Week # 10 Mortgages

Mortgages Agenda

• Overview of mortgage topics:

  • Mortgage Terminology

  • Types & Features

  • Mortgage Approval

  • Mortgage Construction & Calculations

  • Mortgage Refinance

Introduction to Mortgages

• Historical perspective:

  • Older generations dreamed of paying off a mortgage.

  • Today's families aspire to secure a mortgage.

• Definition of Mortgage:

  • Transfer of interest in property as security for debt repayment.

  • Borrower retains the right of redemption upon full payment.

What is a Mortgage?

• A mortgage is a loan for purchasing property.

• Characteristics of a mortgage:

  • Long-term loan paid off over many years.

  • A contract detailing terms and clauses.

  • Allows the lender to possess the property upon non-repayment.

  • The property serves as security for the loan.

Mortgage Participants

• Mortgagor:

  • The homeowner, maintains property possession.

  • No legal title until the loan is fully paid.

• Mortgagee:

  • The lender, holds title until the loan is fully paid (first mortgage).

Mortgage Terminology

• Key terms associated with mortgages:

  • Amortization: Period to repay the loan completely.

  • Equity: Difference between property value and outstanding mortgage.

  • Principal: Original amount borrowed.

  • Interest Rate: Cost of borrowing expressed as a percentage.

Types of Mortgages

Conventional vs. High-Ratio Mortgages

• Conventional Mortgage:

  • Requires a down payment of at least 20% of property value.

  • Generally not insured by CMHC.

• High-Ratio Mortgage:

  • Down payment is less than 20%, insured by CMHC or similar.

  • Insurance premiums range from 0.6% to 4.5% of the mortgage principal.

Down Payment Guidelines

• Varies based on property price:

  • $500,000 or less: 5% down.

  • $500,000 to $1.5 million: 5% on first $500,000 + 10% on additional.

  • $1.5 million or more: 20% of purchase price.

• Possible sources of down payment:

  • Personal savings, RRSP/TFSA, borrowing, and assistance from relatives.

Costs in Purchasing a Home

• Purchases involve various costs:

  • Closing Costs: 1.5% to 4% of the purchase price (legal fees, taxes, etc.).

  • Cash Outlays: Inspections, deposits before mortgage closure.

  • Financed Costs: Mortgage insurance included.

  • Other mandatory costs: property insurance, utility bills, taxes.

Types of Mortgages: Open vs. Closed

Open Mortgage

• Allows prepayments without penalties.

• Can be fully paid off anytime.

Closed Mortgage

• Payments follow a strict schedule, penalties for extra payments.

• Limited prepayments typically allowed.

Fixed Rate Mortgage

• Interest rate locked for the term of the mortgage.

• Maturity at the end of the term (6 months to 7 years).

• Suitable for those who want predictable payments.

Variable Rate Mortgage

• Interest linked to the prime rate (e.g., prime + 1%).

• Rates fluctuate with market conditions, can make additional payments.

Mortgage Repayment Structure

• Amortization: Time to fully repay (max 25/30 years).

• Term: Duration of interest rate and payment schedule (6 months to 7 years).

• Maturity Date: Date to renew the mortgage terms.

Monthly Payment Calculation Example

• Scenario: Carol's mortgage details and calculation approach.

• Reader task: Calculate payment for a different mortgage scenario (e.g., $625,000 mortgage).

Prepayments

Prepayment Privilege

• Up to 10-20% of principal can be prepaid without penalty.

Prepayment Penalties

• Fees apply if exceeded, typically the higher of:

  • Three months' interest.

  • Interest Rate Differential (IRD).

Charge on Property

• Lenders register a lien against the property:

  • First Mortgage: Existing before any other.

  • Second Mortgage: Registered afterward, higher risks, higher interest rates.

Mortgage Features

• Varies by lender:

  • Convertibility, Portability, Assumability, Mortgage Cash Account, Cashback, Interest Capitalization.

Mortgage Refinance

• Ending current mortgage to start a new one.

• Reasons include lower rates, accessing equity, debt consolidation.

Qualifying for a Mortgage

Key Criteria:

1. Security Quality: Appraised property value.

2. Borrower’s Creditworthiness: Measured by the 5 C's (Character, Capacity, Capital, Collateral, Condition).

Credit Approval: The 5 C's

1. Character & Credit History: Conduct and stability.

2. Capacity to Repay: Income level, debt ratios.

3. Capital: Client's net worth.

4. Collateral: Security provided for the loan.

5. Condition: Loan purpose and rates.

Debt Ratios

• Debt to Income (DTI): Indicator of financial health.

  • Low DTI is favorable, indicating lower risk.

• Gross Debt Service Ratio (GDSR): Max 32% of gross income; CMHC limits at 39%.

Mortgage Approval Process

• Mortgage Pre-Approval:

  • Step completed before house-hunting, knowing affordability limits.

• Repayment in Arrears: Failure to pay leads to default, foreclosure, or power of sale processes.

Conclusion & Next Steps

• Prepare for upcoming test (#3, worth 15%).

• Review content on leasing vs buying a car as next topics.