Buying your first home can be a little overwhelming. There is so much to learn, and there might be some words you’re unfamiliar with. If you feel like a kid sitting at the grown up table, don’t worry! You are not the only person who feels this way. Here’s the good news: we’re going to help you make sense of everything. We’re starting with the basics: what is a mortgage and how does it work? Keep reading to learn the basics of a mortgage: what it is, how it works and how to get approved.
So what is a Mortgage?
A mortgage is a legal contract made between an individual or business and a bank or other creditor. The bank/creditor will lend money to a mortgagee in exchange for interest to be paid back on the loan, and regular payments to be made on the principal amount. A borrower will assign the property as collateral to provide security to the lender in the event the borrower cannot pay the loan on time or not uphold the contractual obligations outlined in the agreement.
Typically, a mortgage requires a portion of the loan on a property to be paid up front. This is called a down payment and in Canada this requirement can range from a minimum of 5-20% of the principal amount (e.g. $250,000 mortgage with a 10% down payment requirement would be $25,000).
Once this is set up the mortgagee will pay a portion of the cost and interest rate amount in monthly, bi-weekly, or other predetermined frequent payments. In Canada, a predetermined term is set over a certain number of years. This is called an amortization period. This period can be 10, 15, 20, or 25 years. This lets you know exactly how long you have to pay off the debt.
What are the most common types of mortgages available in Canada?
Open Mortgages
Open mortgages can be fully paid off or renegotiated at any time without penalties. They also only carry an amortization period of up to 5 years. Open mortgages do tend to have higher interest rates compared to other types, so they are not as popular.
An open mortgage might be a good choice for you if:
- You plan to pay it off quickly
- Plan to sell the property in the near future
- If you receive extra money at times (i.e. work bonuses, inheritances) that can help pay down the mortgage quickly
Closed Mortgages
A closed mortgage cannot be fully paid off or renegotiated before the end of the term without penalty. This type of mortgage allows you to have a fixed monthly payment, which can help with budgeting. This type of mortgage may allow for pre-payment flexibility. This allows a mortgagee to pay up to a certain percentage annually on top of their set monthly payment, which can slightly reduce the term of the loan. These types of mortgages are the most popular among your average home buyer.
A closed mortgage might be a good choice for you if:
- You plan to keep the property for the duration of the amortization period
- The pre-payment flexibility options fit with the flexibility of extra payments you will be putting towards the mortgage
- You are not worried about penalties
Tips for first-time home buyers
Familiarize yourself with the available programs offered to first-time homeowners in Canada.
- First-Time Home Buyers Tax Credit
- RRSP Home Buyers Plan
- Land Transfer Tax Rebate
Information on each of these is available on the Government of Canada website.
Tips to help you get approved for a mortgage
Build a Good Credit History
Qualifying for a mortgage and buying a home has one very important element: Credit history. This is a record of your behaviours toward repayment of debts. Lenders will check reports recorded through Canada’s credit rating agencies. A bad credit rating history can hinder your ability to be approved for a mortgage.
You can build a good credit history by:
- Paying bills such as utilities and taxes on time and in full
- Paying your credit card bill on time
- Paying more than your minimum payment on your credit cards each month helps build a positive report. This shows that you are able to pay more than the interest that is being charged.
Calculate your Total Debt Service Ratio (TDSR)
Lenders take your current debt into consideration when considering you for a mortgage. They will analyze your current household expenses as well as repayments on other loans such as your car and credit cards. Your total monthly debts and expenses divided by your gross monthly income is your TDSR. For example, if you earn $5,000 per month and your mortgage is $2,000 per month, your TDSR radio is 40%. Lenders ideally like to see a 40% TDSR. If this ratio is higher they are more likely to decline your application for a mortgage. You can easily calculate your TDSR on the Canada Mortgage and Housing Corporation's website.
Get a Pre-Approval on a Mortgage
A mistake that some homebuyers will make is looking at houses outside their budget. One way to not be disappointed by looking at properties that are outside your budget is to apply for a pre-approved mortgage. This allows the lender to review what you qualify for first and how much they are willing to lend you. You can then start house hunting with a sense of confidence, knowing what your budget looks like.
Avoid switching jobs frequently
Try to avoid changes to your employment status. Stable income is critical when a lender is analyzing a mortgage application. Changing jobs can flag the approval process. New jobs often have probation periods. This can be seen as a non-guarantee in income. If you are currently working in an unstable job, or if you’re thinking about changing jobs in the near future, it may be a good idea to delay looking at getting a mortgage for the time being.
If you feel these tips might impact you negatively, don’t be discouraged! It just means you might have to wait a bit longer before getting a mortgage. Look at it this way: the longer you wait to buy a home, the more time you have to save for a down payment.
Get the Right Protection Coverage for Your Investments
If you do find the perfect home and you’re approved for a mortgage, you will need to insure that home. A home is most likely the biggest investment you’ll ever make, so it’s important to protect it!
Consult with an experienced insurance broker from BrokerLink to make buying insurance easier by showing you the best options available for your insurance needs. BrokerLink can give you peace of mind knowing that your assets are protected.
It’s easy to get in touch:
An introduction to mortgages FAQs
What is the difference between a mortgage and a home loan?
Mortgages and home equity loans are similar in that they both use the home as collateral. The difference is a home equity loan is taken out when a borrower already owns or has equity in the property.
What can I use as collateral for my mortgage application?
In a standard mortgage, your home is considered collateral. If you fail to make your mortgage payments and go into default, your lender (usually a bank) has the legal right to your house.
Can I have two mortgages at the same time?
Yes, you can have two mortgages at the same time. For example, you may want to upgrade to a bigger home. You could buy a new home to live in and rent out the first home. In order to secure a second mortgage, your lender will make sure your finances allow this new investment. You can also get a second mortgage on your property that is already mortgaged. To discuss your circumstances, talk to a trusted financial planner.
