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.