Are you financially ready to buy a home? It may be a good idea to sit down and write a draft household budget. Get a sense of your current monthly expenses. A licensed mortgage broker or bank can also help you determine if you’re financially ready, but there are things you can think about on your own too:
A down payment is the part of the purchase price the buyer pays in cash rather than financing with a mortgage. Buyers typically need a minimum 5% of the purchase price as a down payment. You cannot borrow down payment funds, though a relative can provide you with a gift of a down payment. In that case, you’ll need a letter from your relative (“gift letter”) verifying the down payment funds are a gift and don’t need to be repaid. Other than any such gift funds, you must prove to the financial institution or lender that your down payment is from your own funds.
If your down payment will be less than 20% of the purchase price, you will need a high ratio mortgage and it has to be your primary residence (i.e. you can’t rent it out). Lenders require borrowers to obtain mortgage insurance for high ratio mortgage, since they can be riskier for financial institutions. The insurance will protect your lender in the event you default on the mortgage. If you need a high ratio mortgage, you need to include the cost of the mortgage insurance in the total mortgage amount. Your mortgage insurance premium will vary depending on the size of your down payment relative to the price of the property, but ranges from under 1% of the purchase price to more than 3%. A real estate professional, mortgage broker, or lender can calculate your exact premium, and some websites have calculators available for doing the math yourself. If your down payment is 20% of the purchase price or more, you do not require mortgage insurance.
You need to provide a deposit with your offer to purchase. Your real estate professional can advise you on the deposit amount, and your deposit funds are typically part of your down payment.
Closing costs are separate from your deposit and down payment, and are typically due on possession date, which is the date when the real estate transaction is complete and the property is yours. Closing costs include lawyer fees, property tax adjustments, title insurance (if any), etc. It is a good idea to budget a couple thousand dollars on top of the purchase price as closing costs.
Remember that being approved for a mortgage of a certain amount doesn’t mean you have to spend that much. In fact, many experts believe you shouldn’t max out on the value of your home. You want to leave enough room in your budget in case you have unplanned expenses come up, interest rates rise in the future, or if there’s going to be a period of time when you’re off of work (sickness, parental leave, etc.), you’ll still be able to make your mortgage payments.
News articles often refer to real estate market conditions. You may hear the terms buyer’s market, seller’s market, or balanced market. But what do those mean?
Market conditions affect home prices. Sellers want to get as much for their property as they can and buyers want to pay as little as they can; the market conditions will dictate who has a stronger negotiating position.
Mortgages carry large financial commitments and risks. Mortgage brokers can help you understand your risks and responsibilities as a borrower.
Being a responsible borrower
You need to know and understand how much the mortgage will cost, if you can afford it, and how it will affect your lifestyle.
How’s your credit history?
Your credit history determines your ability to get a mortgage. Lenders ask to check your credit history when evaluating your mortgage application. Keep in mind that too many credit checks over a period of time may have a negative effect on your credit score.
How stable is your income and employment?
Seasonal or contract workers may have more difficulty qualifying for a mortgage. Lenders often want to see stable employment, though there are mortgage products available for those who are self-employed or have less stable income. Mortgage brokers can help you find an appropriate mortgage product.
How much does owning a home cost?
The costs of owning a home are more than just the mortgage payment. There are closing costs, including legal and other fees. Once the home is yours, there are moving expenses, property taxes, insurance, condominium fees, home repairs, and so on. Make sure to include all of these expenses as part of the total cost when you are considering buying a home.
Will owning a home affect other financial and life decisions?
Mortgage payments could limit your ability to manage other expenses. After making your mortgage payments, will you have enough money to pay for the things you might need in the years ahead? You might need a vehicle, wish to travel, have children or add to your family in the future. Will a mortgage prevent you from being able to manage other commitments or goals?
What happens if you cannot make the mortgage payments?
Not paying your mortgage on time and in full can lead to penalty fees, default, and even foreclosure. If you default, the lender has the right to take possession of the property to recover the money still owed on the mortgage. Depending on the circumstances, you may never get the home back and the lender may sell the home.
If this happens, all of your previous mortgage payments, all of the money you invested into the home, and any equity (value beyond what is owed on the mortgage) could be lost. If the lender sells the home for a price that is less than the balance of the mortgage when it went into default, you might even have to pay the difference.
Will your property value increase or decrease?
A home is often a good investment, but not always. Home values fluctuate. A decrease in value can result in losses of equity.
Understanding your mortgage contract
Like most legal contracts, mortgages can be complicated. Make sure you know and understand what you are committing to. Before signing a mortgage contract, you need to understand all of the terms and conditions.
Preapproval vs. mortgage contract
A preapproval is approval for a mortgage based on a borrower’s qualifications made in advance of a real estate purchase. Mortgage preapproval is not a guarantee a lender will enter into a mortgage contract. Once you make an offer to buy a property, the preapproval is subject to you submitting supporting documentation and confirming your financial position. The preapproval is also subject to the property meeting the lender’s requirements. A lender might choose not to offer you the mortgage after more closely assessing you and/or the property.
Total cost of the mortgage
The total cost of the mortgage depends on the terms and conditions for paying it back, such as the interest rate and the amount of time it takes to pay off the entire mortgage, including interest (also known as the “amortization period”). The total cost is typically much more than the amount you are borrowing. You can save money on interest by shortening the amortization period, but this is subject to your ability to afford the resulting increase in payments. The lender or mortgage broker must give you an estimate of the total cost of borrowing for the term of the mortgage.
Finding payment options that work for you
Mortgage payments may occur every week, every two weeks, once a month, or twice a month. Make sure you can handle the frequency, timing, and amount of the mortgage payments. Having higher payments will enable you to pay off the mortgage faster and reduce the total cost of the mortgage, but you need to make sure you can afford the payments and all of your other expenses.
Your interest rate affects the total cost of your mortgage. There are variable, fixed, and convertible interest rates. Variable rates risk going up. Fixed rates may increase when you renew the mortgage.
Watch out for fees and penalties
Not all mortgages are the same. There are often fees and penalties included in a mortgage contract. Understand not only which fees and penalties may apply, and when, but also how the amounts are calculated. There should not be any surprise fees. The broker must disclose in advance all applicable fees.
Pre-payment is when you pay more than the scheduled payment amount or pay off the entire mortgage ahead of schedule. Pre-payments can help you pay off your mortgage back faster, but most mortgages have rules and restrictions. Some do not allow pre-payments and some come with costly penalties.
With mortgages, the borrower agrees to make payments for a specific period of time (the “term” of the mortgage). Ending a mortgage before the term finishes can lead to penalties and fees. The amount of penalties and fees depends on the lender and the mortgage contract.
Review the services included in the mortgage agreement. You may not want all of the services the lender provides. Find out the costs and if any services are optional.
Administration & discharge fees
If you exit a mortgage agreement, renew the mortgage with another lender, or pay the entire mortgage amount early, you may have to pay for the administrative work needed to make the change.
Late payment penalties
Your lender may charge you fees and penalties if you make a late mortgage payment. You should understand both the triggers and the amount of these penalties.
Some mortgage contracts allow homeowners to keep the same mortgage contract (rate and terms) and transfer it to a new home. This is mortgage portability. If your mortgage is not portable, your lender could charge you a penalty if you are moving and ending your mortgage early.
Change in use
Your mortgage might include an agreement on the use of the property. There can be penalties or you may be prohibited from changing how you use of the property (e.g., changing your property from a residence to a place of business or a rental property).
Be prepared for renewal
The agreement with the lender is usually for a limited term (often one to five years) and not for the entire length of the mortgage (i.e., the amortization period). At the end of the term, you will need to renew your mortgage or pay it out. There are no guarantees the lender will renew your mortgage.
Contact your mortgage broker well before you have to renew. If you do not use a mortgage broker, be prepared to look elsewhere to negotiate the interest rate and other terms and conditions.
Being aware of other risks
Be cautious when you agree to a mortgage.
Be completely honest
You must be honest when you apply for a mortgage. All of the information you give to a broker or a lender, including information on the mortgage application documents, must be accurate, complete, and truthful. Errors in your application can easily lead to a mortgage that is not right for you. Misstating facts or providing false information in your mortgage application is illegal and may constitute mortgage fraud.
Do not become a straw buyer
Never pose as the purchaser of a home or apply for a mortgage for someone else. A “straw buyer” is a person that applies for a mortgage for someone else. This is illegal. You will be responsible for the mortgage, it will damage your credit score, the lender could sue you, and you may face criminal charges. If someone asks or offers you money to apply for a mortgage for someone else, say No.
Get a receipt for payments
Never make payments without receiving a receipt. The mortgage brokerage or company is supposed to receive all payments for mortgage broker services, not the individual mortgage broker. If a mortgage broker asks for cash or payment made directly to them, say no and contact the brokerage and the Real Estate Council of Alberta.
Think before using a mortgage to invest in something else
If someone encourages you to take out a mortgage in order to invest in something, make sure you understand all of the risks of the investment. All investments involve a risk that you can lose some or all of your invested money. The mortgage will remain no matter what happens with the investment.
Beware of offers that are too good to be true
Individuals may approach you with offers and services to help you save money on your mortgage. Be careful before agreeing to any plan promising you mortgage savings, especially if it sounds too good to be true. These plans may come with fees and charges that cost more than the promised savings. Your mortgage broker might be able to provide the same advice for free and your lender might be able to offer you the same savings. When in doubt, ask another financial professional or mortgage broker for a second opinion.