When you are buying a property and intend to get a mortgage, the down payment is the portion of the purchase price that you pay yourself. The mortgage will usually cover the rest of the purchase price.
The down payment is a very important factor in determining what kind of a mortgage you qualify for, how much the mortgage will cost you in the long run, and how much equity you have in your home.
The bigger your down payment, the more equity you have in your home, the smaller the mortgage you need to take out to buy the property, and the less you end up paying in mortgage costs.
How much you can afford depends on your monthly income, your existing monthly payments (credit cards, car loans, etc.), and the appraised value of the home you wish to mortgage.
Different lenders will have different thresholds, but for the most part the calculation is as follows:
A: Take your gross monthly income (before taxes), and multiply it by 0.32. This is the first estimate of how much you can afford for your mortgage payment,
property taxes and heating costs combined.
B: For a second estimate, take your gross monthly income (before taxes) and multiply it by 0.40. Then subtract all of your monthly bills for debt, including credit
cards, loans, lines of credits, financing, child support, etc.
The lesser of A or B is how much you can roughly afford to put toward your monthly housing payments, including mortgage, taxes, heating, etc.
Now this is truly a rough estimate; you may actually want to opt for a smaller monthly payment, in order to allow yourself room for the unexpected, or for other expenditures that you consider important. The key is to really look at your budget, at your monthly expenses, and figure out which sacrifices you will have to make to afford your monthly payment, and how stable and secure your monthly income is as well. If you are self-employed and your income fluctuates a great deal from month-to-month, you will want to leave a wide margin for lean months, to make sure you are not ever in a position where you can’t make your mortgage payment.
A young buyer without an established credit history, may have a hard time obtaining a mortgage through a major bank. Banks generally have very strict credit guidelines with few exceptions for those who have not yet had a chance to establish their credit history. That being said depending on the length of reporting history on your credit bureau and the types of credit you do have it is worth a try to speak to a Licensed Mortgage Agent who can shop your application around to see if the many lenders they have access to will make an exception.
The same holds true for those whose credit rating may have been affected by hard times – prolonged unemployment, death, illness, all can result in difficulties paying one’s monthly bills, which can drastically lower one’s credit rating, or force bankruptcy. Lower credit ratings and recent bankruptcies (or consumer proposals) can make it very difficult to obtain a mortgage through a major bank.
However a mortgage broker has access to a much wider pool of lenders across Canada, many of whom are willing to consider other means of establishing a person’s creditworthiness, such as looking at their utility bills, cell phone bills, or rental payments. There are lenders that will approve a 1 or 2 year mortgage with the purpose being that in that time one should be able to correct the deficiencies with their bureau and put themselves in a position to qualify once again with the major banks at AAA rates.
Some lenders will also help clients in consumer proposal refinance their mortgages to pay out their outstanding debts, as well as consider alternative options for those who have recently declared bankruptcy (less than two years).
Talk to one of our mortgage specialists today to discuss your special circumstances, and we will put you in touch with the right lender.
Equity is basically the share of your home that you own outright, the part you do not have to repay. If you have a mortgage, your initial equity is equal to the down payment you put on your home. Over time, as you begin to pay down your mortgage, your equity grows. If your home increases or decreases in value over time, your equity increases and decreases as well.
For example, let’s say you bought a home for $250,000, with a $200,000 mortgage and a $50,000 down payment. Your initial equity was $50,000. Five years later, your home is now worth $280,000 – so you’ve gained another $30,000 in equity. And since you have been making payments against your mortgage during that time, you’ve gained another $45,000 in equity – meaning at the end of five years, your equity is now $125,000.
Equity is a valuable resource – it can be used to weather difficult financial times by refinancing your mortgage to pay down other debts or make important purchases you couldn’t otherwise afford.
As a rule of thumb, 5% is the minimum down payment required to qualify for a mortgage. However, these are considered higher risk mortgages, and depending on the lender your credit score may be an important factor in securing a mortgage with just 5% down.
In some areas, there may be restrictions on the maximum principal allowed for a 5%-down mortgage (also called a non-conventional mortgage). In some Canadian cities or districts, non-conventional mortgages may only be possible for low to mid-range property values, while more expensive properties (and therefore bigger mortgages) require a more substantial down payment.
Mortgages with down payments less than 20% are typically required to be insured by the Canada Mortgage and Housing Company (CMHC) or Genworth Financial Canada.
If you are a first-time homebuyer and don’t have enough free cash for a down payment, you have the option to use your RRSP (Registered Retirement Savings Plan) savings to help with the down payment or the closing costs on your home. This is called the Home Buyer's Plan (HPB) and it is a federal government program meant to help new homeowners withdraw up to $25,000 against their RRSP savings, which can then be repaid interest-free over a period of up to 15 years.
As long as you have not owned a principal residence in the last five years (excluding an income property like a rental home), your RRSPs were invested for at least three months, and you intend to live in your new home for at least one year after closing, you may qualify for this program.
You can also accept a cash gift from a family member to use as a down payment on your home. In this case, the family member usually must sign a letter stating that it is truly a gift rather than a personal loan. If you require insurance from the CMHC or GE, then you must have the gift money in your possession before sending in your insurance application.
Programs do exist where lenders will provide up to 5% for your initial down payment requiring that you have only 1.5% of the purchase price on hand for closing costs involved in the purchase. As you might expect this does not come free, your ineterest rate is higher under these programs so the bank can recoup the money they have provided upfront. In the end you will end up paying the money back in extra interest charges and then some.
The CMHC has mortgage insurance options available for those who are self-employed, with or without independent proof of income, which allows them to qualify for a mortgage or a mortgage refinance. There is no loan maximum amount, and down payments can be as little as 10%. In order to be eligible for the program, you must have been employed in the same line of work for at least two years (self-employed or otherwise).
This insurance program allows self-employed persons to get a mortgage at competitive interest rates, where they might otherwise be considered too high-risk to qualify, or pay exorbitant interest rates.
There are two ways to understand your mortgage ‘term’ – as the total length, or lifetime of your mortgage, which is how long you have to pay it back (also known as the amortization); or as the term of your current agreement, i.e. the length of time you are locked into a given interest rate, payment schedule and other variables.
The amortization term can be as short as six months, if you are able to pay the mortgage back that quickly, or as long as 35 years in some cases. The more common amortization terms are from 15-25 years.
The shorter the amortization, the less interest you have to pay overall – but the higher your monthly payments. Longer amortizations cost you more in interest in the long run, but also gives you more affordable monthly payments.
The agreement term can be anywhere from six months to ten years. The interest rates offered will vary depending on the length of the term and the conditions at the time of the agreement, with lower rates typically offered for shorter terms. The more common agreement term lengths are from one to five years.
Deciding how long an agreement term to lock in for is difficult; it depends on a number of different factors, such as your tolerance for risk, how high or low interest rates at the moment, when you intend to sell your mortgaged property, and more. Your mortgage broker can help you review and assess all the relevant factors to make an informed decision.
There are two kinds of mortgage insurance: mortgage loan insurance, and mortgage life insurance.
Mortgage loan insurance is required for high-ratio mortgages, where the down payment is less than 20% of the home’s value, to protect the lender in case you are unable to make your payments. The premiums range from 0.5 to 7%, and can be paid as a lump sum or added to the balance of the principal to be repaid over time.
In most cases, these loans are portable, meaning they can be carried over to your new home if you decide to move, saving you money on premiums.
Mortgage life insurance is optional, and is purchased to protect your family by paying out the outstanding balance in the event of your death. Policies may also include covering your payments during times of critical illness or disability, to make sure you do not risk losing your home during a difficult time in your life.
Different lenders have different maximum age limits, designed to ensure the borrower can continue to make the payments until the mortgage is paid off. If you are nearing retirement age, you may still qualify, as long as you can show that you will continue to have access to sufficient funds during retirement to meet your monthly payments. You may be required to accept a shorter amortization period. Contact one of our mortgage brokers to find out if you are still eligible for a mortgage.
Fixed-rate mortgages offer the same interest rate for the entire term of the agreement, which can be set anywhere from six months to ten years. This means no matter what happens to interest rates during that period, your interest rate (and mortgage payment) remain the same.
Variable-rate mortgages fluctuate over the term of the agreement. Depending on what interest rates are at the time of the agreement, you might be locked in under, equal to or above the prime rate, which is the bank’s base interest rate. As this prime rate goes up and down, so does the interest you pay on your mortgage, and in some cases so too does your monthly payment.
The two can be combined in what is variously known as a hybrid, blended or combination mortgage; a portion of your total loan amount will have a fixed interest rate, and the remainder will have a variable interest rate. The proportion of the two can be adjusted to allow you to maximize savings and minimize risk according to your personal preferences.
Choosing to opt for a fixed or variable-rate mortgage is a complex decision, that depends a great deal on what current interest rates are like, what they are predicted to be in the near and mid-term future, how much risk you can tolerate, how much flexibility you have in your monthly payments, among other factors. Talk to our mortgage brokers today to assess which is the right option for you.
A pre-approved or pre-qualified mortgage is an important part of the home-buying process. A lender will pre-qualify or pre-approve a mortgage by reviewing and verifying all the relevant application information and supporting documents, including your gross monthly income, down payment and outstanding debts, to determine the maximum mortgage amount for which you are qualified. You can then use this pre-approval to make an offer on a home that fits the bill, which can put you ahead of other buyers who might only be able to put in offers 'subject to financing'. Its better to know how much the banks are willing to lend you in advance, finding your dream home only to find out that your bank will not approve the mortgage amount is not a position anyone would want to be in.
Once your application has been received and your information verified, the only step that remains to receive a full approval is the purchase and sale agreement and a property appraisal, which would be performed by the lender after you make an offer, to ensure the purchase price (and corresponding mortgage) is in line with the property's real value.
Pre-approval is not the same as a simple rate commitment, which a lender can also provide, ensuring you stability in your interest rate while you shop around for a home. Otherwise, if interest rates were to fluctuate significantly, the total mortgage you could afford would be affected, changing your maximum purchase price. With a rate commitment, you know what prices you can afford to offer on potential properties, and you can rest easy knowing that if interest rates go up, you are still guaranteed the lower rate.
A pre-approval is also more rigorous than a pre-quantification, which is basically just a lender's assessment of how big a mortgage you might qualify for, without verifying your income, employment, credit rating or other information you provide.
Different brokers and lenders may disagree on what exactly constitutes pre-qualification - the best way to know whether you have been fully 'pre-approved' is by making sure you have provided a full application with all supporting documents, and that your lender will commit to a mortgage amount and interest rate subject to the property appraisal in writing to you.
There are a number of ways you can reduce the total interest you pay over the life of your mortgage, after you've locked into (hopefully) the lowest rate possible.
Your amortization term will have a dramatic effect on your total mortgage cost: choosing a shorter amortization will dramatically reduce the interest you pay over the course of the mortgage, with only a small increase in monthly payments.. A simple calculation shows how much of a difference five years can make on a $200,000 mortgage at 5.5%:
- 30-year amortization - Monthly Payment: $1127.82; Total Interest: $206,088
- 25-year amortization - Monthly Payment: $1220.79; Total Interest: $166,292
- 20-year amortization - Monthly Payment: $1368.79; Total Interest: $128,550
Your mortgage renewal is a good chance to shorten your amortization; if you can increase the amount of your payment, choose a shorter term to save big.
Another easy and effective way to save is to increase your payment frequency. Instead of paying monthly, you can choose bi-weekly or even weekly payments. Since some lenders now calculate interest monthly, instead of twice a year, your interest will be calculated on a principal that drops more frequently; the savings accumulate significantly over time, and can shave years off your mortgage as well as thousands of dollars.
This option is not for everyone - those with irregular incomes (commission-based salaries, self-employed, small business owners) may prefer to stick with monthly payments. However, if you have a regular salary, and can budget to make your payments more frequently, it's well worth it in the long run.
Most lenders also offer prepayment options. How much you can prepay will vary from lender to lender - some allow you to prepay up to 20% each year, others limit prepayments to a fixed percentage once in the mortgage's lifetime. Prepayments made earlier in the mortgage's lifetime have a greater effect; by reducing the principal early, there is less interest accumulated in the subsequent years. If you can, make your prepayments as often as possible throughout the year, rather than saving up for a lump sum - earlier is always better. Look for good prepayment terms when you are shopping around for a mortgage - an offer with good prepayment terms could offset a slightly lower interest rate from another lender.
A similar option is the 'double-up' payment. Originally, this was designed for those with irregular incomes - letting them double their payment one month, to cover a future month when funds dry up. This 'safety net' can also be used to reduce interest, as the extra payment is generally applied directly to the principal. For those aren't comfortable with the increased payment frequency, this is a good option to add a little more over the course of a year to bring down the balance and get the long-term savings.
Several lenders offer "cash-back" mortgages, offering a percentage of the mortgage principal as cash payable on the date the mortgage is advanced, ostensibly to cover all the fees and peripheral costs associated with closing a home purchase - land transfer taxes, lawyer's fees, moving costs and other expenses. For the most part, these mortgages come with interest rates substantially higher than the best rates available, and there are severe penalties for breaking the mortgage early.
This means it can be an expensive way to borrow money, but it remains an option for those who are strapped for cash after putting together a down payment on a home.
My purchase property needs a lot of improvement - what are my options?
Because these improvements will generally increase your home's value, and your own equity, many lenders will allow you to add the cost of improvements to your mortgage, up to 95% and in some cases higher. This is over and above the maximum mortgage principal you qualify for, but subject to the same interest rate and repayment terms. You must provide written estimates from contractors for the work to be done. Typically, the cost of the upgrades will only be disbursed once the work is done. Since mortgage interest rates and terms are some of the most favourable available, this is one of the best options for borrowing the cost of home improvements.
This type of mortgage plus home improvement loan can be insured by Genworth Financial Canada under their Purchase Plus Improvements Program.