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Mortgage Wise

Last modified: 16 May 2016

Buying a home is more than just a financial commitment. It involves choosing a neighbourhood and community that is right for you. Home ownership may be the biggest investment you’ll ever make, so approach the housing market with a firm understanding of the buying process, your objectives and current market trends.

What can you afford?

Before looking for a home, determine what you can afford. Closely examine your finances. It is important that you consider how much you can afford as a down payment, the total cost of owning and maintaining a home, and whether you will be able to manage your other living expenses as well.

GDS and TDS Ratio

Two simple calculations can help you estimate how much of your income can be allocated to monthly housing costs: the Gross Debt Service Ratio (GDS) and the Total Debt Service Ratio (TDS).

GDS Ratio: Most lenders recommend that you spend no more than 32 per cent of your gross monthly income (before tax) on combined housing costs – monthly mortgage principal and interest, taxes, utility costs and if applicable, 50 per cent of condominium fees.

TDS Ratio: According to most lenders, you should spend no more than 40 per cent of your gross monthly income to service your mortgage and cover other debts and obligations, such as vehicle payments. Keep in mind that these numbers are maximums. Try to keep your housing costs as low as possible for a more affordable lifestyle.

The federal Home Buyers Plan (HBP)

This plan allows first-time home buyers to withdraw up to $25,000 per person from their Registered Retirement Savings Plans (RRSP), without tax liability, to buy a home in Canada. You don’t have to start paying back your RRSP until two years after the purchase of the home. Before cashing in your RRSP to buy a home, weigh the pros and cons carefully. Consider the details of the Home Buyers Plan.

To be eligible for the Home Buyers Plan:

  • You need a written agreement to buy or build a home
  • You intend to occupy the home as your principal residence
  • You are a first time homebuyer
  • Your HBP balance on January 1 of the year you withdraw has to be zero

Talk to a financial advisor. To find out more about this program contact the Canada Revenue Agency.

Extra costs

There is more to buying a home than the down payment and mortgage. You need to budget another 1.5 per cent to 4 per cent of the price of your home for extras associated with the original purchase. Some of these costs include the survey fee, home inspection cost, mortgage default insurance (if applicable), title insurance, property insurance, land registration fees, land transfer tax, legal fees, goods and services tax, moving expenses and closing costs.

Credit report

Before making an offer on a house, you may want to review your credit profile to verify that the information your lender sees is accurate and up-to-date. A credit report gives a snapshot of your financial history, such as your previous and current debts and whether or not you’ve had any problems paying off those debts. Many real estate agents recommend that buyers check their credit report before shopping around for a house.  You can order your credit reports from Equifax and TransUnion.

Pre-approval

Know how much you can afford to pay. Ask for a “pre-approval” from a financial institution. To do this you need to submit your financial information to a potential lender, who then approves you for a predetermined mortgage amount. The pre-approval may guarantee the interest rate for a mortgage taken out during a set period.

Down payment

A down payment is the initial amount of money put towards buying a home. Depending on the type of mortgage, down payments generally range from 5 per cent to 20 per cent of the purchase price for first-time buyers. Keep in mind that the higher your down payment, the lower the interest costs over the life of the mortgage.

Mortgage loan insurance

Mortgages with less than a 20 per cent down payment, known as a high-ratio mortgage, are required by law to be insured against default. If you default on your mortgage, mortgage loan insurance pays back the mortgage lender. Mortgage loan insurance requires the payment of a premium, which is usually added to the amount of your mortgage – another good reason to make a larger down payment.

Interest on mortgage

Interest is the amount added to the amount borrowed to compensate the lender for the use of their money. It is represented as an annual percentage rate applicable to the mortgage. Interest is usually paid to the lender in regular payments along with the repayment of the principal (loan amount).

Example of Interest on Mortgage (Applied Monthly)

Amount to borrow

$250,000

$250,000

$250,000

Interest rate

7%

7%

7%

Years to repay

15

25

35

Payment

$2,233.12

$1751.04

$1,579.66

Total yearly payments

$26,797.44

$21,012.48

$18,955.92

Cost of borrowing

$151,961.60

$275,312

$413,457.20

Getting your mortgage

When shopping for a mortgage, keep your goals and needs in mind. There are many options and a mortgage can be customized to meet your own circumstances.

Open vs. closed mortgage

An open mortgage allows you to pay off as much of your debt as you wish, whenever you want, without being

charged a pre-payment fee. This option allows for flexibility, but interest rates are higher on open mortgages. Closed mortgages have a set term and fixed conditions. With a closed mortgage, you may be able to make some prepayments each year without penalty, and, for agreeing to keep the mortgage for the full term, you may get a more favorable interest rate.

Fixed rate vs. variable rate

A fixed rate mortgage has a set interest rate for the term of the mortgage; the rate does not fluctuate with market changes. With a variable rate mortgage, the interest rate rises and falls from time to time as market rates change.

Other types of mortgages

Second mortgages: A second mortgage is granted when there is already another mortgage registered against your property. If you default and the property is sold, the second mortgage is paid only after the first mortgage has been repaid.  Given the higher risk, second mortgage interest rates are generally higher than those for first mortgages.

Leasehold mortgage: The leasehold mortgage is a mortgage on a home where the land is leased rather than owned. These mortgages must be amortized over a period that is shorter than the length of the land lease.

Collateral mortgage: A mortgage on real estate which is used as security for a loan or line of credit. The funds borrowed can be used to buy a property, or for other purposes such as furniture or home renovations.

Bridge financing: This refers to a special short-term loan needed to cover the time between completing the purchase of a property and finalizing the arrangements to pay.  It is usually used when you are taking possession of the property you are purchasing before completing the sale of an existing property.

Vendor take-back mortgage: The seller offers to lend funds to the buyer for the purchase of the property. The buyer repays the loan directly to the seller at an agreed-upon interest rate.  

Paying off your mortgage

The mortgage amortization period is the number of years it takes to repay the mortgage in full. If your mortgage amortization period is 25 years, it will take 25 years to repay your mortgage. The longer the amortization period, the more you pay in interest.

Tips for paying off your mortgage

  • Contribute as much to a down payment as you can.
  • Make your payments as frequently as possible. Paying weekly or biweekly instead of monthly can save you money over time.
  • Increase your payment amounts. By doing so, you can reduce the length of the amortization period and pay less interest.
  • Take advantage of any annual pre-payment privileges to pay a lump sum on your principal.
  • Choose the shortest possible amortization period and try to reduce it every time you renew your mortgage.
  • The most important consideration in determining the terms for your mortgage should be your monthly household budget.

Prepayment charges

When you sign a mortgage agreement, you are signing a contract with the lender agreeing to pay the amount borrowed at a specified interest rate over the term, or duration, of your mortgage. You may want to break the mortgage contract if you sell your home; if you choose to renegotiate your mortgage to take advantage of lower interest rates; or if you have an opportunity to pay off your mortgage in full early, before the term ends.  If you break your contract, your lender will likely charge a prepayment charge to compensate it for the loss of interest and other costs the lender incurs to reinvest the funds.

Information about the prepayment charge  is outlined in your mortgage agreement and is typically the greater of three months’ interest, or the interest rate differential (IRD). The IRD is the difference between the interest rate on your mortgage contract compared to the rate at which the lending institution can re-lend the money for the remaining term of your mortgage. Your mortgage agreement will tell you how prepayment charges are calculated for your mortgage and will give you a formula to estimate what your prepayment charge would be.  For a more exact estimate, call your lender. Please note that any estimate that your lender provides is only accurate at that time. A day or a week later, the variables used to calculate that estimate could change.  For example, interest rates could change or the remaining term of the mortgage could be different.  These changes affect the amount of the prepayment charge.  

If you commit to prepay your mortgage and set a date for that prepayment, the lender can then fix the charge so that you avoid any subsequent changes.

Resources

Banks in Canada provide a wealth of information for consumers on home buying and mortgages. Visit their websites to learn more.

Publications

  • Buying a Home
    Canada Mortgage and Housing Corporation
  • All About Mortgages
    Financial Consumer Agency of Canada (FCAC)
    (this is a link to all of the FCAC's mortgage publications)

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