Mortgages (for Canadians)

There’s so much to think about when you’re applying for a mortgage. Should you choose open or closed, short or long-term, fixed or variable rates? Who can offer you the best mortgage, and what can you do if you’re turned down? Here’s how to determine which mortgage is right for you.

Finding and buying a home is one of life’s greatest adventures. And after a divorce, it can also become one of the most difficult. If you’re looking for a new roof above your head because of divorce, you probably won’t be able to pay the full cost of a new home in cash, so you’ll need to look into getting a mortgage.

A mortgage is a huge debt: typically one of the highest household expenses and one of the biggest investments that you’ll ever make. Be sure you are financially and emotionally ready before making this move, and educate yourself about the housing market and mortgages so you can make a wise choice.

What is a mortgage?
A mortgage has two parts: one part is a loan that someone — usually a bank or trust company — agrees to lend you at a given interest rate, and you agree to pay it back with interest; and the other part gives the mortgagee a claim on your house as security to make sure that you repay the loan. If you don’t repay the loan, the lender can choose to sue you on your promise to repay, or take your home and use it to repay your loan.

Every mortgage must be repaid in full by a fixed date. The length of time you have to repay your mortgage is called the “term” of the mortgage. Most have terms of no more than five years. But since mortgages are usually for many tens of thousands of dollars, the monthly payments would be astronomical if you had to repay such a large loan in equal monthly installments in only five years. In order to make the monthly payments manageable, lenders usually calculate the payments as if the loan were being repaid over a longer period of time than the actual term. The payment is usually calculated as if you had 25 years to repay the mortgage. This make-believe period of time is called the “amortization period” of the mortgage.

Your amortization period consists of a series of smaller time periods, called “mortgage terms,” ranging from 6 months to 25 years. You select your mortgage term when you begin your mortgage and every time you renew. Altogether, your amortization period can be as long as 25 years.

Different types of mortgages
Should you choose a short or long-term mortgage? Are you better off with a open or closed loan? Should you get a fixed or variable rate? As well as making these choices, you also have to select your amortization period. Choosing the mortgage that’s right for you depends on your unique needs and circumstances. You should consider a number of key factors before making your decision.

The long and the short of it
A short term, such as a six-month or one-year agreement, means that you are at the mercy of current interest rates. If rates go up, so will your monthly payments. On the other hand, if rates fall, you’ll be able to profit from the drop.

Selecting a long term locks you in, so you’ll know exactly how much your mortgage will cost for years to come. This may be an important consideration if your budget is predictable and inflexible. But you will pay to protect yourself against higher interest rates in the future, since lenders demand higher interest rates for long-term mortgages.

Open and closed mortgages
An open mortgage is one that can be prepaid or renegotiated at any time and in any amount without interest penalty. Open mortgages usually have terms of six months or one year. You can make extra payments whenever you want, in the amount you want, which could save you thousands of dollars in interest charges over the term of your mortgage. But this flexibility comes at a cost of an interest rate that is often 1% higher than that of closed mortgages. If you’re planning to sell your new home in the near future without buying another, or you expect to be receiving a sum of money that will enable you to pay down a sizable amount of the mortgage, this may be the best route for you.

A closed mortgage means you can’t prepay, renegotiate, or refinance before the end of your term without incurring penalties. Because the lender expects you to make fixed monthly payments, closed-mortgage rates will be lower. A closed mortgage is probably flexible enough for you if you plan to remain a homeowner for a few years and your financial situation is unlikely to change.

Fixed rate, variable rate
A fixed-rate mortgage offers you the security of locking in your interest for the term of your mortgage. This type of mortgage has a fixed term and amortization. You still can make lump sum payments or completely repay the full amount, but there is usually a penalty for doing so. The interest rates are usually lower than variable rates but the terms are not as flexible. You might opt for a fixed-rate mortgage if you are planning to own your home for several years and prefer predictable regular payments.

If you think that interest rates will fall, a variable rate mortgage may be the one for you. If rates drop, more money is put towards your principal balance, which means you’ll pay off your mortgage faster. And in the future, if you think that interest rates have fallen as low as they can go, you can always convert to a fixed mortgage for a small fee. The only disadvantage of this type of loan is if interest rates rise, in which case you’ll be putting your money towards paying the interest instead of the balance of your loan.

Mortgages are so complex these days that it makes good sense to discuss your needs with a mortgage broker or a specialist at your local bank to help you determine which kind of mortgage is right for you.

Finding the best lender
Most people try banks first when looking for a mortgage lender. Banks tend to apply strict standards to a client’s income, credit rating and other qualifications, and some tend to make lending decisions slowly.

Trust companies are usually much more aggressive and willing to provide a better deal than banks. But they’re also quite strict when it comes to income and credit rating.

Mortgage brokers can sometimes offer a lower rate than banks because they usually deal with smaller trust companies, foreign bank subsidiaries, and finance companies. Even a saving of 1/4% to 1/2% can add up to thousands of dollars over a life of a mortgage. On the other hand, if you don’t qualify from a mortgage from a conventional source, a mortgage broker can provide you with a mortgage but will probably charge you a higher interest rate to compensate for the risk. Be aware that there are good brokers and bad brokers, so ask for a referral from your real estate agent, lawyer, accountant, or a friend.

Some mortgage brokers will charge you a fee for finding a lender, others are paid by the lender directly. A good broker can be a great source of information, helping you choose the type of mortgage and terms that make the most sense for you, and guiding you through the process. He or she can also help you present your loan package in the best light, making you more attractive to potential lenders.

An alternative to the traditional mortgage broker is the Mortgage Centre (check out their website at www.mortgagecanada.com, or call 416-633-7447 or 800-282-1169), a company that electronically submits your application to a number of different lenders with a promise of getting you letters of commitment in four hours or less. The Mortgage Centre claims that the financial institutions they deal with know that they’re part of a competitive bidding process, so they’re more inclined to put the best foot forward.

How much should you borrow?
By creating a realistic budget, you can determine the mortgage size you can handle.

Most lenders will typically loan up to 75% of the purchase price, which means that you’ll have to come with 25% for a downpayment. Borrowing 75% or less is called a “conventional” mortgage. Once your loan is approved, you don’t need to get any special insurance and you can bargain for the best rates going.

The only way to know what size mortgage you’re eligible for is to talk to some lenders. Lenders can inform you of the maximum amount that you qualify to borrow, but you shouldn’t necessarily borrow the maximum. You need to consider your overall financial situation, examining your monthly expenses and long-term goals. For example, how much should you be setting aside for your retirement? How much should you be saving each month for your share of the kids’ education? Are you willing to reduce spending money on entertainment or travel in order to pay a mortgage?

You should also be prepared for emergency home repairs or unexpected events. Taking a close look at your budget will tell you how much you can afford to spend on a new home and associated household expenses.

How to save money on your mortgage
There are many ways to save money over the life of your mortgage. Here some of the most common strategies.

Weekly or bi-weekly payments (as opposed to monthly) can save thousands of dollars in interest and cut years off your mortgage. If you pay on a bi-weekly basis (which is probably how your employer pays you, so it’ll also simplify your budgeting), you end up making 26 payments a year, which equates to an extra month’s payment every year. But since the payments are spread out, they’re easier on your pocketbook than trying to come up with an extra month’s payment all at once.
Make extra payments whenever possible. Most lenders allow you to make an annual lump-sum payment (usually about 10% of your principal) that goes directly to reducing the principal. Some offer you the option to increase one payment by any amount up to a maximum of double the regular monthly payment once a year over the term of the mortgage. If you take advantage of these annual payments, you could cut your mortgage in half.
Choose a shorter amortization — a 20-year rather than a 25-year amortization, for instance. The slightly higher payment can reduce interest costs substantially over the life of the mortgage.
Keep making the same payments when interest rates fall. If rates have fallen when your mortgage comes up for renewal — great. Take advantage of renewing at the lower rate, but tell your lender that you want your actual payments to remain the same. Again, this could cut years and thousands of dollars off your mortgage.
Shop around for lower mortgage rates before your current term expires. Your contract with the lender expires at the end of each term — regardless of the length of amortization. So you can change any or all of the terms, or even change lenders. You can get a guaranteed rate offer from another lender that’s good for 60 days, and ask your company to match it. If they won’t, you can take your business elsewhere.

If you don’t qualify
If you’re turned down for a mortgage, don’t give up on the dream of owning your own home. Look at it as incentive to work hard to pay your debts before trying again: the more credit card, auto loan, and other consumer debt you have, the less chance there is of getting a lender to give you a mortgage.

If you are self employed or have been out of the workforce for a while, then you probably won’t be considered an ideal applicant for a mortgage by a bank or other lenders. A way to work around this problem is to make a larger downpayment. If you can put down at least 35%, lenders probably won’t care what your income is. Their thinking is that if you can’t make the payments, they’ll just repossess your property and sell it to recoup their loss.

If low income is the reason you’ve been turned down for a mortgage, you might want to consider getting a co-signer. You can ask parents, relatives, or friends who aren’t in a lot of debt to help you qualify for a larger loan than you could get on your own. Be aware that this is a lot to ask of anyone, so be clear about how you’re going to make your monthly payments before asking anyone to co-sign your mortgage.

You also might want to let your lender know of anything that they might consider to be a problem before applying for a loan, telling them what you are doing to correct the problem. Government Help
In 1995, the federal government created the RRSP Home Buyers’ Plan to allow any Canadian to borrow up to $20,000 from his/her RRSP — without having to pay any tax or interest on it — to put a downpayment on a house.

There are conditions, however: you must repay the money into your RRSP within 15 years, and the minimum you have to pay each year is the equivalent of 1/15 of the amount borrowed. These payments aren’t considered RRSP contributions, so you don’t get any tax write-offs for them. And if you miss a payment, you’ll have to pay income tax on it as though you had withdrawn it directly from your RRSP (which means that the sum is included as part of your income for that year). Other possible drawbacks are: you have to repay the required amount of borrowed funds before you can make a new contribution to your RRSP, so you may have to miss out on substantial tax savings; and you’re not allowed to make an RRSP contribution in the year that you withdraw funds for a downpayment on a house.

If you have never taken advantage of this program, you may be wondering if you can use it after your divorce — even though you may not be a first-time home buyer. The short answer is “maybe.” The RRSP program states that you must have sold your previous residence at least five years prior to the purchase of a new home in order to be eligible for today’s RRSP withdrawal program. You can use your RRSPs for a downpayment, but anything you withdraw would be taxed at your marginal tax rate.

If you’re ineligible or don’t want to dip into your RRSPs, there are other alternatives for you to consider. Offered under the provisions of the National Housing Act, Canada Mortgage and Housing Corporation (CMHC) offers help to people other than first-time buyers by allowing them to make a minimum downpayment of only 5%. If you had to sell your matrimonial home as a condition of your divorce, you would qualify for the 5% minimum downpayment. Anyone who buys or builds a house in Canada as their principal residence is eligible for the lower downpayment as long as they haven’t owned a home during the last five years. The only restriction is the maximum purchase-price of your new home can be no more than $250,000.

To get more information on the RRSP program, review Revenue Canada’s Guide to Entitled Home Buyers Plan for 1998 Participants, which is available from any Revenue Canada tax office. And for more information on the CMHC 5% down program, call (416) 781-2451.

Mortgages (for Canadians)

Determine which mortgage is right for you. There's so much to think about when you're applying for a mortgage. Should you choose open or closed, short or long-term, fixed or variable rates?

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