Buying a home? Here’s everything you need to know about conventional mortgage loans
**if you have urgent questions regarding a mortgage or home loan, call (778) 233-2377
All About Conventional Mortgage Financing
What is a conventional mortgage in Canada?
- A conventional mortgage refers to the amount of down payment, or the amount of equity you will be putting into the purchase of your property. A minimum of 20% down is required for a conventional mortgage.
- The value of the loan on a conventional mortgage cannot exceed 80%. In other words, the Loan to Value, or LTV for short, on a conventional mortgage is 80% maximum.
- In other words, in Canada, in order to qualify for a conventional mortgage loan, one of the requirements is that you have a minimum of 20% of the purchase price available, yourself.
Down Payment
- The down payment is the amount of money that you pay up front towards the price of your home. Your mortgage loan covers the rest. In Canada, the minimum down payment for a property purchase is 5% for properties up to $500,000 in value. For the value above $500,000 and up to $999,999.99, the minimum required amount is 10%.
- Mortgages where the Down payment is less than 20% are referred to as high ratio mortgages, and are only available for properties below $1 Million in value.
- For properties that are valued at $1 Million dollars or more, only conventional mortgage financing options are available.
Down Payment Guidelines
Types of down payment that are considered Your Own Sources:
Accumulated Savings:
The last 3 months, or 90 days of applicable chequing or savings account statements with the transaction history, must be provided. The statements must clearly show proof of ownership of the account, the applicants name and account number must be clear. An explanation of any large deposits will also be required during this time frame (this is why the transaction history needs to be visible, as the lender will be looking for this, and has to in fact make note of these). This history is required from each account where the money that is going towards the down payment is held.
RRSP/TFSA/Investment Accounts:
Similar as above, a 90 day history of account statements showing the applicant’s name and account number. RRSP accounts must be at least 90 days old in order to avoid any tax withholding.
Proceeds from a Sale of Property:
A copy of the signed Offer to Purchase, the most recent mortgage statement which confirms the balance outstanding, the payments and whether or not property taxes are included in the payment. The bank may also want to see a current copy of the property title (30 days old max).
Proceeds from Separation/Divorce:
A copy of the divorce agreement, must be signed and finalized. Proof of deposit OR lawyer’s proof of money held in trust.
Inheritance:
Legal documentation and proof of deposit of the funds
Sale of Vehicle or other Asset:
Bill of sale, copy of your previous registration confirming your ownership and proof of deposit into your account/ copy of the bank draft.
Equity from a different property/ HELOC:
proof of ownership (title) of the property and statements confirming the limit/funds available.
Gifted Down Payment:
if your down payment is going to be a gift, it must be from an immediate family member. A gift letter must be signed by all parties, including the persons gifting the money as well those receiving the money. Proof of deposit of the gift will also be required. A banks statement snapshot should be sufficient.
Borrowed Down Payment
So long as you qualify, a portion of the down payment funds can be borrowed. The source of the funds, i.e. an unsecured line of credit for example – a statement will be required. There is a standard that a bank takes unless it is otherwise indicated. For example, for a line of credit, 3% of the balance will be taken as the minimum monthly payment. If the down payment is a loan, a loan agreement with the payment structure will be required, and that payment will be taken as part of the debt service calculations.
Choosing between rate options – fixed, ARM or VRM
The difference between a fixed rate mortgage and a variable rate / adjustable rate mortgage is one of the hottest topics when it comes to mortgages. In fact for most people, payment and rate are the only 2 things they consider when getting a mortgage. Now, your payment and your rate is certainly important, but they are not the only things you should be focusing on. Doing so, can often lead you
to learn the hard lessons of having to pay unnecessary interest and fees on your mortgage. This is not really what we will be focusing on here though, however if you have some questions around this, please do feel free to call us at 778 233 2377.
A fixed mortgage:
A mortgage where the interest rate stays the same (seems obvious, but it is fixed) for the entirety of the term that you choose. Fixed rate mortgages in Canada are available for the following terms 1,2,3,4,5,7&10 years. Most Canadians elect to go with the 5 year term, and about 75% of Canadians choose the fixed rate option. In contrast, in the United States, most mortgages are 30 year mortgages. Especially of late, our friends down south in the United States have joked about our mortgages here in Canada being nothing but Adjustable Rate Mortgages, and when you think about it, this is actually true. Every 5 years you must renegotiate your rate. This is very similar to the ARM rates in the USA that were popular before the 2008 Financial Crisis. Historically, in Canada though, locking in for a greater than 5 year term has proven to be costly for many Canadians. In 2012 and 2013, the 10 year fixed mortgages were in line with the 5 year offerings with a lot of lenders, ranging between 3.59% to 4.14%. Since then though fixed rates have seen lows of 1.59% in 2020. The other thing that comes with these fixed rates are higher penalties to break, within the first 5 years anyways. So, a longer term is not necessarily better, at least in Canada.
The interest rate on a variable rate mortgage is tied to prime, and is therefore subject to change if the bank of Canada decides to adjust interest rates in Canada, by impacting the overnight lending rates that they offer to the big banks. If the overnight band is increased, this tends to impact an increase to the prime rate, and therefore leading to a rate increase. The opposite is true if the bank of Canada lowers their overnight lending rates. Typically both variable and adjustable rates come with a discount in relation to prime. PRIME – 0.5% for example would mean that you would receive half of a percent of a discount of the prime rate. If prime was sitting at 5% for example, then your rate would be 4.5%.
The biggest distinction between the VRM and the ARM (variable and adjustable) is that for the VRM your payment would stay the same, it would be the distraction of the payment going towards principal and interest that would be change. If rates went up, more payment goes to interest and less to principal. And if the rate when down, the principal portion would increase and the interest portion would decrease. With the ARM, your payment would change, it would go up when prime goes up, and down when prime goes down.
When you’re paying more interest and less principal, this will impact the length of time that that it takes to pay off your mortgage completely.
There are 2 different words that refer to key time periods in a mortgage. The mortgage term is the length of time that the mortgage agreement is at your current interest rate. The amortization is the length of time it will take to fully pay off the amount of the mortgage.
Amortization and Term:
Generally speaking, your amortization is a schedule, that can change depending on your payment and the rate. In Canada, the maximum amortization period that you can start with on your mortgage contract is 30 years. We are speaking strictly about a Conventional, institutional mortgage, many private lending options can stretch the amortization to 40 years. In our above example of the variable rate mortgages, where your payment remains the same and your rate increases due to increases to prime, there can be a point where your amortization schedule is impacted, this point is reached when the bulk of the payment is going towards interest and no principal is being paid off.
This can also happen when you are in a fixed mortgage as well. If at the end of your term your interest rate jumps dramatically, your payment has to be adjusted in order to remain on your original amortization schedule.
In order to avoid payment shock, it is often recommended to increase your payments if market rates are increasing relative to your current rate, so that you become used to a higher payment that you may inevitably have to make at renewal, as well as the added benefit of aggressively paying down your principal while the rates are lower.
For payment certainty, fixed rates and variable rates are often preferred – however, as we have discussed, the amortization and payment shock can be a drawback. And with fixed rate mortgages as well, there is a potential for higher penalties to break the mortgage contract. On average, a fixed rate mortgage costs about 4.5% of the current outstanding balance to break, vs 0.5% to 1% for a variable/adjustable rate mortgage. On average in Canada, a mortgage is around $500,000, that can mean a difference of $22,500 vs $2,250 to $5,000.
Open vs Closed Term Mortgages:
An open mortgage can be paid off in full at any time, without penalty, while a closed mortgage allows only limited lump-sum prepayments and includes a penalty if it is repaid in full before the end of its term. The interest rate will be higher on an open term mortgage than with a closed mortgage.
So you get a better rate with a closed term, but are limited on how much extra you can pay towards your mortgage each year. Often closed mortgages come with annual 15% lump sum options, on average. This varies between lenders. Some lenders also only allow the payment to come on the anniversary date of your mortgage, and others permit you to make the payments at any payment date throughout the calendar year. If you pay more than your allotted amount, you will be charged a prepayment penalty. Therefore it is important for you to be aware of your limits and options. Know your limit, stay within it!
There are also other options that come with closed terms, such as payment double ups, which you can take advantage of in conjunction with the lump sum options. Another important point on the lump sums, is that some lenders allow the calculation to be a percentage of the original mortgage balance, and others calculate the lump sum percentage annual of the outstanding balance. Your mortgage is likely never going to be as large as it was at the start so you would want to have a lender that allows the calculations to be a percentage of your original mortgage balance.
Deciding between an open term and a closed term really depends on what your plans are. If you are planning to sell property within a month or two than the open term might be the option for you. For most people however, if you are carrying the mortgage for 3 months or more, the closed option would make the most sense, because the amount you will be saving on interest will be equal to or more than what you will be paying out in a penalty to break the mortgage. Of course you want to know this for sure, so you need to do the calculations. We can certainly help you with this!
Is a shorter term better?
Most mortgages come in a 5 year term and a 30 year amortization nowadays. A shorter mortgage term is referred to terms that are less than 3 years. In order to decide which is better for you, you must make the following considerations.
What do you want from your mortgage? The mortgage that you got when you purchased your place may have been right for you at the time. Like the seasons in the sun, your life has many changes and transitions. You may now be married, expecting your first child, and your needs may now be different than when you were single. Likewise, your needs as a new married couple expecting their first child are different than an empty nester. You may have already or be close to outgrowing your current space and require an upsizing/upgrade. Or on the other hand, you may be looking to downsize. All of these factors and plans need to be discussed and taken into account when choosing you mortgage term.
Shorter term mortgage
You need housing right now, and this is what you can afford right now. Your life can change in a year or two though, and therefore you might want some flexibility with your mortgage. You might have a new baby and feel almost ready for a larger home. Perhaps your elderly parent is becoming more dependent and you might need a larger house for a live in nurse in a couple of years and you want to prepare for this.
You need housing right now, and this is what you can afford right now. Your life can change in a year or two though, and therefore you might want some flexibility with your mortgage. You might have a new baby and feel almost ready for a larger home. Perhaps your elderly parent is becoming more dependent and you might need a larger house for a live in nurse in a couple of years and you want to prepare for this.
Advantages:
Typically a shorter term offers the following advantages:
- lower rate comparatively
- flexibility
- favourable math for penalty calculations
Disadvantages:
A shorter term may have the following disadvantages:
- less stability
risk in an - increasing rate environment
- more transaction costs / fees
Longer Term Mortgages
You may simply not want to be bothered with trying to predict the interest rate market and just want to know what your payments are going to be for an extended period of time. You know how much you have to pay each month, and how long it is going to take for you to pay off your mortgage and this is good enough for you.
Advantages of longer terms:
- Stability
- Easier to budget
- develop a deeper financial history and relationship with your lender
Disadvantages of longer terms:
- rigidity
- higher rate
- potential for higher penalties if you have to break when things don’t go as planned
How to Compare Lenders and Loans
There is nothing wrong with shopping for a mortgage. In fact, we encourage shopping around to ensure that you are getting the best deal possible. There are some key questions that you should be asking when you looking for the best mortgage. In other words, there is a right way and a wrong way to shop for a mortgage, and most Canadians get it wrong.
Inside Scoop on how to do it right!
First: Make sure you are working an experienced professional mortgage professional. The largest financial transaction of your life is far too important to place into the hands of someone who is not capable of advising and troubleshooting the issues that may rise along the way. But how can you tell whether the person you are working with has the necessary experience?
Here are four simple questions your lender absolutely must be able to answer correctly. If they do not know
the answers…RUN…DON’T WALK…to a lender that does
- What are mortgage interest rates based on?
The only correct answer is the Bank of Canada rate for variable mortgages and mortgage backed securities, specialized
mortgage bonds, or Government of Canada Long Bonds for fixed rates. A professional mortgage originator ought to at
least know the basics of how your interest rate is determined. Do not work with a lender who has their eyes on the wrong
indicators, or worse yet, has no idea what the indicators even are. At The Mortgage Specialist, we constantly review
these indicators and you can therefore be confident in our ability to suggest sound mortgage strategies up front and to manage
your mortgage for the long term.
1. What are mortgage interest rates based on?
The only correct answer is the Bank of Canada rate for variable mortgages and mortgage backed securities, specialized
mortgage bonds, or Government of Canada Long Bonds for fixed rates. A professional mortgage originator ought to at
least know the basics of how your interest rate is determined. Do not work with a lender who has their eyes on the wrong
indicators, or worse yet, has no idea what the indicators even are. At The Mortgage Specialist, we constantly review
these indicators and you can therefore be confident in our ability to suggest sound mortgage strategies up front and to manage
your mortgage for the long term.
2. What is happening in the market today, and what do you see in the near future and why?
If a lender cannot explain how Mortgage bonds and interest rates interact and where they are headed, why would you trust
their advice for your costliest investment?
3. What strategy are you recommending and why?
The key here is the word “strategy”. If a lender cannot clearly articulate the strategy behind their recommendations to you
then they are simply quoting a rate, and quite frankly anyone can do that. On your largest investment make sure you are
dealing with someone who has a solid financial plan that is considering your overall financial wellness for you.
4. What commitment are you giving me to personally manage my mortgage over the long term?
This is the most critical question of all. Many lenders, especially bank personnel, have no desire or ability to proactively
manage your mortgage over the long haul. How can you take advantage of changing markets in the future if no one is
watching them for you? What if the long term rate you are considering today drops significantly in a few years? Who will
ensure you don’t miss an opportunity to renegotiate? If you are considering a variable rate mortgage why would you do this
with someone who is not committed to keeping an eye on it? At The Mortgage Specialist we truly believe our real
job begins when your mortgage funds. Anyone can sell you a mortgage but only truly committed mortgage professionals can
manage that mortgage over the long term. With this long term management approach we can significantly reduce your total
cost of home ownership, isn’t that the point?
Closing Costs:
Most experts would tell you to budget between 3%-5% of the purchase price of the home that you are buying, in order to account for closing costs when you are purchasing a home in Canada. Below is a list of the costs that you will need to be aware of when closing on a mortgage. Some of the costs are related solely to when you are purchasing a property.
Property Transfer Tax – this is a tax that the province charges when you are buying a property. It is basically a tax on changing title of a property.
Legal Fees – these are fees related to closing of the legal documents and proceedings, and are charged on both purchases and refinances.
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