Photo: James Bombales
Qualifying for a mortgage is a huge milestone for a first-time buyer on the quest to homeownership. In a time of restrictive mortgage rules, federal stress testing and climbing prices, scoring your first mortgage is a tough, but crucial component of the home buying journey.
“We are finding, especially for first-time home buyers, unless they have a large gifted down payment from a family member, [the stress test] is making it very difficult to get into their first home,” says Nicole Daoust, a RBC mortgage specialist based in Barrie, Ontario.
Earning that first mortgage, however, is more than just keeping a healthy credit score and saving for a downpayment; choosing the right mortgage term and amortization, which will have a lasting impact on your mortgage payments and refinancing plans, is a vital ingredient for a mortgage best-suited to your financial needs. How much you should borrow from a lender, and when and how you pay off your mortgage, is at the discretion of the buyer.
“Borrowers should decide for themselves what they’re comfortable spending and not use, ‘What’s the most a lender will lend me?’ as a way to determine how much they should borrow,” says David Larock, an independent mortgage broker.
If you can’t tell the difference between a mortgage term and a presidential term, never fear — the experts are here. We called on Daoust and Larock to explain mortgage terms and amortization, and how to select the best options for you.
What is a mortgage amortization?
Mortgages take years to pay off — we’re talking decades.
During your mortgage-hunt, you will choose an amortization. This is the length of time it will take to pay off your entire mortgage. While amortizations range in length, the average mortgage amortization in Canada is 25 years, according to the Canada Mortgage and Housing Corporation. You could choose an amortization as high as 40 years with a private lender, but CMHC-insured mortgages are capped at 25 years. Under this regulation, if you don’t have 20 percent down payment and your mortgage is insured, you can’t extend your amortization beyond 25 years.
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While the 25-year CMHC cap regulation had minimal impacts on cooling the housing market upon its implementation in 2012, Larock explains that, combined with the federal mortgage stress test, the effects are being felt hard now.
“The challenge now is with the mortgage rules changes and stress test doing exactly what it was intended to do, which is slowing down the market and making houses less affordable, it means people either have to wait until their incomes rise, they have a bigger down payment or they buy a less expensive property,” says Larock.
Canadian home sales falling sharply this year as a result of the stress test prompted some real estate developers and lenders to lobby policymakers to extend the insured mortgage amortization to 30 years. A longer amortization allows a borrower, at the cost of paying more interest over time, to spread out costs and make smaller monthly mortgage payments. Some argue that this change would make it easier for first-time homebuyers with smaller down payments to qualify for mortgages. While the Liberal government chose to forgo this recommendation in its recently released federal budget for 2019, there is still growing pressure on policymakers to provide relief for first-time buyers.
Extending your mortgage amortization out to 30 years could be a benefit for those needing a little wiggle room in their monthly budget, but Daoust explains that this is dependant on the borrower’s lifestyle. Financial restraints, such as a spouse on maternity leave, could be a good opportunity to opt for smaller mortgage payments, but poor budgeting habits or a spotty credit history might mean a 30-year mortgage isn’t the best fit.
“Anybody that has notoriously late payments on their credit and, or run their credit cards to the max … and they’re coming in and wanting a 30-year amortization, it’s not that I’m not going to do it, because of course I will, but I’m going to have a very serious conversation with them at that point,” says Daoust.
What is a mortgage term?
Within a mortgage amortization, there are mortgage terms. A mortgage term, which ranges from six months up to 10 years, is the amount of time you’re locked into a lender, an interest rate and any mortgage conditions. When your mortgage term is up, you can choose to refinance and renegotiate the terms of your mortgage.
Your mortgage term can determine how quickly you’ll pay off your mortgage, but also how much money you could save depending on how often you choose to refinance, at which interest rates and if you opt for a variable or fixed rate. Larock uses the yield-curve, a measure of how much interest is paid over time to borrow money, when examining terms for his clients. For instance, a two-year mortgage term with a fixed interest rate of two percent could save you more interest costs over a longer five-year term with a higher interest rate, but with an added risk of interest rates rising upon refinancing.
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“I would look at that and say, ‘Well, if you take on a two-year fixed rate, you’ve got to come back to the market in two years. So if rates go way up, there’s a risk that you could get significantly higher payments in two years time, but you’re saving a big whack of interest costs over the first two years because you’re getting a big discount for going with only a two-year term,” explains Larock.
If your plans change — you separate from your spouse or want to step out of the property market — you could break your mortgage term, but at a steep cost. Big-five banks will charge you thousands in penalties to break your term, though Larock explains private lenders will charge you significantly less, around $1,600 for a five-year fixed rate in some cases. With a private lender, Larock says the penalties could be worth it to break and refinance if needed.
Avoiding the need to break your term can be done with careful planning. Daoust, who works with a lot of military families who tend to move around a lot, says it could be possible to port your mortgage, where you can pay off the remainder of the term in your new home.
“If you’re relocated within three years, anywhere in Canada, we’re just going to take your mortgage from one house and transfer it to your next house penalty free,” says Daoust.
What will the first mortgage term look like for me?
If you’ve established your mortgage amortization and term, you’re halfway there, but you’ll still need to determine how often you’ll pay your mortgage.
A borrower has several choices with the frequency of their mortgage payments: monthly, bi-weekly, accelerated bi-weekly, weekly or accelerated weekly. Accelerated payments mean that you make an extra payment or two a year at a slightly higher monthly cost, but compared to regular payments, you’ll save thousands in interest and pay off your mortgage more quickly. If you choose a 30-year amortization, Daoust recommends taking accelerated weekly or bi-weekly payments because it costs less than a 25-year amortization.
Photo: James Bombales
“If I’ve got a family where maybe only one of the members is working full-time … then I will for sure do a weekly or bi-weekly payment because then, once again, that is even less than accelerated [payments], even on a 30-year amortization,” she says.
Daoust and Larock both express the importance of properly researching the other expenses of homeownership when choosing how much mortgage to borrow — your utility bills, property taxes and maintenance costs are crucial to factor in. An amortization or mortgage term can’t help you much if you borrow more than you can handle. Instead, Larock encourages homebuyers to frame their thinking in how much they are comfortable spending on their mortgage per month. This way, he says you can avoid house poorness and bidding more than you can pay for in a multiple-offer scenario.
“Borrowers should keep in mind that the lender doesn’t care if you ever save for retirement, go on vacation or take your significant other out for a nice dinner. All they want to know is, ‘Will your income allow you to make our payments?’ and to heck with anything else.”
