Mortgage Insurance
How a Lender Makes Decisions About You

FIRST TIME HOME BUYER

Selecting a Home Type
The Role of the Major Players in your Purchase
Using an RRSP
Getting a Mortgage Pre-Approved Before you Buy
What Type of Mortgage you Should Get
How the Bond Market Affects Mortgage Rates
How Market Changes can Affect Mortgage Decisions
How the Lenders Manage Mortgage Rates and Products

REPEAT BUYER

The Role of the Major Players in your Purchase
The Costs of Purchasing
What Type of Mortgage you Should Get
Paying Off your Mortgage Faster
How the Bond Market Affects Mortgage Rates
How Market Changes can Affect Mortgage Decisions
How the Lenders Manage Mortgage Rates and Products

SWITCHER

What your Current Lender can Do
What Happens Legally When you Switch
What Type of Mortgage you Should Get
Paying Off your Mortgage Faster
How the Bond Market Affects Mortgage Rates
How Market Changes can Affect Mortgage Decisions
How the Lenders Manage Mortgage Rates and Products

REFINANCER

Consolidate Other Debt
Combining Mortgages
Breaking a Closed Mortgage to Transfer to a New Lender
"Blend and Extend" your Current Mortgage
Selling your Home and Not Repurchasing

"Mortgage insurance" is one of the most ambiguous and least understood terms in the industry. This is because it can take on any of the following radically different meanings in different situations:

MORTGAGE DEFAULT INSURANCE

This is a one-time insurance premium you pay when buying a home with less than 25% down payment, or in a few other situations where a lender is not willing to take all the risk of lending you money. Some examples of this might be:

• a non-standard dwelling such as a mobile home on leased land.
• a rural property with non-standard utilities (well and septic systems).
• a multiple-unit dwelling where you may or may not be occupying one of the units.

MORTGAGE LIFE INSURANCE

This is simply regular life insurance which is used to ensure that, in the event of the death of either of the borrowers, the mortgage will be paid off in full from the proceeds. Since this is not mandatory, an important question to ask of any lender who offers it is "who is the beneficiary?". If the lender is the beneficiary, it can be used by them to retire the mortgage in full...which may not be the survivor's desired course of action, particularly if the mortgage is at a much lower rate than the survivor can earn after tax on investments.

MORTGAGE FIRE INSURANCE

All lenders, without exception, require that a fire insurance policy be in effect at the time they fund a mortgage...for the obvious reason that if an uninsured house burns down on a property they have mortgaged, the only remaining value is in the land. While this may not actually cause a loss directly, (due to the high value of many lots) the funds will be unavailable to reconstruct the building, and thus force a sale or re-mortgaging.

MORTGAGE PAYMENT PROTECTION INSURANCE

In recent years, it has become possible to buy income protection insurance specifically to ensure mortgage payments can be maintained in the event of not only disability (now a standard product), but also loss of employment.

Each lender assesses how likely you are to make your payments, and repay your mortgage in full. To make this assessment, lenders will review the following:

CREDIT HISTORY

• Your record of payment on previous and current obligations. Lenders may enquire about your record at the appropriate Credit Bureau.
• The only significant item that does not usually appear on the credit report is how well you've made any mortgage payments in the past. If you have recently had a mortgage, the lender will call the previous mortgagee (lender) directly to confirm your history. This is called a "mortgage rating."

INCOME

• Lenders require that you pay out no more than 27% to 35% of your provable gross income on all shelter costs. This is known as the "Gross Debt Service Ratio."
• You may have other debt, of course, but in combination with shelter costs, the total of all regular payments should not exceed 37% to 42% of your income. This is the "Total Debt Service Ratio."

DOWN PAYMENT

• At least 5% of the value of the property in the case of a purchase, (with a default-insured mortgage), should come from your own savings.

JOB STABILITY

• Quite a separate issue from the amount and type of income is "how stable is the flow of income?" While exceptions are usually made, lenders generally look for several years in the same company, or progressive income increases in a succession of related jobs.

 

	Re-Sale Home (vs. New from Builder)
PRO	Price is lower because of some wear and tear. (which varies greatly - check closely!) You get the benefit of upgrades (finished basement, pool etc.) at a depreciated price. Established neighbourhood..current neighbours/ other variables are a known quantity.
CON	The home has been used by others. There is no "warranty" for major repairs required by law, although it can be specifically arranged. You often inherit someone else's taste in decorating, which can be expensive and time consuming to change at retail prices.

 

	New Home from Builder (vs. Resale)
PRO	You are the first occupants...the house is an empty canvas for you to add your touch. Priced lower than new homes in similar recently completed subdivisions...appreciates as soon as construction is 100% complete. You can choose colours, design features to your own taste as an inclusion in the purchase price, with upgrades negotiable. There is usually excellent protection from defects in construction required by Provincial Law.
CON	There is often an extended period of time without lawns or paved driveways, and with dust from unsodded areas and construction traffic. There can be problems with permits or trade strikes that prevent timely completion and occupancy. Some closing costs apply to new homes that do not exist with resales.

• Keeps track of the latest properties offered on the Real Estate market - through the Multiple Listing Service (MLS) and others - which meet your requirements.
• Investigates properties which appear to meet your requirements and arranges to view them with you.
• Acts as agent for the seller if it is an MLS listed property - unless you agree to have them act as your agent. This is known as Buyer's Agency and means the Realtor is acting specifically and contractually in your best interest - even though the commission is usually still paid by the seller out of the proceeds of the sale.
• Negotiates terms and conditions of your purchase with the agent for the seller (if not themselves) or with the seller directly. (if a private seller or their own listing)
• Arranges to get information for you, or for certain conditions to be fulfilled, as agreed with you, such as; survey, appraisal (for mortgage purposes), and a home inspection report.
• Coordinates closing with the Lawyer, Appraiser, Inspector, and Municipality, as needed.

LAWYER

• Ensures arrangements are in place for funds to be available for closing.
• Ensures all legal requirements of the transaction are fulfilled - Compliance Letter that no outstanding liens or work orders are in effect; Tax Department's release that property taxes are up to date, determines that the current or proposed occupancy usage conforms to local by-laws, etc.
• Coordinates with lenders the setup of legal documents for any mortgage security.
• Ensures that all mortgage terms and conditions are met, and that title is clear in order to make undertakings to lender(s). May obtain title insurance on the buyer's behalf if there is any issue surrounding title that may cause a claim or work order of some kind in the future.
• Arranges with you the signing of legal documents and submission of remaining funds not provided by the Mortgage Lender(s).
• Coordinates closing of the purchase transaction with the lawyer(s) for the seller of the property and the lawyer(s) for the lender(s). Your lawyer is in most cases appointed to act on the lender's behalf.

MORTGAGE LENDER

• Arranges for the funding of a real estate purchase which conforms to their lending criteria. These have been set in conformance with their legally regulated role.
• Arranges for an Appraiser to inspect and evaluate your property.
• Communicates with you and your lawyer to ensure that the value and all their lending criteria and specific conditions for the loan have met to an acceptable degree before providing funds.

APPRAISER

• A legally accredited valuator who inspects, and issues a report to the party who engages them which, with certain conditions:
  • certifies for legal purposes that the price paid by a purchaser reflects the true market value of the property.
  • ascertains on behalf of the lender that the property value supports the mortgage amount requested.
  • provides a purchaser a second opinion relative to their Realtor's assertion as to the value of the market property (to be) purchased.

HOME INSPECTOR

• An individual, not requiring Provincial licensing in most cases, who inspects a property on behalf of a purchaser (usually as a condition of a purchase agreement), t
  • identify the soundness of the structure and any improvements.
  • note any specific deficiencies and their impact on the value of the property.
  • indicate the approximate cost to correct any identified deficiencies.
• Their final product is referred to as a Home Inspection Report

BUILDER'S REPRESENTATIVE

• A sales representative employed by a Builder to arrange the sale of new homes to the buying public. Although they are governed by regular consumer law, their duty is to the builder...they are in fact the Seller's Agent.

(A number of these costs vary by Province, and many change frequently)

2. LAWYER'S FEES
Depends entirely upon the deal between you and your lawyer. Be sure to ascertain exactly what this will amount to in a worst-case situation. Usually ranges from $350 to $2,500 depending upon whether one or more mortgages are to be drafted and registered.

3. LAND TRANSFER TAX
A tax payable to the Provincial Government by the purchaser upon the transfer of title from a seller. In Ontario a simple formula applies*:

• First $55,000; One half percent. (0.5%)
• $55-250,000; One percent.
• Over $250,000; One and a half percent.

4. REGISTRATION FEES
Fees paid to the provincial government for recording a title transfer, mortgage registration or other instrument such as an Assignment or Lien with the local authorities.

5. DEFAULT INSURANCE
This is a Federal requirement for lending institutions which helps many people in Canada purchase their first home, or re-purchase after they have lost equity. If you are buying a home for less than 25% down payment, or in other cases where the lender requires insurance against your possible default, a sliding scale of fees applies, depending on the percentage of the purchase price required in a first mortgage (some minor exceptions). For example, as of May 1997 Canada Mortgage and Housing Corporation (CMHC) and its competitor MICC (operated by GE Capital) charge a 2.5% one-time fee - which can be added to the mortgage - for any mortgage over 85% of the purchase price. 

6. COMPLIANCE LETTER
Required in many municipalities throughout Canada before a property transfer can take place. This is an acknowledgement from the building department that the property either has, or is clear of outstanding work-orders. Work-orders are specific clean-up or fix-up requirements that the owner must complete, particularly before a transfer of ownership.

7. TAX CERTIFICATE
At the time of a sale, the lawyer for the buyer must confirm that local taxes have been paid up to date. If they are, a Tax Certificate is issued, from which any adjustments can be made - usually requiring the buyer to compensate the seller for any prepaid taxes. If they are not up to date, the municipality requires that the seller pay them off from the proceeds of the sale. If there are insufficient proceeds, then it may fall upon the buyer to pay them.

8. PROVINCIAL "NEW HOME WARRANTY PROGRAM" PREMIUMS - NEW HOMES ONLY!
A third party (provincial) warranty program between a builder and a buyer. With the exception of Ontario and Quebec, membership in such a program is voluntary for the builder. Through these programs, your home is guaranteed against defects for at least one year. All homes with a high-ratio insured mortgage (greater than 75% loan to value) must be enrolled in such a program.

9. MISCELLANEOUS MUNICIPAL LEVIES
Special levies can be charged by municipalities to recover the cost of special services, if these services cannot, for some reason, be funded out of general revenues, or apply primarily to homebuyers. Examples: Water meter installation; road improvements, sewer improvements.

10. MORTGAGE APPRAISAL AND APPLICATION FEES
Although often paid by the Lending Institution, these fees (a few hundred dollars each at most, unless the property is exceptional) will usually have to be covered at the time of application for a mortgage.

11. HOME INSPECTION
A report commissioned by a property owner or purchaser, usually to verify the condition of a property prior to the "firming up" of a Real Estate transaction. The scope and detail may vary, but most reports indicate the specific problem and the cost to repair. Unfortunately, no licensing is required, and this service is not specifically regulated other than by general consumer protection legislation. The best safeguard against inadequate work is to ask for the resume of the Inspector, and if possible check references from previous customers.

12. LAND SURVEY
The legal written and/ or mapped description of the location and dimensions of your land. The survey should also show the dimensions and placement on the lot of any structure, including additions such as pools, sheds and fences. An up-to-date survey is often required by a lender as part of the mortgage transaction.

13. CONNECTION CHARGES
Some local utility companies (hydro, gas, oil) charge a fee on closing to connect new buyers up to their service. More normal, however, is an extra charge on the first billing.

14. PROPERTY TAX AND PREPAID UTILITIES ADJUSTMENTS

If the previous owner prepaid property taxes or other utilities, they will be credited the prepaid portion on closing. If they paid all their taxes by April, expect a large adjustment cost on closing!

15. INTEREST ADJUSTMENT (IA)
If you arrange to make your mortgage payments monthly on the first day of the month, and your transaction closes after the first day of the month, your lender may charge you interest on closing up to the first theoretical payment date, called the Interest Adjustment Date (IAD). This can be a sizeable amount, and can often be negotiated down (or away).

16. GST
On new homes only. Fortunately the 7% is almost without exception paid by the builder. Not a bad idea to raise the subject, though. Don't include in your calculation.

 

DESCRIPTION OF TYPES AND HOW THEY APPLY TO YOU

Long-term
	Annual prepayments... traditionally, 10% to 20% of the original princ, ipal balance have been allowed as a lump sum prepayment once a year, often on the "anniversary date". Recently, options of up to 20% of the original balance payable on any payment date have been added to this feature. Finally, the "double-up and skip-a- payment" feature has been included in many offerings. This allows a borrower to "bank" extra mortgage p, ayments for a rainy day, at which time they can just "skip", with the added be, nefit that, if it never "rains", principal is permanently reduced, along with the interest cost Short-term risk and variable If rates are low and stable, and/ or you have decided to take the "staying short" strategy regardless...you can generally pay a significantly lower rate (by up to 2%). This is achieved by simply rolling over your term every 6 months, or having your rate float against prime - with the option of locking in to a longer term at a later date. This is not for everyone, however, as sudden upward rate movements - not unknown in Canada - can cause severe stress. Any term 3 years or longer is considered "lo, ng term" in today's economy. Because long-term rates are usually higher than short-term rates, many Canadians who have a choice do not select this option. There are m, any, however, that consider a long term mortgage necessary due to their exposure to rate inc, reases relative to their inability to manage a significantly higher payment. Split Term A mortgage which allows you to minimize - or hedge - your interest rate risk by splitting y, our mortga, ge into 3 to 5 parts. For example: A $150,000 mortgage could be split into five $30,000 segments with terms of 6 months, 1, 2, 3, and 5 year terms negotiate, d at today's best rates. The average rate (say, 6.25%) would rise or fall much more slowly than chan,, ges in the market, however, as only the shorter terms are affected , by even the most volatile rate movement, is over the first few years. Protected Variable In , 1993 several Canadian Banks introduced the protected variable rate mortgage, which floats at about prime plus 1%, and is, capped , at (i.e. will never exceed) about 1/2% above the posted 5 year rate. It does offer a way to reduce the risk of floating, while preserving an acceptable long-term rate. (This type is also known as the "capped" variable rate mortgage). Prepayment Options Payment changes Most mortgages now allow the amortization to be adjusted by increasing the payment on closed terms by 10% - 20% per year, once annually. Payment Frequency Most mortgages now come with the option to pay , your mortgage at a frequency that matches your cash flow - weekly, bi-weekly or semi-monthly. The added benefit of the "accelerated" weekly and bi-weekly, payments is that by dividing a regular monthly payment into two or four respectively, and deducting it at the new interva, l, an extra payme, nt a year is made directly against principal. The surprising effect of this one extra payment a year is to reduce the amortization of the average mortgage by up to 6 years, with enormous savings of cash at the end of the mortgage term.

SUMMARY

If you are risk-avoider...go for a fixed rate long-term mortgage, or hedge your bets with a protected Variable Rate Mortgage. If you're a risk-taker, simply stay with a short-term mortgage and watch closely for the signal to lock in a longer term deal. Wherever you can stand the additional cash flow requirement, increase your payment frequency and amount, and prepay principal wherever possible. Remember...because mortgage interest is not tax-deductible, every dollar you pay off your mortgage gives you an AFTER TAX RETURN of whatever your rate is, because you're saving interest you'd otherwise have to pay with after-tax dollars!

The single biggest dilemma for Canadian mortgage borrowers since 1992 has been whether or not to lock in to a long term mortgage or stay 'short'. History has shown that, overall, it might have been better to stick with a short term or variable rate mortgage. That, however, is 20/20 hindsight, and many who locked in their mortgage at 6.75% in March of 1994 and then watched as rates zoomed through the roof when constitutional discord ravaged the Canadian dollar, would argue that they got the better of the deal. It remains to be seen what the next decade will hold. Let's consider a few of the dynamics directly affecting rates, and then see how personal mortgage decisions might be affected.

As described in the previous section on bond markets, it is clear to see that accuracy in interest rate prediction can only be judged after all the world's political and economic events have worked their way through the bond market over a period of time. One of the brightest analysts in Canada predicted a cataclysmic National Debt for Canada by the turn of the century, even suggesting that the International Monetary Fund (IMF) would have to place controls over the Canadian currency and foreign borrowings in order to stabilize the situation. Interest rates were confidently predicted by some to be heading back to double digits by the year 2000.

And yet, following severe damage control by the Bank of Canada in the late 1980's and early 90's, through draconian monetary policies, combined with fiscal restraint and heavy cutbacks by the Federal Government, C, anada's financial house appears to be in order, paving the way for stable growth with a well controlled interest rate market.

In Canada, the threat of Quebec separation continues to be the 'wild card' which could tip the balance in terms of whether the Canadian dollar once ag, ain undergoes a ,, prolonged attack. This would force the Bank of Canada to once again defend the dollar by driving up short-term rates and causing Canadian Bonds to be heavily discounted in the , market. This would in turn drive up long te, rm rates as explained in the previous section.

This leads us to the conclusion that there are three basic strategies that Canadians could follow given the current state of the market. Each is represented by a "risk tolerance" on the part of borrowers:

• Stay 'short' with a 6 month convertible or variable rate mortgage, watching for indications that a long lasting upheaval warrants either a long-term lock-in or a 'hedging' strategy. This approach is for the 'risk-taker', or the borrower who can easily absorb significant rate hikes and is prepared to live with a reasonable average over the long haul.

• 'Hedge' your bets by either taking a protected variable rate mortgage with a ceiling half a point above current posted rates; or a split-term mortgage with terms varying from 6 months to 5 years, in amounts which suit your risk tolerance level. This strategy is the best for those that are cautious, and possibly vulnerable to significant rate increases in the near term...or simply partners with different risk tolerances!

• Lock in now, after negotiating your best long term rate - as long as 10 years from some lenders. This dispels all concerns about the direction of the market, and gives the risk- averse borrower an opportunity to reduce their mortgage balance significantly before they are once again exposed to interest rate risk.