FIRST TIME BUYER: MORTGAGES, PRE-APPROVAL, PRE-QUALIFICATION AND THE STRESS TEST

CONGRATULATIONS, YOU’VE DECIDED TO PURCHASE YOUR FIRST HOME! BUYING A HOUSE IS AN EXCITING TIME, AND IF YOU ARE LIKE MOST FIRST TIME HOME BUYERS, YOU FEEL EQUAL PARTS EXCITEMENT AND DREAD. FORTUNATELY GETTING A MORTGAGE AND BUYING A HOME ISN’T AS DIFFICULT AS YOU THINK AS LONG AS YOU DO YOUR RESEARCH FIRST.

Download my First Time Home Buyer Guide Here

 

 

 DOWN PAYMENT

Although first-time homebuyers are not expected to pay cash in hand for the entire amount of their first property, you are required to save a down payment. Down payments can range from 5% to 20% of the purchase price.

If you save a down payment of 20% or more, you will qualify for what is known as a conventional mortgage. If you save less than a 20% down payment, your mortgage will require Mortgage Insurance. Mortgage insurance is a one-time payment that protects the lender if you default on your mortgage. This insurance can cost from 1% to 3.10% of the total amount of the funds borrowed.

Of course, not everyone can or wants to save 20% for a down payment on their first home, but by having a larger down payment you can cut the cost of the mortgage insurance. Having a larger down payment will also reduce the monthly interest and principal payment, as well as the total amount of interest you pay over the life of your mortgage.

There are also several government grants and programs that can assist first-time buyers.

First Time Home Buyers’ Tax Credit (FTHB)

The First Time Home Buyer Tax Credit offers a $5,000 non-refundable income tax credit amount on a qualifying home acquired after January 27, 2009. For an eligible individual, the credit will provide up to $750 in federal tax relief.

Home Buyers’ Plan (HBP)

The Home Buyers’ Plan (HBP) is a program that allows you to withdraw up to $25,000 in a calendar year from your RRSPs to buy or build a qualifying home for yourself or a related person with a disability.

GST/HST New Housing Rebate

You may qualify for a rebate of part of the GST or HST that you paid on the purchase price or cost of building your first home, on the value of substantially renovating or building a significant addition onto your existing home, or when converting a non-residential property into a house.

 

MORTGAGE BROKER OR BANK

There are a variety of different ways to obtain a mortgage.

Mortgage brokers, who work as middlemen between mortgage lenders and borrowers to secure financing for homeowners.

OR

Banks with lenders that work directly with homeowners to provide the funding.

So how do you know what is the best option for you?

Most first-time buyers understand that they need to be pre-approved for a mortgage, and most go first to the bank they deal with for their finances for answers; but did you know that there is another option? A mortgage broker is another option that you can use when shopping for a mortgage. Mortgage Brokers often have access to multiple different types of lenders, if you have a specific situation, like a low credit rating, high debt ratio, self-employment, new to Canada, talk to a mortgage broker who may be able to offer you more options than your traditional financial institution.

If you aren’t sure whether to use your bank or a mortgage broker, ask friends and family who own their home who they used, and ask them for referrals to banks or mortgage brokers they have had successful transactions with.

There are pros and cons to both Banks and Mortgage Brokers, both can be the right choice for homeowners, but it comes down to your loan scenario, your individual needs. There are some scenarios in which you have little choice between the two if you have poor credit or a tricky loan scenario.

Before you sign, you should take into consideration mortgage rates, mortgage terms and conditions, and services offered by your mortgage provider.

You can find more information about the pros and cons of both banks and mortgage brokers in my First Time Home Buyer Guide here.

 

MORTGAGE BROKER

1. Free Personalized Service: Mortgage Brokers do not charge you a fee for shopping around for the most competitive rates. Lenders pay them a finder’s fee. You can expect them to assist you with completing your application, providing advice on what documents are needed, what the next steps are, etc. With the growing population of online mortgage brokers, a lot of the time you can do all of your communication via email and phone calls. Mortgage brokers have an incentive to keep you happy and will try to make the process as pain-free as possible for you.
2. Save Time and Effort: You don’t have time to research and negotiate with hundreds of different lenders while shopping for a reasonable rate. Mortgage brokers have access to a large pool of lenders including major banks and private lenders. Unlike the mortgage associates at a bank, they are not “married” to any one lender.
3. Experience: Mortgage brokers have vast knowledge, tools, and lending options at their disposal which they use to secure low-rate mortgages. If you have poor credit or low income, a mortgage broker may be the only resource for obtaining a mortgage.
4. Terms and Conditions: Mortgages come with terms and conditions, repayment terms, porting rules, payment deferral options, and penalty clauses, etc. The lowest rate may come with unfavourable conditions that make them more expensive in the long run. Always ask a mortgage broker about all terms and conditions within your mortgage.

 

BIG BANKS

1. Familiarity: if you have an existing good relationship with your bank you have the benefit of being familiar with bank staff, processes and may be offered exclusive perks and competitive rates for being a loyal customer. As a longstanding customer, you may have some negotiating power.
2. Other Perks: Obtaining your mortgage from a bank opens other opportunities and perks that may not be available through a mortgage broker. These include access to a home equity line of credit (HELOC), bank paying for an appraisal, etc.
3. Trustworthiness Factor: Some people feel more comfortable with the feel of a bank. Major banks are perceived to be “safe” and more accountable for actions.
4. Usually Higher Rates: rates posted by a major bank are traditionally higher than the lowest rate available. If you are unable to negotiate a discount, you may be paying a few extra thousand dollars over the life of your mortgage.
5. Fewer Options: bank loan officers will only consider in-house products when offering you a rate. You lose out on the ability to compare rates across different lenders.
6. Negotiation: Bank loan officers are not obliged to provide you with the best discount on their posted rate. You have to work for it. They get paid a commission on their sales, and the onus is on you to negotiate the best deal you think you can get.
7. Stricter Conditions for Approval: Major banks have more stringent rules in place (for a good reason) for approving mortgages.

 

PRE-QUALIFICATION VS. PRE-APPROVAL

It is essential to understand the difference between being pre-qualified or receiving a pre-approval from a bank or mortgage professional. It can be the difference between purchasing the home you love or walking away from it due to a lack of financing approval.

WHAT’S THE DIFFERENCE?

Mortgage Pre-Qualification is generally a quick, simple process. You provide a mortgage professional with some personal financial information including your income, debts and assets. Based on the information you give the lender will provide you with a tentative assessment as to how much they would possibly be willing to lend you toward a home purchase. Pre-qualification can usually be done over the phone or online and often at no cost.           A pre-qualification is NOT A GUARANTEE.

Mortgage Pre-Approval is a much more significant milestone in the home buying process because a lender is checking your credit and verifying the financial information you have submitted. If you are pre-approved a lender is making a real commitment (subject to conditions and property valuation) to loan you money. You are under no obligation by getting pre-approved, but you want to be comfortable with the amount and terms of your pre-approved mortgage.

Not sure if you have been pre-approved? Ask yourself these questions.

1. Has your credit been checked?
2. Has your income been verified?
3. Has your down payment been confirmed?
4. Do you have written pre-approval from your broker or bank?

If you answered no to any of the questions above you may not be pre-approved, you should contact your bank or mortgage broker to clarify, and should request a pre-approval in writing.

 

WHAT IS THE NEW MORTGAGE STRESS TEST?

So, what exactly is a mortgage stress test you might ask? It’s something that you’re likely to come across, if and when you apply for a mortgage with a traditional lender these days. Recent studies have shown the average level of household debt in Canada has been growing over the last few years. Essentially, with the gradual rise of housing and interest rates across the country, many would-be homeowners have been buying up houses that they won’t be able to afford in the years to come. In fact, according to the Canadian Real Estate Association, the average price of a house in August 2017 was an estimated $472,247, which is a 3.6% increase from last year.

To alleviate the country’s household debt problem, the Office of the Superintendent of Financial Institutions Canada (OSFI) proposed some changes to Canadian mortgage and housing rules in July of 2016. One of which is the implementation of a new mandatory “stress test” for potential homeowners who are borrowing through federally regulated lenders, such as banks. Initially, the test only applied to people applying for high-ratio mortgages, meaning those who weren’t making more than a 20% down payment, and therefore required default mortgage insurance. The test also included homeowners with a mortgage term of fewer than five years. However, as of October 17th of 2017, all candidates, even those applying for conventional uninsured mortgages (more than a 20% down payment), will have to take the test. This new regulation, which refers to both new applicants and current borrowers planning on switching lenders when their mortgage term ends, took effect on January 1st, 2018.

HOW DOES STRESS TEST WORK?

From a financial perspective, a stress test is just how it sounds. It’s a way of testing how you and your finances might be affected by a sudden bout of financial turmoil, such as a loss of employment. When it comes to mortgages, it’s how you, as the potential homeowner, would cope with your mortgage payments if your interest rate rises or you suffer a financial emergency of similar circumstances. Simply put, the stress test forces you to come face-to-face with the very high costs of being a homeowner. So, all potential homeowners will now need to prove they can afford their potential mortgages based on their lender’s minimum “qualifying rate.” For federally regulated institutions, this refers to the Bank of Canada’s current five-year benchmark rate, which as of July 19, 2019, is 5.19%. However, it might also be based on their contract rate (the rate they’ve been quoted and agreed to), plus two percentage points.