Financing and Mortgages

Your home will probably be the largest purchase/investment you will ever make and in most cases you will be borrowing money to complete the purchase. There is nothing inherently wrong with debt but it is crucial that you understand the legal and financial implications of borrowing money.

Mortgages

A mortgage is an agreement between a lender (the mortgagee) and a borrower (the mortgagor) whereby the mortgagor receives money to buy a house and agrees to pay the loan back over time with interest. The lender assumes the right to claim the property if the loan terms are not met.

How much can you borrow?

There are two considerations for the financial institution/lender. First, since the property is the collateral on the loan, the institution will typically be willing to lend up to 80% of the appraised amount of the property and you will put up the other 20% as a down payment. This provides the lender with a 20% ‘cushion' should the value of the property drop. However, loans are available on up to 95% of the value of the property. These are known as ‘high ratio' mortgages and must be insured. The interest rate charged on a high ratio mortgage may be higher than on a conventional mortgage due to the higher risk.

The second consideration when determining how much they will lend a buyer is your ability to make the mortgage payments. Lenders typically use two ratios to determine your ability to make the required payments:

Gross Debt Service Ratio (GDSR)

This ratio is calculated by dividing the monthly costs associated with the home such as interest and principal on the mortgage, heating costs and property taxes, by your gross monthly income. As a general rule, this ratio should not exceed 32%. Here is a table that you can fill in to get an idea of your GDSR.

Total Debt Service Ratio (TDSR)

This ratio is calculated by dividing not just your monthly housing costs but also any other household debts such as auto and credit card debt by monthly gross income. As a general rule, this ratio should not exceed 40%. Here is a table which you can fill in to give yourself an idea of your TDSR.

How much should you borrow?

Lending institutions will typically be prepared to lend up to 32% GDSR and 40% TDSR as described above. However, you need to sit down and decide how much you are willing to borrow and still maintain your peace of mind. Based on the ratios you may be able to borrow $500,000 with monthly payments of $3,000 but this might be based on the assumption that you and your spouse are continuously employed. You would want to consider the implications if one of you is not working. There are many cases where families are house rich and cash poor or even worse have lost their homes due to the inability to meet large mortgage payments. You need to seriously consider how much of your monthly income you want to commit to a mortgage payment.

Current Federal Mortgage Insurance

Effective July 9, 2012, the Department of Finance announced four new measures dealing with mortgages and home ownership. These measures were introduced to deal with what was seen as overly aggressive borrowing practices. These measures are currently still inplace.

These measures are:

  • The maximum amortization period for government-backed mortgages will be reduced to 25 years from 30 years for mortgages with loan to value ratios of higher than 80%.
  • The maximum amount that can be borrowed on refinancing of a mortgage will be reduced to 80% of the value of the home from 85%.
  • The maximum Gross Debt-Service Ratio (GDS) will be set at 32% and the maximum Total Debt-Service Ratio (TDS) is lowered to 40%.*

Government-backed mortgages are no longer be available on homes with a value of more than $1 million.

Mortgage Features

Mortgages can be quite flexible and you will need to decide what features will be right for you. Some of the areas where flexibility is available are:

  • Term. This is the period over which the interest payments are fixed (for example, a one-year mortgage vs. a five-year mortgage).
  • Amortization period. This is the period over which the mortgage will be paid off (for example, 20 to 25 years).
  • Payment schedule. You can decide how often you will make payments (for example, weekly or monthly). Paying weekly or semi-monthly will result in the mortgage being paid off more quickly than monthly.
  • Pre-payment options. Most mortgages will allow you to pay off additional amounts if you choose. This will enable you to pay off your mortgage more quickly. Pre-payment maximums will be in place.
  • Portability. This allows you to transfer the mortgage to another property should you buy a new home during the term of the mortgage
  • Open or closed. An open mortgage allows you to prepay the mortgage at any time while a closed mortgage requires the fixed payments over the specified term. You will pay more interest to acquire an open mortgage.

Your advisor can assist you in discussing these various factors and how they can be structured to suit your situation and objectives.

Mortgage Insurance

It is always wise to have life insurance in place to pay your mortgage off if anything should happen to you. You can buy mortgage insurance through your financial institution or buy term life insurance from your advisor or life insurance agent. If you buy mortgage insurance ensure that the costs decline over time as the amount of mortgage you owe declines. Your advisor can help you determine what type of insurance is best for you.

* The GDS and TDS must be calculated using the higher of the contractual rate arranged by the buyer and lender and the Bank of Canada fixed five year rate.