Mortgage 101: Knowledgebase and FAQs
- Down payment
See how much money you need for your down payment to get a necessary mortgage. - Down payment financing options: Home Buyers' Plan (HPB)
Find out how you may use your RRSPs for the down payment. - Mortgage payments: interest and principal costs
Learn how your mortgage payments can affect the loan. - Amortization periods
See how an amortization period influences your interest costs. - Different mortgage types and terms
Find out about all your mortgage options before making a final decision. - Fixed and variable interest rates
Make sure you know the differences and see how your decision may affect the payments. - Mortgage payments frequency
Learn how alternative payment options can save you thousands of dollars. - Mortgage default insurance
Get all the necessary information and see the examples of how it works. - Some other insurance options
Find out about other mortgage insurance types you may get. - Cash back mortgage option
Things to pay attention to before making your choice. - What should you do before shopping around for a mortgage?
See if your credit report is in order. - The pre-approval process
Read about how the process works and start the preparation. - Mortgage qualification
Make sure you understand the formulas used to calculate your maximum borrowing limit. - Additional costs
Be ready for the additional costs related to owning a home.
Down payment
A down payment is a sum of money a borrower has to pay when purchasing a house. The rest of the cost is covered by a mortgage loan. It’s highly recommended to decide how much you can put towards the down payment before consulting your lender or a professional mortgage advisor.
The minimum down payment depends on many different factors, especially, the type of house, but usually it’s at least 5% of the total purchase price. In other words, if a house costs $250,000, the minimum down payment will be $12,500.
As a rule, the minimum down payment should be paid by a borrower, although there are other ways to do it, for example, get another loan. And still, it’s certainly better to think about it beforehand and save for a down payment, as it will reduce your potential debts.
Another service that can help you get the money for your down payment is the Home Buyers' Plan (HBP), but you need to have investments in Registered Retirement Savings Plans (RRSPs) in order to meet its requirements.
Down payment resources
There are many resources your down payment can come from, such as:
- Your chequing or savings accounts
- Canada Savings Bonds
- Guaranteed Investment Certificates (GICs)
- Stocks, bonds or other non-registered investments
- Tax-Free Savings Account (TFSA)
- RRSP (under the Home Buyers' Plan)
- Family gifts, or
- some other assets.
Down payment financing options: Home Buyers' Plan (HPB)
In case you’re a first-time home buyer, the Home Buyers' Plan (HBP) may help you solve the problem of your down payment. It’s administered by the Canada Revenue Agency (CRA) and allows you to withdraw money from your Registered Retirement Savings Plan (RRSP) without any taxes.
Of course, there are some requirements you have to meet in order to be eligible for the HBP. To get more information, please, contact CRA.
The maximum sum you can withdraw
- HBP allows you to withdraw up to $25,000 from your RRSP.
- In case you decide to purchase a house together with your spouse, partner, or someone else, each of you can withdraw up to $25,000. In other words you’ll get up to $50,000.
- This withdrawal is tax-free. It won’t be included into your income on your annual income tax return.
How long is the payback period?
- HPB gives you two years after the house purchase without paying back the money to your RRSP.
- You have to pay back all the withdrawals from your RRSP during 15 years. You must make RRSP deposits every year, starting the second year after your withdrawal. Your minimum annual repayment will be determined by CRA. You will also be notified when you need to start paying back the money.
- If you don’t repay the necessary amount in a given year, it will be included into your taxable income, so you'll have to pay income tax on this amount.
Example: HBP repayment
For example, in 2010 Richard withdraws $12,000 from his RRSP to participate in the HBP to purchase a house. It means that Richard’s minimum annual repayment to his RRSP, starting 2012 (2 years after the purchase), will be $800 ($12,000 ÷ 15 years).
If Richard doesn’t make any repayments in 2012, he will have to include $800 in his income when filing 2012 income tax return. In the same time, his minimum yearly HBP repayment will stay the same ($800) for the whole payback period.
On the other part, if Richard makes a HBP reimbursement of $1,500 to his RRSP in 2012, the minimum yearly repayment for the following years will be $750 ([$12,000 - $1,500] ÷ 14 years).
Things to consider before making the final decision
- Can you afford making the annual repayment to your RRSP every year?
If you can’t, then using RRSP funds for buying a house will cost you quite a lot in income tax.
- Can you use your RRSP investments to avoid paying mortgage default insurance and increase your down payment?
If so, you may save much money. For more information, please visit the section on mortgage default insurance.
In this situation your financial advisor or a professional mortgage broker can help you make the decision and find answers to all you questions concerning this topic.
Mortgage payments: interest and principal costs
It’s necessary to understand that at first money from each of your mortgage payments is used to pay the interest on your loan. And only the remaining sum comes to decrease the principal, which is the exact amount that you’ve borrowed.
As a rule, during the first years of your mortgage the largest part of the payment is used to cover the interest costs. In the end, the principal may be reduced by only a small amount. In time your mortgage balance will decrease, and then more of your payment will be used for paying off the principal.
Another important thing to understand is that during a 25-year mortgage the total amount of all your payments may be double the amount that you’ve borrowed (or even more). Of course, the exact sum depends on the interest rate you get.
That’s why it’s always recommended to pay off the principal as soon as possible – this way you’ll definitely save a lot of money. In other words, if you can afford paying off your mortgage faster, you have a chance to save thousands of dollars in interest costs.
Amortization periods
The notion “amortization period” refers to the period of time, necessary for paying off a mortgage in full.
For a long time the longest mortgage amortization period in Canada was 25 years. But now some mortgage lenders offer also other periods, up to 40 years (up to 30 years in case of insured mortgages).
Of course, the longer amortization period you choose, the lower your mortgage payments will be. In the same time, a shorter period will save you a lot of money on interest charges, that’s why it’s better to get the shortest amortization period and the largest payments you can afford. Nevertheless, today real estate prices are quite high, so it’s easier to qualify for a mortgage with a longer amortization.
Here is an approximate table that shows how much interest you can pay on a $150,000 mortgage, depending on the amortization period. For this example, let’s suggest you get an annual interest rate of 5.45%.
The influence of amortization on total interest costs |
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| Mortgage amount | Amortization | Monthly payment | Total interest paid |
| $150,000 | 30 years | $841 | $152,860 |
| $150,000 | 25 years | $911 | $123,368 |
| $150,000 | 20 years | $1,022 | $95,391 |
| $150,000 | 15 years | $1,217 | $69,027 |
| $150,000 | 10 years | $1,620 | $44,360 |
In other words, if you increase your payments by only $70 from $841 to $911 per month, you will pay off your mortgage five years earlier. As a result, you’ll save about $30,000 in interest costs.
If you decide to increase the monthly payment by $181, you’ll be mortgage free even 10 years earlier and save more than $57,000 in interest.
Different mortgage types and terms
A mortgage term is the period of time during which your mortgage agreement is in effect (e.g.5 years). When the term comes to its end and you can’t pay off your mortgage fully at that moment, you’ll need to renew or renegotiate it.
Usually, lenders can offer two kinds of mortgages for different terms: open and closed.
There are certain differences between these two types, mainly concerning the flexibility of making extra payments on the principal or paying off the mortgage faster. Such extra payments are usually called prepayments.
Open mortgages
If you have an open mortgage:
- you’re allowed to make prepayments any time you decide;
- you can pay the mortgage off completely before the end of the term without any penalties;
- In the same time, the interest rate on open mortgages is generally higher than on closed ones.
Closed mortgages
If you have a closed mortgage, there are some limits for you, for example:
- If you want to change your mortgage agreement during the term (for instance, get a lower interest rate), you will have to pay a penalty for breaking your mortgage term agreement.
- Meanwhile, the mortgage lender may allow you to make prepayments without penalties.
- Such prepayment privileges might vary, depending on the lender. One lender may let you put a 20% lump sum payment each year, and in case of another one you may be allowed to put only 10% down every year.
- On the other hand, the interest rate on closed mortgages is usually lower than on open ones.
Fixed and variable interest rates
When you apply for a mortgage, you have to choose a type of interest rate: fixed or variable.
This decision is made separately from the choice of a mortgage type.
Mortgages with a fixed interest rate
A fixed interest rate is determined at the moment you apply for a mortgage. It is the same for the whole term. In this case the sum of your monthly mortgage payments is also fixed.
The benefit of a fixed rate mortgage is that your interest rate does not change during the term, so you know for sure what amount of interest you have to pay (of course, if you don’t make any prepayments).
Mortgages with a variable interest rate
If you apply for a variable interest rate mortgage, you should know that a variable rate can change during the term. It depends on the changes in market interest rates. It means that you can’t be sure about how much of your original loan will be paid off during your mortgage term. Nevertheless, the lender will definitely give you an estimate based on the rate you get at the beginning of the term.
There are two types of regular payments amount with a variable mortgage:
- fixed, and
- variable (the amount changes according to the interest rate tendencies).
The choice of a payment type depends on the lender and the terms of your mortgage.
The benefit of a variable rate mortgage is that variable rates are usually lower than the fixed ones. That’s why this type of mortgage may be quite attractive for the short terms.
In other words, the benefits of your variable rate mortgage depend on whether the market rates rise or fall and it’s very difficult to predict these tendencies. For instance, during the period from 2000 to 2009 the Bank of Canada Bank Rate, which directly affects mortgage rates, varied from 0.5% to 6.0%.
Source: Bank of Canada, Bank Rate
Variable interest rate: tips for getting the best mortgage
Today some lenders may offer you interest rate caps or convertibility features on their mortgage loans. Such options can partially protect you from certain interest rate hikes. But these features become available only after signing a new mortgage agreement.
The notion “interest rate cap” refers to the maximum interest rate a lender can charge on your mortgage, regardless of the current rate increase.
If you have a mortgage with convertibility feature, you’re allowed to convert it into a fixed rate mortgage during the term. Usually, there are no penalties for such a conversion, but in some cases you may face certain requirements, that’s why it’s always better to consult your lender.
Pay attention:If you decide to use the convertibility option, you should know that your new fixed interest rate may be higher than the variable one you had been paying.
Choosing between fixed and variable rate mortgages
Of course, both variable and fixed rates have their own benefits. In order to understand what type of a mortgage rate is the best for you, it’s necessary to consider a few important factors:
| A fixed rate mortgage may be a good choice for you if: | A variable rate mortgage may be a good choice for you if: |
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Mortgage payments frequency
Usually, the majority of financial institutions offer a few different payment frequency options:
- monthly
- semi-monthly
- biweekly
- accelerated biweekly
- weekly
- accelerated weekly
Accelerated type of payments
Both accelerated weekly and accelerated biweekly payments can help you save tens of thousands in interest costs. This way you'll pay off your mortgage even faster, because in the end you’ll make the equivalent of one extra monthly payment each year.
Standard payments
There are different standard payment options, such as:
- weekly
- biweekly
- semi-monthly
- monthly
Actually, there’s no great difference between these types of payments when it goes to the total amount you will pay over a year. In other words, you won’t have much saving if you switch from one standard payment option to another.
Payment options in details |
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| Payment frequency: | Description: |
| Monthly | You make one payment each month for a total of 12 per year. |
| Semi-monthly (twice a month) | You make two payments each month for a total of 24 per year. With this type of payments the total amount you’ll pay over the year is just the same as with the monthly payment. |
| Biweekly (every two weeks) | You make one payment every two weeks. As there are 52 weeks in a year, the total number of payments over the year will be 26 (52 ÷ 2). But in the end the total payment over the year is still the same as with the monthly payment (monthly payment x 12 months ÷ 26). |
| Accelerated biweekly | You make a half of the monthly payment every two weeks. As there are 52 weeks in a year, you will make 26 payments a year (52 ÷ 2). In order to calculate the amount of your accelerated biweekly payments, you should divide your monthly payment by two (e.g. $1,000 ÷ 2 = $500). With this type of payment frequency, you will make the equivalent of one extra monthly payment each year. It means that you’ll pay off your mortgage much faster and save money in interest charges. |
| Weekly | You make one payment each week for a total of 52 payments per year. As a result, the total annual payment stays the same as with the monthly payment. |
| Accelerated weekly | You make one quarter of the monthly payment every week. In order to calculate the amount of your accelerated weekly payments, you should divide your monthly payment by four (e.g. $1,000 ÷ 4 = $250). With this type of payment frequency, you will make the equivalent of one extra monthly payment each year. You’ll also be able to pay off your mortgage much faster and save in interest charges. |
Mortgage default insurance
Mortgage default insurance (in other words, mortgage loan insurance) serves to protect the mortgage lender if you’re not able to pay off your mortgage. So it doesn’t have anything with protecting you.
You have to pay for the mortgage default insurance in case your down payment is less than 20% of the total house price. This type of a mortgage loan is called a high-ratio mortgage.
If you can afford at least 20% of down payment, you’ll get a conventional mortgage. With this type of loan the mortgage default insurance is usually not obligatory. But still, there may be certain exceptions, for example, if you don’t have a regular salary.
Who can provide you with the mortgage default insurance?
There are three main insurers which offer mortgage default insurance:
- Canada Mortgage and Housing Corporation (CMHC)
- Genworth Financial
- Canada Guaranty Mortgage Insurance Company.
If you need to get it, your lender will make all the necessary arrangements for your mortgage default insurance.
How much should you pay?
Of course the premium (the cost of your mortgage default insurance) depends on your down payment amount. It means the higher your down payment percentage is, the lower your mortgage default insurance costs. Generally, mortgage default insurance premiums may range from 0.5% to 3% of the total amount borrowed.
Premium table
CMHC/GE Premiums |
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| LTV | Amortization 25 yrs | Amortization 30 yrs |
| 80% | 1.00 | 1.20 |
| 85% | 1.75 | 1.95 |
| 90% | 2.00 | 2.20 |
| 95% | 2.75 | 2.95 |
It should be noted that in case you have an amortization longer than 25 years, the premium will be a bit higher.
An example of mortgage default insurance premiums
Laura's down payment of $35,000 is 17,5% of the $200,000 purchase price of the home. It means that her down payment is less than 20%, so she will have to get the mortgage default insurance.
Let's assume she has the following mortgage characteristics:
- the premium is added to the mortgage of $165,000
- the insurance premium rate is 2%
- the mortgage will be amortized over 25 years
- the interest rate is 5%.
In this case the mortgage default insurance premium will cost her $165,000 x 2% = $3,300
As a result, the total mortgage loan would be $165,000 + $3,300 = $168,300.
This example shows that mortgage default insurance would cost Laura $3,300 and it would be added to the total mortgage sum. So the monthly payment would increase from $960 to $979. In the end, during the amortization period, the mortgage default insurance would cost her $2,458 more in interest charges.
Some other mortgage insurance options
Mortgage life insurance
This type of mortgage insurance will pay off the rest of your mortgage balance to the lender in case of your death. Mortgage life insurance can be a good choice if you have dependants or a spouse who would like to keep the house after your death, but who might have difficulties with making mortgage payments for you.
Mortgage disability insurance
Mortgage disability insurance will make necessary mortgage payments to your lender in case you can’t work because of a serious injury or illness. It should be noted that many disability insurance plans include several conditions with a list of covered or excluded illnesses or injuries. For example, pre-existing medical conditions are generally not covered by the insurance company. As a rule, you can find these terms in the insurance certificate, so it's recommended to read it carefully before signing the insurance agreement.
The cost of insurance
The total cost of these types of mortgage insurance (life or disability) is called the premium and usually depends on the mortgage amount and your age.
Where can you get mortgage life or disability insurances?
There are a few ways to buy these mortgage insurances. You can get them through your mortgage lender, or use the help of another financial institution. And, of course, it's always better to shop around first in order to be sure you've found the best insurance you need.
Cash back mortgage option
Cash back is an additional mortgage option that pays you a certain percentage of your loan in cash at once. Sometimes it's available in return for a higher interest rate than you would have paid without this option. This feature can be a good thing to consider if you need money for legal fees or furniture. Some financial institutions may allow using it even toward the down payment.
Cash back restrictions
Some lenders can have specific restrictions concerning this option. For instance, you may have to repay the entire cash back amount or some part of it, if you plan to refinance, transfer or renew your mortgage before your term comes to the end. Before making the final decision, please, consult the professional and try to shop around and find the best conditions you can apply for.
What should you do before shopping around for a mortgage?
Before you start searching for the right mortgage, there are a few things to do. First of all, order a copy of your credit report to make sure it's filled correctly and there are no mistakes in it. A credit report shows your financial history. It includes the information about your previous and current debts. The report will also specify whether you've had any problems with paying off your debts. You can also ask your mortgage consulter to run the credit report for you and send it to several lenders without any additional requests.
Your lender will look at the copy of your credit report and then decide whether to approve you for a mortgage. You can always order a copy of your credit report either by mail or by telephone. Moreover, it's absolutely free. There are two main credit reporting agencies in Canada that can provide you with this service: Equifax and TransUnion. In case you decide to do it systematically, you can find out your credit score on-line for a certain fee.
The credit score is another characteristic any lender will want to check. This score reflects your financial situation at a specific period of time. It also shows your potential ability to pay off your debts in the future. The score is based on the information of your credit report. When you apply for a mortgage, the lender may use either the credit score from the credit reporting agency, or use the information in your credit report for calculating your score in compliance with the lender's own formula.
It's necessary to understand that a bad credit score may become a serious obstacle on your way to the best mortgage you want. In this case your lender may refuse to give you a loan, or could approve it for a lower amount or a higher interest rate. Certain mortgage requirements may differ from one lender to another. For example, some lenders may consider your application only if you can afford a large down payment, or if you have a co-signer.
The pre-approval process
Some borrowers prefer to get a pre-approval in order to make sure they'll get the best mortgage they need. A pre-approval is a preliminary discussion with a mortgage lender concerning how much you’re able to borrow and what interest rate you can get. The pre-approval opens new possibilities for you, such as:
- you can lock in an interest rate to protect yourself from an unexpected rate hike before you actually buy a house. The maximum available period of the rate guarantee depends on the lender and may vary from 6 months to 1 year;
If the rates go down before you purchase a home, you still may get the lower rate.
- you can estimate your mortgage payment in order to include it in your budget;
- you will also know the amount of a mortgage that you may qualify for. It will help you not to waste time searching for a house you can't afford.
Nevertheless, a pre-approval doesn't mean you'll get the mortgage loan for sure. When you find a house you'd like to buy, you'll have to convince the lender that this home meets all the necessary standards (e.g. the home's proper condition or market value). Only then you can be approved for the mortgage. The lender may refuse your mortgage application, though a pre-approval for a certain amount was made.
Note that the pre-approved amount is the maximum loan amount you can receive. That's why it's better to search for a house of a bit lower price and not to feel too much limited at the budget.
What do you need for the pre-approval interview?
When you decide to talk to a potential mortgage lender or broker, the following information will be quite useful:
- identification
- proof of employment
- proof of stable salary
- job position and the period of time you're working with the organization - proof of down payment
- recent financial statements, such as bank accounts and investments - your current debt or financial obligations
- credit card balances and limits (store credit cards included)
- child support or alimony amounts
- car loans or leases
- lines of credit
- other loans.
Questions you should ask
- Will you automatically get the lowest rate in case the rates fall while you are pre-approved?
- How long is the pre-approved rate guarantee?
- Can you extend the pre-approval period?
Mortgage qualification
Your financial information, including your income and current debts, will be used by mortgage lenders to see exactly how much they can lend you. In order to determine it, they generally use two financial formulas:
- the gross debt service (GDS) ratio
- the total debt service (TDS) ratio.
and
Pay attention: CMHC has strict guidelines of 32% of your gross income for the GDS ratio and 40% for the TDS ratio. And in case of an excellent credit score, CMHC and certain lenders may allow some exceptions on TDS - up to 44%. These ratios are used by all mortgage lenders for determining the maximum loan amount you can get.
GDS ratio
Gross debt service (GDS) is the percentage of your gross income (before income tax deductions), necessary to cover your housing costs, including mortgage payments, property taxes and heating. As a rule, the maximum GDS ratio is 32% of your gross income.
TDS ratio
Total debt service ratio (TDS) is the percentage of gross income (before income tax deductions) necessary to cover your housing costs, including mortgage payments, property taxes and heating, plus some other debts, e.g. credit card payments, car payments or credit lines. As a rule, the maximum TDS ratio is 40% of the home owner's gross income.
Calculating the GDS and TDS ratios
The mortgage rate used for your qualification depends on many factors, including the amount of your down payment, rate type, term etc. For example, if you can't afford a 20% down payment and are applying for a variable mortgage or a fixed mortgage with the term of less than 5 years, federally regulated financial institutions will tend to use the five-year fixed interest rate for your qualification, even if you want to get a shorter term with a lower rate.
Additional costs
Closing costs
Closing costs are the costs you have to pay at once when you buy a house. As a rule, you must do it before you move in. A professional lawyer will explain to you all the necessary details. Closing costs may include:
- appraisal fees
- legal fees
- title insurance
- land registration fees (also called land transfer tax, deed registration fee, tariff or property purchase tax)
- prepaid property taxes and/or utility bills (to compensate the previous vendor's prepayments)
- survey or Certificate of Location cost
- water tests
- septic tank tests (if necessary).
In the same time, there might be some other additional closing costs, which should be discussed with your lender.
Other up-front costs
Here are some other costs you may have to pay before moving in:
- moving costs
- storage costs
- real estate costs for selling your home (if necessary)
- redirecting mail.
There may also be certain costs you will have to pay right after moving in, for example:
- utility hook-up fees
- basic furniture and appliances
- painting and cleaning.
Ongoing housing costs
There are also certain ongoing costs related to owning and maintaining a house. Actually, these costs may take the biggest part of your monthly budget when you finally settle in. These are the following:
- mortgage payments
- property taxes
- utilities
- property insurance
- renovation costs
- landscaping and maintenance
- repairs.
