Buying a home requires a significant amount. Most homebuyers cannot afford to pay upfront costs, so they take up mortgages. A mortgage is a loan used to buy property. The borrower (homebuyer) agrees to pay back the loan over a set period, typically 25 to 30 years, through regular payments that cover both the principal (the amount borrowed) and interest (the lender’s fee for providing the loan).
Mortgages are secured against the property. This means the lender can take possession of the home if the borrower defaults on their payments. As a first-time home buyer, getting a mortgage may seem complex. That’s why we have created this beginner guide to answer all queries you have about mortgages.
What Is a Mortgage?
If you’re borrowing for the first time, knowing some basic mortgage terms is important. The principal is the initial amount you borrow. Interest is the cost of borrowing this money and is usually given as an annual percentage rate (APR). Your interest rate is influenced by your credit score, down payment, loan term, and the state of the economy.
Amortization is how long it will take to pay off your mortgage fully. The term is how long your current mortgage deal lasts before needing a renewal or renegotiation. Finally, the down payment is the upfront amount you give when buying a home, often shown as a percentage of the home’s price. Knowing these terms can help you handle the residential mortgage with more confidence.
Income
Anyone of legal age can get a mortgage. However, you must prove to the lender that you can afford the amount you want. You must prove that you have a stable source of income that will allow you to make regular mortgage payments. For individuals in employment, the lender may require you to provide pay stubs, tax returns, or a letter from your employer to demonstrate a steady income.
If you are self-employed, you may need to provide additional documentation, such as several years of income statements, tax returns, and business financials. The lender will assess your debt-to-income ratio to ensure you can afford the mortgage payments and other financial obligations.
Credit Score
A credit score is one of the most important factors lenders consider when approving a mortgage. The lender uses it to determine if you are creditworthy. A good credit score tells them you will likely pay them on time.
Your credit score must be at least 600 to qualify for a mortgage in Canada. However, higher scores can improve your chances of approval and get you a better interest rate. If your score is lower, you might still qualify for a mortgage but face higher interest rates or need a larger down payment.
Down Payment
The lender will not pay the entire purchase price of the property. You will pay several costs, including the down payment. In Canada, the minimum down payment depends on the purchase price of the home: The minimum down payment for homes under $500,000 is 5%. For homes between $500,000 and $999,999, it is 5% on the first $500,000 and 10% on the portion above $500,000. For homes $1 million or more, it is 20%.
If you put down less than 20%, you will need mortgage default insurance, also known as CMHC insurance. It protects the lender in case you default on the mortgage. However, the coverage doesn’t protect the borrower in any way. The insurance cost is added to your mortgage payments and can range between 0.6% to 4.5% of the mortgage amount.
Fixed-Rate Mortgage vs. Variable-Rate Mortgage
A fixed-rate mortgage offers stability because the interest rate remains unchanged for the entire term. This makes budgeting easier, as your payments won’t change regardless of market fluctuations. In a variable-rate mortgage, the interest rate fluctuates based on the lender’s prime rate, which is influenced by the Bank of Canada’s interest rates.
Closed vs. Open Mortgages
Closed mortgages come with lower interest rates but restrict how much you can repay during the term without incurring penalties. They are suited for buyers who plan to stay in the home for the entire term. Open mortgages offer more flexibility, allowing you to repay the mortgage fully or make extra payments without penalties. However, they have higher interest rates.
High-Ratio vs. Conventional Mortgages
If you make a down payment of 20% or more, you qualify for a conventional mortgage. If your down payment is less than 20%, you will need a high-ratio mortgage, which requires you to purchase mortgage default insurance. Taking a mortgage can help you achieve your goal of owning a home. However, before applying, you must understand how mortgages work so that you can make informed decisions.
