Lecture 10, Purchasing and Financing a Home (Part 2)

Down Payment

Represents your equity investment in the home.

Conventional Mortgage

A mortgage where the down payment is at least 20 percent of the home’s appraised value.

• Lender bears the risk that you may default on the loan.

• Down payment provides a cushion in situations where the lender has to repossess the home and sell it.

High-Ratio Mortgage

A mortgage where the down payment is less than 20 percent of the home’s appraised value.

• Cushion provided by the down payment is much smaller.

• Lender will require that your mortgage be insured.

  • In the event of default, a mortgage insurer insures the mortgage, thereby protecting the lender’s investment.

  • The lender will pass on the cost of the insurance to the borrower.

  • Mortgage loan insurance premium may be paid immediately by the borrower or add to the mortgage

Sources for Non-Traditional Down Payment

• Borrowed money.

• Gifts.

• Lender cash-back incentives.

Closing Costs: Home Inspection Fee

The cost for a report on the condition of the home.

Closing Costs: Appraisal Fee

A cost paid by a home buyer to cover the expense of a professional appraisal, which estimates the property's market value.

Closing Costs: Real Property Report/Land Survey

The cost for a legal document that clearly illustrates the location of significant visible improvements relative to property boundaries.

Closing Costs: Estoppel Certificate

A document which will tell you whether all condo fees (and special assessments) have been paid, whether any interest charges have been paid, and when those fees are normally due.

• A document you should obtain if you purchase a condominium.

• Outstanding costs belong to the condo unit, not the previous owner, and become the responsibility of the current owner.

Closing Costs: Land Transfer Tax

A tax that is imposed by the government when ownership of a property is transferred from one owner to another.

• Levied (i.e., imposed) in Ontario, British Columbia, Manitoba, Nova Scotia, and Quebec (i.e., all provinces except Alberta and Saskatchewan).

Closing Costs: Legal Fees

Charges for a real estate lawyer's professional services.

Closing Costs: Disbursements

The out-of-pocket costs the lawyer pays on your behalf during a home purchase.

Closing Costs: GST/HST

Taxes on the purchase of a brand new home.

Closing Costs: Title Insurance

Protects the insured against loss resulting from an outdated, non-existent, or inaccurate real property report.

Interest Adjustment

Occurs when there is a difference between the date you take possession of your home and the date from which your lender calculates your first mortgage payment.

Closing Costs: Prepaid Property Tax and Utility Adjustments

If the seller has prepaid some bills, either the seller or the buyer will have to reimburse the other party.

Closing Costs: Homeowner’s Insurance

Covers expenses if something unexpected or accidental happens to or in your home.

• The lender will require you to purchase this before the mortgage proceeds are advanced to your lawyer.

Closing Costs: Loan Protection Life and Disability Insurance (i.e., Creditor Insurance)

An insurance that can help pay off or reduce your debt in the event of your death or diagnosis of a covered illness, or help take care of your payments if you are disabled and unable to work due to illness or injury.

Amortization

The expected number of years it will take a borrower to pay off the entire mortgage loan balance.

• The maximum period is typically 25 years for a high-ratio mortgage and as high as 40 years for a conventional mortgage.

• The longer the period, the lower the monthly periods.

Mortgage Term

The period of time over which the mortgage interest rate and other terms of the mortgage contract will not change.

• Typically includes six months and one, two, three, four, five and ten years.

• Will always be less than or equal to the amortization period.

Payment Frequency

The frequency with which you make a mortgage payment.

• Most significant savings are achieved by using the accelerated mortgage payment frequency methods.

Types of Mortgages: Closed Mortgage

Restricts your ability to pay off the mortgage balance during the mortgage term unless you are willing to pay a financial penalty.

• Interest rates are lower than open mortgages.

Types of Mortgages: Open Mortgage

Allows you to pay off the mortgage balance at any time during the mortgage term.

• Interest rates are higher than closed mortgages.

Pre-Payment Privileges in a Mortgage Plan

A feature that allows borrowers to increase their monthly mortgage payment and to pay off a lump sum of the original mortgage balance during the course of each mortgage year.

• e.g., Allow the borrower to increase their monthly mortgage payment during any 12-month period by 20 percent of the original mortgage payment amount.

• e.g., Allow the borrower to make lump sum payments once per year of up to 20 percent of the original mortgage amount.

Fixed-Rate Mortgage

A mortgage in which a fixed interest rate is specified for the term of the mortgage.

• Preferred when interest rates are expected to rise.

• Lenders usually willing to decrease their posted rates.

Amortization Schedule

Discloses the monthly payments, based on…

• A specific mortgage amount,

• A fixed interest rate level, and

• An amortization period.

Allocation of the Mortgage Payment

Each payment includes repayment of a portion of the principal of the loan and an interest payment.

In a fixed-rate mortgage, the larger the mortgage amount…

The larger your monthly payments.

In a fixed-rate mortgage, the lower interest rate…

The smaller your monthly payments.

In a fixed-rate mortgage, the longer the amortization period…

The lower your monthly payments, but the interest payable over the life of the mortgage is higher.

Variable-Rate (or Adjustable-Rate) Mortgage

A mortgage in which the interest charged on the loan changes in response to movements in the prime lending rate.

• May be open or closed.

In a variable-rate mortgage, if the mortgage rate increases…

More of each mortgage payment will go towards interest and less will go toward principal.

In a variable-rate mortgage, if the mortgage rate increases too much…

The mortgage payment may no longer cover the interest portion of the mortgage.

Prime Lending Rate

The rate used by banks to determine the interest rate to charge their customers on variable rate loans.

• e.g., Prime rate + 0.50%.

• Changes in this rate will follow changes in the Bank of Canada target overnight rate.

Costs of Renting

Includes…

• Monthly rent payments.

• Opportunity cost of security deposits.

• Tenant’s insurance.

Costs of Renting

Includes…

• Down payment.

• Monthly mortgage payments.

• Opportunity cost of the down payment.

• Closing costs.

• Maintenance and repair costs.

• Property taxes.

• Homeowner’s insurance.

Mortgage Re-Financing

The act of paying off an existing mortgage with a new mortgage that has a lower interest rate.

• You will incur closing costs again and may have prepayment penalties.

• Advantageous if the savings on your monthly mortgage payments exceed the new closing costs and any prepayment penalties.

Types of Mortgage Re-Financing: Rate Modification (Blend-and-Extend)

In which the fixed-rate mortgage is revised to reflect the prevailing mortgage rate.

• Mortgage lender may charge a one-time fee.

• Avoids costs/penalties associated with mortgage refinancing.

Re-financing tends to be more beneficial when…

A homeowner plans to own the home for a longer period.

• The savings from a lower interest payment can accumulate over each additional year the mortgage exists.