortgage
The penalty to pay out most variable rate mortgages is 3-months interest. As such, switching to a lender that can offer you a significantly lower Variable rate than what you have with your current lender may even make sense. Mind you, you need to factor is potential fees involved when switching lenders such as legal and appraisal fees. However, if the math makes sense where you could still save money in the long run then switching lenders to get a deeper discounted Variable rate mortgage might be worthwhile looking at as well.
As I said at the top of this article, what course of action to take is dependent on many factors and comes down to a personal decision. Everyone’s personal situation is different and there is really no “right” action to take. It comes down to what you are comfortable with (new cash flow, impact on long term plans, & overall risk tolerance).
My name is Danny Duong and I am an Accredited Mortgage Professional (AMP) and service clients across Metro Vancouver. Feel free to connect with me should you have any questions about mortgage financing. I can be reached at firstname.lastname@example.org or directly at 778-998-7142.
It has become tougher to get Mortgage Default insurance through CMHC (Canada Mortgage & Housing Corp). Big banks (like TD, Scotia, RBC, BMO, etc.) and non-bank lenders alike routinely require borrowers to pay for mortgage default insurance if they have less than 20% down payment. These are referred to high-ratio mortgages (or insured mortgages).
FACT: Non-bank lenders also routinely paid for the mortgage default insurance where borrowers had more than 20% as well behind the scene. They did this for strategic reasons which allowed them to better compete against the big banks. Consumers benefited from this with more lender options and often better rates through the non-bank lenders.
As of Nov. 30th, however, more strict rules came into effect in order for mortgages to be insured through the government. The following criteria must now be met:
- Insured mortgages can only be for a purchase or transfer of an existing mortgage (with no increase to the mortgage amount)
- Purchase of primary residence up to max price $1 million only. Owner occupied rental properties with 2-4 units such as a house with basement suite(s) or triplex are ok as well.
- Maximum 25 years amortization
- Minimum credit score of 600. If score is 680 then there is a little more flexibility.
- All mortgage applications are subject to a stress-test whereby borrowers must qualify for the mortgage based on a bench-mark interest rate (currently at 4.64%). This is almost 2% higher than the typical fully discounted 5 yrs fixed rate right now at 2.69%. Because of this, borrowers on average will now have to confirm 20K more in income to qualify for the same mortgage compared to last month.
These policy changes basically took away the non-bank lenders’ ability to insure all of the mortgages that they were routinely insuring before. As a result, many non-bank lenders have either increased requirements, increased interest rates, or pulled their previous mortgage offering completely in the case of pure rental properties, amortization beyond 25 yrs, refinances where borrowers are looking to pull out additional equity, or where borrowers could only qualify without the stress test.
What does this mean for borrowers?
- They need to be informed and talk to an experienced Mortgage Broker who can offer a variety of options and help them weigh through all the different lender requirements. This is more crucial now than ever before. And they should do this early in the home shopping process.
- For pure rental properties, they must expect to pay slightly higher interest rates like 0.25% more or accept specific restrictions attached to their mortgages.
- They will have to pay slightly higher interest rates if they need/want amortizations over 25 years (ie 30 or 35 years).
- If they are looking to refinance an existing property, they should also expect to pay slightly higher rates and likely have fewer lender options than before.
Effective today, borrowers with LESS than 20% down payment are required to qualify at the Bank of Canada benchmark interest rate (which is currently 4.64%). It does not mean you will pay this higher rate, but rather you just have to demonstrate that you can qualify even at this higher rate. Borrowers with 20% down payment or greater will not have to qualify in this manner until Nov. 30th.
1) Foreign buyers who are not residents of Canada AT THE TIME they purchased a property will have to pay capital gains taxes when they later sell their Canadian properties from now on. This closes a couple of loop holes that were being used by foreign buyers to avoid the capital gains taxes up until now.
2) Home buyers with less than 20% down payment will now have to confirm more income to qualify for a mortgage than before – instead of qualifying based on a typical fully discounted 5 yr fixed interest rate of 2.49% now, they must qualify based on the Bank of Canada Benchmark rate which currently 4.64% going forward. They don’t pay this higher interest rate, but rather they have to qualify based on it so it will be more difficult for anyone with less than 20% down payment going forward. Inevitably, lenders and the regulators will also very likely apply this same more stringent qualifying criteria to all borrowers, even ones with more than 20% down payment. Stay tuned…