Demystifying the mortgage process

By Jade Towle

Many Canadians are now choosing to buy a home instead of renting but it is important to understand the ins and outs of the mortgage process before you begin shopping for your new home.  This article attempts to break down the process and offer some tips on how to secure the mortgage that's right for you.

Clearing up existing debt

A safe approach to buying a home is to go in debt free. You need to rid yourself of debt so you are able to cover your monthly payments. First get a copy of your credit report and check for any mistakes or discrepancies the company may have made.  Some common errors that may appear on your credit report include not clearing a balance when a loan has been paid off, listing accounts you are not responsible for, and failing to include a credit account.

It's also essential to get a bank account which allows you to offer proof of adequate funds for closing costs.

Debt-to-income ratios-how much can you afford?

Front-end ratio- shows how much of your gross (pre-tax) monthly income would go toward the mortgage payment. As a general guideline, your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should not exceed 28%of your gross monthly income. Maximum housing expense = annual salary x 0.28 / 12 (months)

Back-end ratio- shows how much of your gross income would go toward all of your debt obligations (mortgage, car loans, child support and alimony, credit card bills, student loans and condominium fees). Your total monthly debt obligation should not exceed 36% of your gross income. Maximum allowable debt-to-income ratio = annual salary x 0.36 / 12 (months)

Shopping for lenders

You'll want to find a lender who offers a reasonable rate that you will translate into a monthly payment and are able to maintain. Find multiple lenders in your area to compare.

Be aware of PMI (private mortgage insurance). This insurance protects the lender (not the purchaser) in case of default. The lender will consider a loan financed at 80% or higher than the value of the house but this results in a greater default risk. Basically, if you fail to make an initial down payment of at least 20%, you're paying PMI. Eg. If a home costs $200,000 and you are able to make a 10% down payment, you'll be paying at least $100/month for PMI alone.

Before you start

Pre-qualification is the first step you can take - but it's not mandatory. If you want an estimate of how much a bank will loan you so you can shop within your price range, pre-qualification is a quick and easy way to find out. Most banks and credit unions will do this over the phone, and your credit history will usually not be checked. A loan officer asks you about your income, assets, debt and projected down payment and then calculates what kind of loan you'd likely qualify for.

Pre-approval is more involved and usually requires an appointment. In this step, the lending institution gathers all the information it requires to offer you a loan, and your credit report will be checked; you may be charged a fee for this at the time of the appointment.The pre-approval step may be a bit time-consuming, but you'll need to complete it with a few lenders in order to comparison-shop. You''ll need to bring some items with you to document your identity and your assets:

• A copy of your most recent bank statements (this includes your daily checking account as well as any money market, savings or other accounts)
• Your most recent W-2 (or entire tax return if you're self-employed)
• Proof of IRAs or retirement accounts and their current balances
• Also, for any stocks or mutual funds you own outside of retirement accounts
• Your driver's license
• The most recent month's paystub(s) from your job
• An application fee (this depends on the lender)

Amortization verses terms

Amortization is the length of time it would take to pay off a mortgage assuming all payments were made, the interest rate hadn't changed and no additional payments were made.

Term is the period of time that you will pay a set interest rate. (5 months, 10 years, etc). At the end of the term, you will renew your mortgage for a new term at the prevailing rates of interest.

Mortgage broker verses bank

From the consumer's standpoint, the difference between a broker and a bank is minimal. Both explain various loan types, help the borrower select one, collect applications, support paperwork and keep in contact until closing day.

• A mortgage broker is a middleman who may represent the mortgage loan products of hundreds of different lenders
• A bank is a direct lender; that is, bank employees alone review your application and make the decision to lend you money.
• Variety: By shopping across a range of different programs and lenders, a mortgage broker may find you a better fit than a mortgage bank.
• Reliability: You probably know and trust your local bank. It is regulated by state and federal agencies and likely has strong ties with your community.
• Qualifying: A mortgage broker can best steer you to the national or regional lenders that are most likely to accept your application based on your financial and personal information.
• Savings: As the loan originator, a bank may save you money in the loan process and/or offer you better terms based on your total assets on deposit with the bank.
• Speed: A broker saves you time shopping for a loan. A bank also may process your loan faster than other providers.

Types of loans

• Fixed rate: Most commonly used, interest rate does not change over a period of time (usually 30 or 15 years)
• Adjustable rate: offers a lower rate for a set period (3-1, 5-1) but after this time, the rate could easily increase to twice as much, depending on the economy.
• Subprime: much higher rates than equivalent prime loans and more likely to have a prepayment penalty, a balloon payment, or both.

Closing costs:

These are some up-front fees that you need to be ready for:

• Prepaid property taxes and/or utility bills: to reimburse the vendor for pre-paid costs such as property taxes, filling the oil tank, etc.
• Appraisal fee: your mortgage lender may require that the property be appraised at your expense. An appraisal is an estimate of the value of the home. The cost is usually between $250 and $350 and must be paid when you contract for those services.
• Estoppel certificate fee (not applicable in Quebec): this applies if you are buying a condominium or strata unit and could cost up to $100.
• Deposit: this is part of your down payment and must be paid when you make an offer to purchase. The cost varies depending on the area, but it may be up to 5% of the purchase price. If you wish to make a down payment of 5% and you give a deposit of 5%, then your down payment is considered to be made.
• Home inspection fee: remember that this may be a condition of your offer to purchase. A home inspection is a report on the condition of the home and generally ranges around $500, depending on the complexities of the inspection.
• Survey or certificate of location cost: the mortgage lender may ask for an up-to-date survey or certificate of location prior to finalizing the mortgage loan. If the seller does not have one or does not agree to get one, you will have to pay for it yourself. It can cost in the $1,000 to $2,000 range.
• Water quality inspection: if the home has a well, you will want to have the quality of the water tested to ensure that the water supply is adequate and the water is potable. You can negotiate these costs with the vendor and list them in your offer to purchase.
• Legal fees and disbursements: must be paid upon closing and cost a minimum of $500. Your lawyer/notary will also bill you direct costs to check on the legal status of your property. 
• Title insurance: your lender or lawyer/notary may suggest title insurance to cover loss caused by defects of title to the property. The one-time title fee, including search and examination, averages around $430 for a $100,000 home.