The Loans Canada team sits down with Gary Schwartz of the Canadian Lenders Association to talk about open banking.
The Lowest Mortgage Rate Might Not Be What You Need
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The decision to buy a home is a big one, but the choice on which mortgage to take out to finance such a large investment is just as important.
Of course, the less you can pay overall the better, right? Obviously, a huge part of how expensive a mortgage will be is the interest rate that you are charged. Higher interest rates mean you’ll be paying more on the interest portion of your mortgage relevant to the loan amount you have taken out. Conversely, a lower interest rate would mean you’d be paying less in overall interest over the life of your loan.
A lower rate is obviously better, right?
Sure, a lower rate is certainly better than a higher rate. But that’s not the only thing you should be considering when shopping around for a mortgage. The thing is, some mortgages that come with a lower rate can sometimes cost you more overall compared to other mortgages that come with a higher rate.
How can this be? How can a mortgage with a higher rate be more affordable than one with a lower rate?
Here’s what to do if mortgage rates increase while you’re trying to buy a house.
The truth is, there are other fees associated with mortgages aside from interest rates. Although interest plays a key role in mortgages and how much they cost borrowers, there are several other factors to include in the equation before determining which mortgage option is more affordable for you.
Here are a few other things that you should take into consideration when choosing a specific mortgage.
Every mortgage has its own set of rules that borrowers must comply with. Otherwise, penalty fees may be charged.
For example, breaking a mortgage contract almost always comes with a penalty. While you may have no intention of breaking your mortgage early when you first sign up, things happen in life that you may not have anticipated.
Whether it’s job relocation, divorce, or a death in the family, things can happen that you have no way of predicting. Such circumstances can change your living arrangements and cause you to have to break your mortgage earlier that you may have expected.
Want to know how to handle a financial emergency? Find out here.
When you’re shopping around for a mortgage, you should find out what mortgage penalties you may be subjected to in order to gauge a more accurate cost of the home loan.
If you take out a variable-rate mortgage – which means the interest rate changes at different intervals – the penalty is typically three months’ worth of interest. It’s pretty simple and straightforward.
But if you take out a fixed-rate mortgage, the penalty fee you are charged will usually be either three month’s worth of interest or the interest rate differential (what lenders determine to be interest lost as a result of the mortgage breaking before the term is up), whichever of the two is greater.
For a more detailed explanation of variable and fixed-rate loans, check this out.
Some lenders might have their own specific penalties that they charge borrowers that are over and above what other lenders may charge, so you will want to find out what these are before you take out a mortgage.
Looking to purchase a house? Check out the prices of homes in your city or province.
While many borrowers are comfortable just sticking to the regular contributions, others might have the financial means and the ambition to make additional payments toward the principal portion of the mortgage. If you plan on doing that every so often, you will want to find out what types of prepayment privileges your mortgage offers.
Most borrowers take out closed mortgages, but in addition to the benefits they provide, they also have some downsides. Closed mortgages place limits on how much you are able to repay during the term of the mortgage. Open mortgages, on the other hand, allow you to pay back the remaining balance before the term expires without incurring any prepayment penalties.
Read this for more information about closed vs. open mortgages.
That said, closed mortgages allow borrowers to prepay a certain percentage of the principal amount once a year up to a specific amount. Doing so can help you pay off your loan sooner rather than later.
You may have the option to take your mortgage with you if you ever move in the near future. This is referred to as “portability” and allows you to bring your mortgage with you rather than breaking it at the time of a move. You may also have the option to combine your current mortgage rate with that of your new home. This will help you avoid any penalties that would be incurred if you break your mortgage.
Reviewing your mortgage contract? Make sure you see these features.
What Credit Score Do You Need to Get Approved For a Mortgage?
Your credit score has a direct impact on the type of interest rate you are able to secure. With a higher score, you can get a lower rate, making your overall mortgage more affordable.
The majority of conventional lenders require a minimum credit score of 680 in order to approve a home loan application. Credit scores provide lenders with some insight into the financial behavior of a borrower. Lower credit scores are associated with a history of missed or late payments, which is exactly what lenders don’t want to deal with.
Want to know what happens when you miss a mortgage payment? The answer is here.
On the other hand, higher credit scores are usually reflective of a clean payment history, which makes these borrowers less of a risk for lenders.
If your credit score is lower than 680, you may have to take other courses of action, including the following:
Get a co-signer – Having another individual with a good credit score and healthy income cosign on your loan can help you increase the chances of mortgage approval. If you ever default on your loan payments, the co-signer would then be obligated to step in and over the payment.
Look at this to discover other types of lenders that accept co-signers.
Work with a bad credit lender – There are many lenders who work with borrowers with bad credit. They use your down payment amount, income, and most recent payment activity to gauge your ability to secure a mortgage, though these loans typically come with higher rates compared to conventional mortgages.
Improve your score – If you have some time to spare before buying a home, consider using that time to give your credit score a boost by doing any one of the following:
- Make all payments on time and in full
- Don’t spend any more than 30% of your credit limit on your credit card
- Keep old credit lines open
- Don’t close out any accounts with outstanding balances
What About Mortgage Insurance?
If you are required to pay mortgage insurance on your mortgage, the overall cost will be higher. Mortgage default insurance – also referred to as CMHC insurance – is a policy that borrowers have to pay on top of their monthly payments if they have a high-ratio mortgage. A down payment of less than 20% will require mortgage default insurance, which protects the lender if you fall through with your mortgage payments.
Want to know some ways of avoiding CMHC fees?
The cost of mortgage insurance can range anywhere from 2.80% to 4.00% of your mortgage. If you want to avoid paying this added expense, you will be required to put a 20% down payment (minimum) upfront, after which the insurance premium will be rolled into your mortgage payments.
Ever wonder about the true cost of borrowing? Check out this infographic to learn more.
What Factors Affect Mortgage Approval?
In order to get approved for a mortgage, you’ll have to meet certain criteria, including the following:
- Good credit score
- Good income
- Debt-to-income ratio of less than 35% (the amount of debt you have relative to your income and assets)
- At least 5% down payment
If any one of these factors is compromised, you may find it more difficult to get approved for a mortgage. That said, it’s not necessarily impossible. For instance, if you have a high income and decent down payment but a low credit score, there are certain mortgage lenders and products available to you.
Looking for some ways of improving or fixing your credit score? Check these out.
How Are Mortgage Interest Rates Determined?
The mortgage interest rate that lenders offer you aren’t some arbitrary numbers that they pluck out of thin air.
The Bank of Canada determines and sets what’s known as the “target for the overnight rate,” which is the rate that banks charge one another to cover transactions they deal with every day. Banks use this rate as a guide when they set their prime lending rate, which is the rate that they offer their best clients when they borrow money. When this overnight rate changes, that triggers banks to change their prime lending interest rates.
Canada’s central bank does not actually directly set mortgage rates. Instead, variable mortgage rates and lines of credit fluctuate in tandem with the prime lending rate. On the other hand, fixed mortgage rates are more dependent on the bond market, and banks depend on this market to raise capital for such mortgages.
Interested in applying for a variable or fixed-rate mortgage? Read this to know how you can.
Need a Mortgage?
If you’re in the market to take out a mortgage, you’d be well advised to do some shopping to make sure you find and choose the right mortgage product for you. At Loans Canada, we can help you connect and compare various mortgage lenders to find one that best suits your situation.
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
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