You’re probably already familiar with the fundamental concept of obtaining a loan to become a homeowner. But in reality, a mortgage is a rather complex marathon of financial calculations, comparing offers, and various approval stages.
In this article, we’ll explore mortgages in depth, and in simple, comprehensible terms. We’ll go over the mortgage process from start to finish, where to look for the best rates, and the vocabulary you’ll need along the way.
A mortgage is a loan that can be used to purchase property, which in turn acts as security for the loan. A mortgage tends to be for a large sum and is usually paid off over 25 or 30 years.
When you sign up for a mortgage, you’re agreeing to make regular payments. These mortgage payments are comprised of both principal and interest. When a payment is made, it’s first used to cover the interest, then the principal. A mortgage lets the mortgage lender take possession of the property should you fail to make the agreed-upon payments on time.
Once you’ve decided you’d like to buy a home, the next step is to figure out how to pay for it. Unfortunately, most of us don’t have the cash saved up to buy a home outright. That’s where a mortgage comes in handy.
Before searching for a property, it’s a good idea to get pre-approved for a mortgage. When you’re pre-approved, you’ll know exactly how much you can afford to spend on a home. You also reduce your risk since you’re a lot less likely to make an offer on a home you can’t afford. (I’ll talk about the pre-approval process in greater detail later on.)
Once you’re pre-approved for a mortgage, you can go shopping for a home. It’s helpful to make a list of needs and wants. That way you can objectively look at each home when deciding if it’s right for you.
Once you find a home you like, you’ll put in an offer. Once your offer is accepted, you’ll work with your banker or mortgage broker to get the mortgage approval. You’ll need to provide documents and information. The lender will then sign off on everything if they’re good, and you can remove condition of financing from your offer (if applicable).
When is a good time to buy a home and take out a mortgage? A good time is when you’re personally and financially ready. That means you have a steady job, you’re settled in your personal life, and you’re committed to staying put in the same place for the next five or 10 years.
When applying for a mortgage, the lender wants to make sure you can afford it on a monthly basis. The lender does this with two debt ratios: the Gross Debt Service (GDS) Ratio and the Total Debt Service (TDS) Ratio.
The GDS Ratio looks at the percentage of your gross monthly income needed to cover expenses related to the home: your mortgage payments, property taxes, heating and maintenance fees (if applicable). Most lenders are looking for a GDS Ratio below 39%.
The TDS Ratio is similar to the GDS Ratio. It looks at all the same things as the GDS Ratio, however, it also factors in any other debt that you might have. If it’s revolving debt, such as credit card debt or a line of credit, 3% of the outstanding balance is usually used for debt servicing purposes. If it’s an installment loan with a fixed payment (i.e., a car loan, car lease, or personal loan), the payment is used for debt servicing purposes. Most lenders are looking for a TDS Ratio below 44%.
It should be noted that the mortgage payments used in these calculations are higher than you’re actually paying. That’s because the payments are calculated using the inflated stress test rate (currently at 5.25%).
While the GDS and TDS Ratios include some important homeownership expenses, it’s important to also factor in any other big expenses you may have, such as childcare expenses.
There are several routes you can take when hunting for a mortgage, including going to a bank or credit union, or working with a mortgage broker.
As you shop for a mortgage, your gut instinct is probably to go to your local bank branch where you have your chequing account. Banks offer a suite of products and it might be convenient for you to hold all your important finances in the same place. And some banks will offer you extra perks for bundling your mortgage with another product.
That said, if you simply get a mortgage with the existing bank you use for chequing and savings, you might miss out on a more competitive rate that’s offered elsewhere. The mortgage market is very dynamic and it’s always a good idea to shop around. I recommend also checking out the mortgage rates offered by virtual banks (sometimes referred to as ‘direct banks’). Virtual banks don’t have physical branches, and their substantially lower overhead costs typically allow them to offer more competitive mortgage deals than traditional banks, particularly for long-term, fixed-rate mortgages.
Virtual banks will also sometimes offer bundling deals, so even if you don’t bank with a brick-and-mortar institution, there are still mortgage deals for you to jump on.
Another way to shop around is through a mortgage broker. An independent mortgage broker has access to dozens of lenders and can provide you with unbiased advice. Even if you end up choosing your local bank branch in the end, at least you’ll have peace of mind knowing you got a good deal.
The benefit of an online mortgage broker is that they likely have access to many more lenders than your local broker would. The more options you have, the more flexibility you get. With multiple lender options, you’re also likely to find a better rate. Not only that, but if you’ve been denied a mortgage from your bank in the past, you can still search for one through online mortgage brokers.
Homewise is a digital mortgage solution that helps you find the best mortgage options from over 30 banks and lenders. You’ll get support from a personal advisor at every step of the way, including understanding the fine print of your offers. The service is free and the process is done online, 24/7, in all of five minutes.
Breezeful is an online mortgage broker that makes it quick and painless to shop around for different lenders. With an online database of over 30 lenders, Breezeful works to match you with one that best suits your particular needs. You’ll get some of the lowest rates possible, all from the comfort of your own home and faster than your normal, brick-and-mortar banks.
Mortgage Pre-Qualification: This is ideal when you’re only thinking about buying a home. A lender will collect basic information about your finances and then give you an approximate figure for how much they’d potentially be willing to lend you to buy a property.
Mortgage Pre-Approval: Getting pre-approved for a mortgage is more formal than pre-qualifying. In this stage, a lender will verify the financial information you provide them and run a credit check. If you’re pre-approved, it indicates that the lender is committed to providing you with a loan, though the final amount they’re willing to lend you and the terms of the mortgage are subject to change based on an actual property valuation as well as market fluctuations.
The Mortgage Stress Test: This is a calculation of whether you can still afford to pay your mortgage in the event that rates increase. The results of this stress test will determine your qualifications for the mortgage you’re looking to take and applies to all home buyers, including those who make a 20% down payment on their home.
Down Payment: This is the amount of money you’re required to pay upfront when buying real estate. The bigger your down payment, the smaller the mortgage you’ll need. The size of your down payment depends on the purchase price of your home. For example, if you spend less than $500,000 on a home, you’re only required to put 5% of the purchase price down.
Mortgage Rate: This is the interest rate you’ll pay on your mortgage. This will determine how much you pay in interest over the life of your mortgage. Your mortgage rate may change depending on if it’s fixed or variable (more on that below).
Closing Costs: These are expenses that you’re required to pay out of pocket leading up to your closing date. Examples of closing costs include real estate lawyer fees, land transfer taxes, a home inspection, and movers. It’s a good idea to budget between 1.5% and 4% of a home’s purchase price towards closing costs.
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