As a first-time homebuyer or even if you are looking for your next home, you may have a lot of questions about the buying process. Here are some common questions about mortgages.
Should I rent an apartment or buy a house?
It depends on both lifestyle and financial factors. Do you have a nomadic lifestyle, or are you ready to settle down in one place? Do you like living close to other people or having your own detached home? Do you want to save money and build wealth by owning a piece of real estate?
Renting an apartment can make sense for people who move often and are too busy to take care of a house. When you rent, your monthly expenses are very predictable, and someone else is responsible for handling repairs. Over the long term, you might be able to save money and invest it in other ways than owning real estate.
Owning a home can make sense for people who want to settle in a certain city, town, or neighbourhood and put down roots. Homeownership brings intangible benefits like the feeling of belonging to a community and the pride of ownership. You can make changes to your home, and there is the possibility of building equity (depending on changes in the real estate market).
How does a bank decide how much of a mortgage I can get pre-approved for?
Mortgage professionals use two ratios to determine if borrowers can afford to buy a home. The ratios are called Gross Debt Service (GDS) and Total Debt Service (TDS). Each financial institution has its own GDS and TDS maximums. GDS is the percentage of your monthly household income that covers your housing costs. TDS is the percentage of your monthly household income that covers your housing costs plus any other debt payments you have (i.e., line of credit, car loan, student loans, etc.).
What information or documentation will I need for a pre-approval?
- Personal information: date of birth, social insurance number
- Residence information: renting or owning, monthly payments
- Employment information: employer name, job title, and income, job letter, pay stubs, last one or two years Notice of Assessment income tax forms
- Assets: RRSPs, vehicles, TFSAs, shares, stocks
- Down payment amount
Depending on your employment situation, your lender may want to see more documentation.
You will also need to show where your down payment money is coming from. In most cases, you simply need to show your bank account activity over the past three months. If your down payment is in the form of a gift, you’ll need to show a gift letter and that the corresponding amount has been deposited into your account. Lenders also like to see you have the money in place for closing costs.
What is a mortgage stress test?
Potential homebuyers need to pass a mortgage stress test. The test is a way of seeing how you would cope with your mortgage payments in the event that interest rates rise or you lose your job, etc. All potential homeowners need to prove they can afford their mortgages based on their lender’s minimum “qualifying rate.”
As of June 1, 2021, you’ll need to qualify at your contracted mortgage interest rate plus 2%, or 5.25%, whichever is higher. For example, if you apply for a mortgage at 3.65%, your lender will assess you as if you were paying at 5.65% (3.65% + 2%), since 5.65% is greater than the benchmark rate of 5.25%.
What is the minimum credit score required for a mortgage?
In 2021, you’ll need a credit score anywhere between 620 and 680, depending on the lender. However, the minimum credit score also depends on several other factors. For example, a borrower with a high income and low debt amount may qualify for a mortgage with a slightly lower credit score than a borrower with a lower income and lots of debt.
How does your credit score affect your mortgage?
A high credit score will help you get a favourable interest rate from a conventional lender like a bank. Credit unions, trust companies, and subprime lenders provide mortgages to people with lower credit scores, and you will likely pay a higher interest rate.
Your best strategy is to take the time to improve your credit score before applying for a mortgage. You’ll have an easier time getting approved for a home loan and qualify for a lower rate, which will make your mortgage less expensive.
What are the different types of mortgages?
A conventional mortgage is a loan for up to 80% of the purchase price or appraised value of a property. The remaining amount required for a purchase (20% or more) is paid by you as a down payment.
If you need to borrow more than 80% of the purchase price, you’ll need to apply for a high-ratio mortgage. High-ratio mortgages must be insured with mortgage default insurance.
The qualifying rules for mortgages now require a stress test. For high-ratio mortgages, applicants need to qualify at the current Bank of Canada benchmark rate. For conventional mortgages, you need to qualify at the higher of either the 5-year benchmark rate or the original contract rate plus two percentage points.
What is mortgage default insurance?
It’s a type of insurance policy that protects lenders from borrowers defaulting on their mortgages. Canadian buyers who have down payments that are less than 20% of the purchase price are required to have mortgage default insurance.
This insurance is provided by three providers: Canada Mortgage and Housing Corporation (CMHC), Canada Guaranty, and Genworth Financial. The insurance is an extra monthly amount attached to your mortgage payments.
Does it make sense to take mortgage default insurance for a cheaper interest rate?
Sometimes. For example, if you have 35% equity and the difference between insured and insurable mortgage rates is 15 basis points or more, you will save money by paying a default insurance premium. If your home purchase is under $1 million, you can qualify for cheaper insured mortgage rates.
When your mortgage comes up for renewal, you can carry that insurance over to your next mortgage term—even to a new lender, if you haven’t refinanced after getting the mortgage.
Some lenders have a disproportionately bigger appetite for insured mortgages and may price them more aggressively. Maintaining active insurance is beneficial because it lets you keep qualifying for the lowest mortgage rates on the market, which are usually high-ratio insured rates.
Is a low-interest rate for a high-ratio mortgage better than a higher conventional rate?
While it’s true that you could save a couple of thousand dollars in a high-ratio five-year fixed rate, the added cost of default insurance offsets that savings by a considerable margin. Conventional borrowers still experience lower all-in borrowing costs.
What are the different types of mortgage interest rates?
- Fixed rate: The interest rate and payments stay the same for the entire term.
- Variable rate: The interest rate will increase and decrease, but you can keep your payments the same for the entire term. This is called a fixed payment with a variable interest rate. You also have the option of an adjustable payment with a variable rate. Variable interest rates are usually lower than a fixed interest rate.
- Hybrid or combination interest rate: Part of your mortgage has a fixed interest rate, and the rest has a variable interest rate. The fixed portion gives you some protection in case interest rates go up, while the variable portion is beneficial if rates fall. Each portion may have different terms, which means these kinds of mortgages may be harder to transfer to another lender.
How much interest will I pay over a 5-year term?
Use this mortgage payment calculator from Canada Guaranty to see what payments you would make in three different scenarios.
What does mortgage amortization mean?
An amortization period is the length of time it will take you to pay off a mortgage. It is an estimate based on the interest rate for your current mortgage term.
If your down payment is less than 20% of the purchase price, the longest amortization you’re allowed is 25 years.