All About Mortgages

This information explains the terminology and workings of a mortgage. A mortgage is, in simple terms, a promise to pay back a loan that you negotiate to buy a home. The loan is secured by the property value and your ability to repay the loan. The amount borrowed is called principal, and the cost of borrowing the money is called interest. The borrower is the mortgagor, and the lender is the mortgagee.

Different Types of Mortgages

Conventional Mortgages: Under a conventional mortgage, a lender will normally provide up to 75% of the appraised value or purchase price of a property, whichever is less. You must be able to provide at least 25% of the financing on your own.

Example:

Purchase Price: Conventional Mortgage (75%): Required Down Payment (25%):

$ 200,000. $ 150,000. $   50,000.

High Ratio or Insured Mortgage: A high ratio mortgage finances a higher percentage, up to 95%, of the appraised value or purchase price of the property, whichever is less. This type of mortgage must, by law, be insured against non-payment by either the Canada Mortgage and Housing Corporation (CMHC) or GE Capital. Mortgage insurance protects the lender against loss if the borrower fails to meet the repayment terms. The application fee (between $75 and $235) and insurance premium (approximately 0.5% to 3.75% of the loan) are paid by the borrower. The higher the ratio of mortgage to down payment, the higher the cost of insurance. Mortgage insurance may be subject to provincial sales tax.

Example:

Purchase Price: Down Payment Available: Assuming insurance premium of 2.5% Amount of Mortgage: Assuming Mortgage Rate of 8% Total Interest would equal 8% plus 2.5% equaling 10.5%

$ 200,000.  $ 20,000. $ 180,000.

Your Down Payment

A minimum cash down payment from your own resources is required because mortgage lenders rarely advance the entire purchase price of a property. Your minimum down payment would normally be 10%, however, a government program has lowered the minimum to 5% for qualified buyers. Another program allows first time buyers to use funds from their RRSP for their down payment.

It's to your advantage to aim for a down payment of 25% or more to be able to qualify for a conventional mortgage and avoid paying the mortgage insurance premium. The larger your down payment, the easier it will be to arrange a mortgage and carry it comfortably. The smaller your loan, the lower your interest expense will be, and the more equity you'll have in your home. Equity is equal to the value of the home minus the amount of the mortgage.

Choosing an Amortization Period

Once you've decided on the type of mortgage that fits your financial circumstances, you're ready to start considering the various options available. Amortization refers to the number of years it will take to repay the loan in full, most commonly 25 years. Longer amortization periods result in lower payments, but increase the total amount of interest paid. If you can handle a shorter amortization period, you'll achieve tremendous savings on the interest cost of your mortgage and live mortgage free sooner!

Example: If you have a $100,000 mortgage with an 8% interest

Amortization Period	Monthly Payments	Total of Payments	Total Interest Paid	Interest Savings
25 Years	$ 763.21	$ 228,963.	$ 128,966.	-----
20 Years	$ 828.36	$ 198,806.	$ 98,805.	$ 30,161.
15 Years	$ 948.15	$ 170,667.	$ 70,668.	$ 58,298.
10 Years	$ 1,206.41	$ 144,769.	$ 44,769.	$ 84,197.

Assuming constant interest rate for entire amortization period.

Each mortgage payment consists of interest plus repayment of a portion of the principal. In the early years of a mortgage, a higher portion of your payment is used to pay interest. By the time you reach the last years of your mortgage, almost all of your payment will be applied against the principal.

Deciding on a Term

The length of time for which the interest rate is fixed is called the term. Most mortgages have terms of six months to five years.

Open versus closed term

An open mortgage is one which allows payment of the principal, in part or in full, at any time without penalty. Open mortgages tend to be for a shorter term - usually six months or one year. Since open mortgages offer greater flexibility than closed mortgages, they usually have a higher interest rate.

A closed mortgage requires you to maintain a specific payment schedule. A penalty usually applies if you repay the loan in full before the end of the term.

A convertible mortgage allows you to renew your mortgage at any time without penalty for a longer term, closed mortgage.

Short versus long term

When interest rates are either high or falling, there is a tendency to choose a shorter term mortgage. This strategy pays off if you can renew at a lower rate six months or one year later.

You may want to consider a longer term mortgage if interest rates are rising, if you have a limited income or if you want to keep your mortgage payments the same for a few years.

The effects of interest rates on the term

As a rule, you'll find interest rates rise with the length of the term. The lowest interest rates are usually associated with six-month and one-year closed mortgages. Higher interest rates mean higher mortgage payments.

Example: If you have a $100,000 mortgage and 25 amortization

Payment Options

The three most common payment frequencies are monthly, bi-weekly and weekly. Increasing the frequency of your payments can allow you to pay off your mortgage sooner and reduce the total amount of interest paid.

You should select a payment frequency based on what is convenient for you. You may want to match your payments to your pay periods. If your goal is to pay off your mortgage quickly, consider accelerated weekly or bi-weekly payment plans. You'll make the equivalent of 13 monthly payments each year, rather than 12, and realize significant interest savings. Other options are choosing a shorter amortization period or taking advantage of prepayment privileges.

Example: If you have a $100,000 mortgage, 8% interest rate, 25 year amortization

Payment Frequency	Payment	Total Interest Paid	Interest Saving	Mortgage Free
Monthly	$ 763.21	$ 128,966.	-----	25 Years
Bi-Weekly	$ 351.29	$ 127,720.	$  1,246.	24 yr. 10 mon.
Accelerated Bi-Weekly	$ 381.61	$   98,483.	$ 30,483.	20 years

Savings assume interest rate of 8% for entire 25 years

Prepayment Privileges

Prepayment privileges are voluntary payments in addition to your regular mortgage payments. The money is applied directly against the principal owing, so you'll pay off your mortgage more quickly. You'll also significantly reduce the total amount of interest you would otherwise have paid.

Some examples of options available (check with your lender to see what they offer:
1) You can increase your regular principal and interest mortgage payment by as much as 100%.
2) You can pay up to 15% of the original principal balance in a lump-sum once annually or on the anniversary date.


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Government Assistance

Thousands of Canadians have greatly benefited from government incentive programs geared towards helping first-time buyers realize home ownership.

Programs such as the RRSP Home Buyers Plan, the Ontario Home Ownership Savings Plan, and the 5% Down Payment Plan have all made housing more accessible to first-time purchasers.

RRSP Home Buyers Plan

If you (or your spouse) have not owned a principal residence, you are eligible to participate in the RRSP Home Buyers Plan. Each spouse can withdraw up to $20,000, for a total of $40,000, from their RRSPs under the plan.

Just complete a Form T1036 (available from your Revenue Canada district office) and submit it to your RRSP issuer after signing the agreement of purchase and sale. Once approved, the form gives you permission to withdraw funds from your RRSP without taxes being withheld.

The money you withdraw from your RRSP must be repaid over a period of not more than 15 years to retain your tax deferred status. Payments begin the second year following the year in which the withdrawal is made.

Ontario Home Ownership Savings Plan

If you're an Ontario resident, over 18 years of age, and earning less than $40,000 per annum (or if you and your spouse have a combined income of less than $80,000), the Ontario Home Ownership Savings Plan may work to your advantage.

To qualify, you must open an Ontario Home Ownership Savings Plan at any financial institution across the province by December 31. Funds deposited into the OHOSP will earn interest at competitive rates. Only one OHOSP can be opened per person (joint accounts are not available).

Ontario Home Ownership Savings Plan (OHOSP) tax credits are available on annual contributions of $2,000 individually or $4,000 per couple. Credits vary depending on income and the amount invested in your OHOSP, but generally, you can earn tax credits of up to $500 individually or $1,000 per couple for five consecutive years.

The plan must be closed and the funds used to purchase a home by the end of the seventh year, otherwise you will have to repay your OHOSP tax credit with interest.

5 Percent Down Payment Plan

Having trouble saving for a downpayment? The 5% Down Payment Plan may be the answer.

Purchasers who can easily afford monthly mortgage payments but are having difficulty accumulating a downpayment may be eligible for financing of up to 95 per cent based on the plan. The property must be used as a principle residence and not exceed a pre-established price ceiling.

A maximum total debt ratio of 40 per cent, including mortgage principle, interest, taxes, outstanding loans, and credit cards, exists.


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Planning for Your Purchase - the Extra Costs

You should be prepared for the many costs associated with the purchase of a home. Some of the more common costs, which vary by province, include:

• Legal fees
  
• Fees for the registration of your deed and mortgage
  
• Mortgage processing fees
  
• Mortgage insurance and application fee (if you have a high ratio mortgage)
  
• Home, fire, mortgage life and disability insurance
  
• GST (only on newly constructed homes)
  
• Adjustments for property taxes and/or utility costs already paid by the existing owner
  
• Connection charges for utilities such as gas, electricity and water
  
• Provincial taxes (B.C. only)
  
• Title Insurance premium (optional)
• Land transfer tax
  
• Land survey fee
  
• Home inspection (optional)
  
• Moving expenses
  
• Appliances, furniture, draperies and gardening equipment
  
• Landscaping
  
• Decorating
  
• Repairs

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What about insurance?

When you purchase a home, consider how to protect your investment.

Homeowner's Insurance

Most mortgage lenders insist on fire insurance coverage at least equal to the loan amount or the building value, whichever is less. You should also consider a homeowner's policy which combines fire insurance on the building and its contents with personal liability coverage. Consult your general insurance agent or broker for professional advice on home insurance.

Mortgage Life Insurance

When lenders refer to mortgage insurance, they're referring to coverage that's provided by CHMC or GE Capital for a high ratio mortgage. Mortgage life insurance (MLI) is inexpensive coverage on your life which protects your family or beneficiaries by paying off your outstanding mortgage in the event of your death. For just pennies a day, you will have peace of mind knowing your beneficiaries will be mortgage free.

MLI premiums are based on two factors: your age and the mortgage amount. Your premium is added to your mortgage payment so there's no extra paperwork, and it remains the same until your mortgage is paid off. Joint coverage for spouses is also available.

Disability Insurance

Disability Insurance is important if your mortgage payments depend entirely or in part on your income. Disability insurance provides a replacement income if an accident or illness prevents you from working.

Job Loss Mortgage Insurance

Recently insurance companies have started to offer Job Loss Mortgage Insurance. This insurance covers the mortgage payments in the event that you involuntarily lose your job.


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Home Inspections = Peace of Mind

Buying your first home is one of the most important investment decisions you will make in your lifetime. As such, it makes sound financial sense to enlist the services of a qualified home inspection company to ensure your home is as solid and secure on the inside as it is on the outside.

A home inspection will determine the structural and mechanical soundness of your home. Your home inspector will identify existing and potential problem areas, suggest practical low-cost solutions, and provide estimates regarding costs for any work required. Shortly after the inspection has taken place, a report summarizing the findings is generally provided to the potential buyer.

By commissioning a home inspection prior to purchase, you're protecting both yourself and your investment, as well as buying a little peace-of-mind. Home inspection costs often range according to size, age, and location of the home (approximately $275 to $400). Ask your realtor to recommend a reputable home inspection service or arrange for a home inspector to visit your property.


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Things I would like in my new home

The following is a checklist of characteristics which can be ranked according to what you see as important in your new home. Use this list yourself when touring the internet or share it with your realtor when you are shopping.

0 = not important      5 = moderate      10 = definitely required

Fireplace:
Large Kitchen:
Garage:
Family Room:
Finished Basement:
Parking:
Close to Schools:
Close to Public Transit:
Close to Shopping:
Quiet Street:
Pool:
Air Conditioning:
Large Backyard:
Handicapped Access:
North/South view:
Master Ensuite:
Walk-in Closet:

Age of Home:
Number of Bedrooms:
Number of Bathrooms:

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