What is a Mortgage?
A mortgage is a loan from a bank, credit union, or other lender that helps you purchase a property. You pay the loan back over time and you pay interest to the lender over time. Most mortgages are paid back over a 25-year period.
When you get a mortgage, you agree on a variable or fixed interest rate (explained below) and a renewal period, at which point you re-borrow and get a new interest rate. The most common renewal period is 5 years. We’ll look at renewals shortly. But first, pre-approvals.
Mortgage Pre-Approval
A mortgage pre-approval is the amount of money a lender ‘might’ lend you at a specific interest rate. A lender issues a pre-approval when they have reviewed your financial information. A pre-approval is not a guarantee.
Usefully, pre-approvals do lock-in an interest rate for a period of time. This helps you plan and budget
Pro-Tip: You legally agree to buy a property and then get a mortgage for it. Pre-approvals aren’t mortgages. Each mortgage is specific to the property you’re buying.
How a lender evaluates borrowing power
A lender will review your finances (income, credit and other factors) and calculate the maximum loan they’ll give you and the interest rate they’ll charge.
Different lenders will offer you different mortgages and rates because they value you differently.
Pro-tip: Sharing your information with a mortgage broker is like tuning your car before you take a long trip. Brokers know what lenders look for and how to position your finances so that they fit each lender. They keep you from buying a home you might struggle to get a mortgage for.
Combined with your down payment, your pre-approval suggests what you could spend to acquire a property. ‘Could’ does not mean ‘should’. A mortgage pre-approval is a useful barometer.
Example: Pre-Approval + Down payment = Budget
Let’s say you’re pre-approved for a $600,000 mortgage and have a $120,000 down payment. Your maximum budget for a purchase is $720,000. There are many reasons why you shouldn’t spend that much.
There’s no guarantee you’ll receive your full pre-approval. Lenders take a closer look as they approach signing off on your mortgage. You don’t want to max out your finances anyway, so it’s smart to search below your maximum mortgage amount. We help you budget at every step, from pre-approval through to your closing and getting ready for your payments.
A mortgage pre-approval is a budgeting tool and a way of locking in a rate (typically for 120 days). If you don’t get a mortgage pre-approval, you’ll have to qualify for a mortgage once you find what you want to buy.
More common mortgage terms
The amortization period
This is a fancy way of saying how many years it will take to pay your mortgage. Most amortization periods are 20, 25 or 30 years. Longer periods have lower monthly payments but cost more as you’re paying interest for a long period of time.
Pro-Tip: Even with today’s low rates, interest on a mortgage can cost hundreds of thousands of dollars
The mortgage renewal period
Every mortgage has a term, usually 1-5 years. When that term is up, you renew your mortgage. That means re-borrowing the outstanding amount and setting a new term with a fixed or variable interest rate. You can also choose a new lender at this time and sometimes that’s a good idea. There’s a lot to consider when renewing.
Pro-tip: Banks often try to ‘sneak in’ a renewal under the guise of making the paperwork and process simpler. Usually that’s because rates have dropped and they don’t want you to pay less.
Interest rates
A mortgage is a loan. Interest is the extra money you pay on top of the loan. The interest rate is the percentage you pay on what you’ve borrowed. If your mortgage has a variable-rate, the interest you pay goes up or down with the Bank of Canada’s rate. If your mortgage is fixed, your rate stays the same.
If you’re buying property in Canada, there are three interest rates to watch:
1) The Bank of Canada (BoC) interest rate (commonly called the overnight rate, key rate, or benchmark rate)
2) A Bank or lender’s Prime Rate – usually a few points higher than the benchmark rate
3) Your Mortgage Rate – whatever you negotiate and/or qualify for
The Bank of Canada changes the benchmark rate to influence and moderate the economy.
Each Canadian bank sets its own Prime Rate. A bank’s Prime Rate sets the benchmark for its lending rates (not just mortgages). Canada’s five main banks tend to have a similar Prime Rate.
When the BoC policy rate goes up, banks tend to increase their Prime Rate, which could increase their available mortgage rates. A variable-rate mortgage will rise and fall in-step with the bank’s Prime Rate. A fixed-rate mortgage will be affected by changes in the bank’s Prime Rate when the mortgage comes up for renewal.
Variable vs Fixed interest rate
Fixed-rate mortgage
A fixed rate means you pay a specific interest rate for the length of your term (1 to 10 years), which means predictable mortgage payments. They offer more security. The downside is that fixed-rate mortgages have higher interest rates. That means higher monthly mortgage payments than might be seen in a variable rate mortgage. Security comes at a cost.
Variable-rate mortgage:
A variable-rate mortgage can change (the interest rate can go up or down) based on the Bank of Canada’s base rate. “Variables”, as they are called, offer a lower interest rate in exchange for more risk.
Choosing between a Variable or Fixed-Rate Mortgage
This choice should reflect your situation, the market, your risk tolerance and other factors. It’s personal. We’ll lay out your choices for you.
Pro-Tip: There are many, many mortgage strategies that might be hand-in-glove for your situation. Rates, terms, and specific lender offerings. We’ll put them in front of you.
What lenders look at before they give you a mortgage
Your credit history (and score) and your income are the only way lenders can evaluate you.
“A” lenders – the big banks, will not usually lend to those with poor scores.
Keep an eye on your credit score — whether you are borrowing or not. Bad or damaged credit can make it hard to get a mortgage or a low interest rate. Some lenders will require you to have a co-signer with better credit. Others will approve you for a lower amount, or require a larger down payment.
Pro-Tip: We review and help you improve your financial picture well before you start house-hunting. Even if you’re just thinking about buying (or even thinking about thinking about it), there are a number of things to tidy up.
Lenders require:
- Personal identification
- A letter of employment, pay stubs or proof of your income
- For the self-employed – Notice of Assessments from the Canada Revenue Agency
- Credit card balances and limits
- Car payment history
- Lines of credit
There are many, many lenders. Each has a set of policies and a sweet spot for borrowers. As mortgage brokers, a key part of our value is to recognize which lenders will be a great fit for your situation and then advocate on your behalf.
The mortgage stress test explained
The mortgage stress test is a market-cooling measure intended to reduce the number of buyers who couldn’t pay their mortgages if interest rates went up. Banks do this by ‘testing’ new mortgage applications at a higher interest rate than what they are offering.
The rate that banks use for the stress test is either:
The Bank of Canada’s five-year fixed mortgage rate
OR
The rate negotiated with the lender + 2 basis points
They use whichever is higher.
Here’s an example:
Person X qualified for a mortgage rate of 2.89%. The stress test adds 2 basis points to that rate, which puts them at 4.89%.
The Bank of Canada’s five-year mortgage rate is (for simplicity’s sake) 5.00%.
5% is higher than 4.89% so the stress test rate is 5%.
Avoiding the mortgage stress test
The stress-test used to affect only buyers with less than 20% down payment, but now every buyer who gets a mortgage from a federally-regulated body needs to pass the stress test. Credit unions and some other lenders do not stress test. We’ll help you explore your options.
Should I get a mortgage from my bank or a credit union?
You can get a mortgage from many, many lenders. Government regulated banks, credit unions, private individuals and so on. Each lender offers different interest rates and conditions for lending. We help you explore a variety of lender options before making a decision. A strong financial picture, down payment and good credit open more lender doors.
What is mortgage insurance?
No matter what lender you choose, your down payment will be a big factor in the interest rate you receive and the amount you can borrow. If your down payment is less than 20% of the purchase price, you will have to buy mortgage loan insurance.
Mortgage insurance is a way that banks and lenders protect themselves in case you can’t make your monthly payments. If you have less than a 20% down payment, you have to buy mortgage loan insurance. You purchase mortgage loan insurance through the Canadian Mortgage and Housing Corporation (CMHC). More on mortgage insurance here.
How do mortgage brokers work?
They work hard! Just kidding. We work for you, not for the lender. We help you optimize your financial situation and present it to lenders who want your business. We quarterback the paperwork, conversations and wrangle the many professionals that a property purchase and mortgage involves. Brokers keep you from agreeing to clauses that might prevent you from changing or repay your mortgage faster.
The mortgage options a broker puts in front of you will be based on their improved relationship with the lenders and tailored to your needs. Usually that means better interest rates than your bank would offer you.
Mortgage brokers typically offer their services for free to buyers. They receive a commission from the lender when the mortgage is complete. There’s no reason not to speak to a broker.
How do I pay my mortgage?
Most mortgages are paid monthly, like a phone bill. Each month, you pay a chunk of the original loan amount. You pay the interest first so that the lender’s risk is reduced. You want to make sure you are paying enough each month to be chipping away at the principal amount and not just paying off the interest.
Can I pay my mortgage early or faster?
Lenders make money off the interest they charge on your mortgage, so they don’t want you to pay your mortgage early or faster. In your mortgage contract, you can negotiate repayment privileges allowing you to pay more than your monthly amount, but you can face repayment penalties if you pay off too much at once.
One strategy to pay off your mortgage faster and save money on interest is to negotiate for bi-weekly mortgage payments. To learn more about this strategy, speak with us about accelerated payments.
Can I break my mortgage?
Horror stories of people breaking their mortgages and being hit with massive penalties often splash on the news. We’ll make sure that you stay out of bad agreements and make sure you understand the terms and conditions before you sign. If your mortgage is no longer the best option, we can help you break it.
When you break a mortgage, you renegotiate your mortgage terms with the same lender or switch to another