Financing – Down Payment, Mortage & Closing Costs

If you are thinking of buying a home, don’t start shopping until you know exactly how much you can afford.  You can find your price range by calculating three amounts:

Canada’s National Housing Act prohibits lenders from loaning the entire amount of a home’s market value, so you will need a cash down payment to cover part of the purchase price.  The Act states that a lender cannot normally provide more than 75% of a homes value unless the mortgage is insured by the Canada Mortgage and Housing Corporation (CMHC) or a private insurance company.  If you qualify for mortgage loan insurance you can borrow up to 95% of a home’s value.  This is called a “high-ratio” mortgage because of the high proportion of borrowed funds versus the cash you bring to the table.

The amount and cost of a mortgage is strongly affected by how much of a down payment you make.  The bigger the down payment, the smaller the loan you will need and the less you will pay in interest over the term.  It makes sense to put down as much as you can afford, but keep in mind there are other costs involved in buying a home.  It is a good idea to have some cash in reserve.

You may be surprised to learn that the cost of moving-up is within your means.  The equity you have already built up in your current home can often handle the down payment for your next home.  Moving-up to a new home can intensify the joys of home ownership.

Mortgage Basics – A mortgage is simply a long-term loan secured using real estate as collateral.  To get a mortgage, you have to fit the criteria that lenders apply to any application for a loan – you need a certain level of income, employment stability, low or manageable debt load, and a good credit history amongst other things.  Even though qualified borrowers can choose from a number of different mortgage options, some things are constant from mortgage to mortgage and lender to lender.

The Interest Rate, Amortization Period and other conditions between the borrower and the lender are specified in a legal document called a Mortgage Loan Agreement.  The agreement stays in effect for a time period called “Term” of the mortgage – usually six months to five years, but sometimes longer.  A typical mortgage amortized over 20 years might end up divided into four terms – say 4 five-year terms – each renewed at the interest rate set by the lender at the time of renewal.

A mortgage is due and payable at the end of a term.  At that time a borrower may either pay off the amount owed, renew the loan with the same lender or change to a different lender.  If borrowers cannot meet their payments, lenders can “foreclose” to take possession of the property before the term is up.

Mortgage Insurance is available through financial institutions and life insurance companies and the cost vary depending on how much of the home’s value is being borrowed.  Mortgage Insurance protects lenders against borrower default and remains in force for the life of the mortgage.

A “pre-approved” mortgage can be set up before you shop and guarantees rate, term, payment periods and other conditions for a certain period of time.

“Fixed rate” mortgagees are structured so that each loan payment is the same amount, based on an  interest rate that doesn’t change during the term.

“Variable rate” mortgages also have standardized payments, but the interest rate can fluctuate from month to month as the Bank of Canada rate varies. When interest rates rise, more of the interest portion is paid and a smaller portion goes toward the principal. In time of falling rates, less interest is paid and more goes to the principal.

“Open” mortgages let you pay off all or part of the principal without penalty before the end of the term, cutting down on your total interest cost. There may be a fee to do this and the interest rate is usually higher than that of a closed mortgage.

“Closed” mortgages allow only regular, agreed-upon payments to be made but usually carry a lower interest rate.

“Assumable” mortgages let Buyers take over a Seller’s loan, with conditions intact, if the Buyer meets the lender’s criteria.

Interest – Interest is what you pay for using a lender’s money and it is usually a percentage of the amount you borrowed.  Theoretically, if you borrowed $100 at 10% annual interest, you would pay $10 per year in interest.  In real life, payments usually pay the interest first and repay some of the money borrowed (the principal), too.  This is called a “blended” payment.  Loan payments are made during a set length of time called the “amortization period”.  Common amortization periods would be 20 or 25 years.  The longer the amortization period, the smaller your monthly payment will be.  However, the amount of the interest paid goes up substantially as the amortization period increases.

Payments – Most mortgage payments are made once a month, but other options would be twice a month, every two weeks, or even in some cases, weekly.  Usually, your principal (the amount still owed) is reduced more quickly if you make more frequent payments and you will end up paying considerably less interest over the full term of the mortgage.

Finalizing  or “Closing” a real estate transaction can involve costs that may come as a surprise if you don’t know what to expect.  There are a variety of fees, taxes and other expenses that require payment before you take possession of your property.

If you are getting a high-ratio mortgage, the cost of ‘mortgage insurance‘ can be paid immediately.  On the other hand, you might have the option of adding the insurance fee to the loan, but then it will cost more because you will pay interest on it over the life of the mortgage.

You will probably pay a fee to your lender to have an ‘appraisal‘ done because most lenders will require an appraisal be done on a property before approving a mortgage.  You will likely have to arrange for pre-paid ‘home insurance‘ too, since you usually can’t get a mortgage without a home-owners’ insurance policy to protect your home and the lender’s investment.

There will be some delay while mortgage documents are being registered in the government ‘Land Titles Office‘.  When that happens you may not get your loan until after the possession date and you may have to pay interest to the Seller on money owed to them at the same rate as your mortgage until they receive the full sale price.

Taxes – No matter where you live, you can’t escape ‘property taxes‘  The tax year is the same as the calendar year, but property tax in British Columbia is generally paid in one amount towards the middle of the year.  Depending on when you take possession, you may have to reimburse the Seller for part of the year if they have already paid the Property Tax Assessment, or you may find the Seller owing you money if you have to pay after you move in.  Either a credit or a debit for taxes will be included in the Statement Of Adjustments prepared by your legal professional at the time of the sale.

You also have to pay a ‘Property Transfer Tax‘ in British Columbia.  Generally, this tax is one-percent on the first $200,000 of the purchase price and two-percent on the remainder.  The only exception is for those individuals who purchase a home and who have never owned property before – anywhere.  These individuals are eligible for the First Time Homebuyers Grant/Exemption.

Additional Services and Costs – A real estate agent’s fee is usually paid by the Seller, but other professional services aren’t.  Almost all home buyers need a legal professional to provide title search, title & mortgage registration, zoning memorandum, a tax certificate amongst other things.  You may also need the services of a surveyor, an engineer, a home inspector or an appraiser.