If you’re buying a home for the first time, it’s important to learn about mortgages and what your options are in financing the purchase. If you have an existing mortgage, you need to be aware of new mortgage rules that went into effect in January, 2018.
This brief guide was prepared to introduce you to mortgage basics in Vancouver, BC.
Banks and Brokers
You can obtain a mortgage directly from a bank, lender, or a mortgage broker. If you have a good long-standing relationship with a bank, qualifying for a mortgage with that institution can prove faster and easier.
Working with a broker, however, offers the advantage of a one-stop-shop where you can learn about various mortgage options in one sitting. Your broker can dig into loan products offered by different lenders to find one that best suits your circumstances.
Types of Mortgage
The basic mortgage types in Canada are the following:
- High-ratio mortgage – This is a loan for home purchases where the down payment is less than 20%. It requires mortgage insurance, the premium for which is typically paid by the borrower.
- Conventional mortgage – In this type of mortgage, the homebuyer makes a down payment of at least 20%. It doesn’t require mortgage insurance and qualifies the borrower for a larger loan than a high-ratio mortgage.
- Open mortgage – This type of mortgage allows the borrower to pay a part of or the entire mortgage earlier than its amortization period without a penalty. The interest rate for this type of mortgage is generally higher than a closed mortgage.
- Closed mortgage – The borrower can pay part or the entire loan amount before the end of the amortization period but with a corresponding penalty. Lenders penalize borrowers since they get their profit from the interests paid throughout the duration of the loan.
- Fixed-rate mortgage – This a type of mortgage where the interest rate and monthly amortizations are the same throughout the term of the mortgage. You get the security of paying the same monthly amortization while the mortgage is in effect.
- Variable rate mortgage – The interest rate for this mortgage type can vary based on the lender’s current prime rate, which then varies depending on bond yields and the Bank of Canada’s overnight rate.
Qualifying for Mortgage
Lenders look at several figures and data to determine how much and what type of mortgage you qualify for. These include:
- Your credit score, which indicates your ability and reliability in paying debts and loans
- Your Gross Debt Service Ratio (GDS), or the percentage of your income that goes to payments for your home, including mortgage amortizations, property taxes, HOA fees, and others. The maximum GDS allowed by major banks and other lenders ranges from 35% to 44%.
- Your Total Debt Service Ratio (TDS), or the percentage of your income that goes to the payment of all your debts, including payments for your home, credit cards, car loans, and others. The maximum TDS allowed by most major banks is 45%, while some lenders do not set a limit.
- Down payment amount – If your down payment is more than 20%, lenders can give you a longer amortization, which can bring your monthly payments down. Conversely, if your down payment is less than 20%, you can expect a higher interest rate and shorter amortization.
New Mortgage Stress Test
A stress test determines your ability to cope with your mortgage payments in cases of unexpected financial problems, such as unemployment, an increase in interest rates, or a financial emergency.
In January 2018, the Office of the Superintendent of Financial Institutions Canada implemented a new mandatory stress test for all mortgage borrowers, whether they’re applying for high-ratio or low-ratio mortgages.
This means that if you’re applying for a mortgage, the lender will test your ability to pay based on the greater of: (1) the Bank of Canada’s 5-year benchmark; or (2) the lender’s contractual rate plus 2%.
Experts say this effectively lowers homebuyers’ estimated ability to pay by around 20%, which means that the maximum home price you’ll quality for is 20% lower than what you’ll likely qualify for before this new regulation. Those with existing fixed-rate mortgages are not affected until the end of their present mortgage term, at which time, renewal of their mortgage may be subjected to the new stress test.