So, you’re looking to buy your first home but you don’t quite understand mortgages and all that they entail.
You wouldn’t be the first.
For many soon-to-be homeowners, mortgages, down payments and interest rates can sound more complex than they are. If you’re seriously considering cracking into Canada’s housing market, learning the financial lingo is a good place to start your research. Below, we give you mortgage jargon de-coded:
What is a mortgage?
Simply put, a mortgage is a loan from a financial institution that helps a buyer purchase property. Seeing as most folks don’t have funds equivalent to the price of a home sitting idle, a mortgage helps them purchase a house without having to pay the entire sum all at once. In purchasing that cozy bungalow or spacious family home, buyers have to contribute a down payment and secure a mortgage requiring monthly payments to a lender over a set period or term. Those payments contribute to the overall cost of the home (called the principal) plus the interest (the fee for taking out the mortgage). If the homeowner fails to make their payments, that’s called defaulting. In such case, the bank has the right to repossess the property (known as foreclosure).
A conventional mortgage calls for the buyer to put down 20% of more. Put down less than a 20% down payment and you will be required to pay for the lender’s mortgage loan default insurance — also known as CMHC fees — to protect the lender’s potential loss (of you not repaying the loan).
Getting approved for a mortgage
Before approaching a lender for mortgage approval, check you credit score. Having good credit shows your history of paying back debts proving you likely to reliably make mortgage payments. It’s also wise to seek pre-approval to know how much you’re entitled to and see homes within that realm.
As of 2018 in Canada, prospective buyers have to pass a “stress test.” This new and stricter criteria is a test to see if buyers are able to pay up should there be a hike in interest rates. To do that, the bank applies a five-year posted interest rate — a posted rate is typically higher than the discounted rate most borrowers will get offered. At present, posted rates are about 2% higher than typical five-year fixed rates, which means the “stress test” makes sure that you can still make those monthly mortgage payments at this higher rate, just in case.
Prior to 2018, this stress test was enforced only for those with a less than 20% down payment, but now it applies to all new mortgages. This rule change was part of the government’s strategy to limit housing market debt by increasing the availability of credit.
Not all mortgages are created equal
Mortgages are not one-size-fits-all. Buyers have to know if they want an open, closed or convertible agreement. An open mortgage has a higher interest rate but it allows to buyer to contribute larger payments than the monthly total without being penalized. The owner also has the freedom to pay off the entire sum before the term ends. Interest rates can also fluctuate.
By contrast, a closed mortgage has a lower and set interest rate and a strict window of time. Here, a buyer can be penalized for paying off the home before the end of the term. A convertible mortgage is when the agreement starts off as either of these and switches part-way through.