Getting ready to buy your own house? Trying to understand the nuances of mortgages and the interest rates that follow? Understandably, buying a home is one of the biggest life decisions and purchases you’ll ever make. Getting to know the aspects of buying a home can be a tad bit overwhelming. Not to worry! We’ve got you covered. This article will give you insight into the world of mortgages so that you can better prepare yourself before applying for one. It’s very important to understand the inner workings of interest rates and mortgages considering that small changes in interest rates can make a difference in how much you’ll pay now and in the long run.
Let’s get right to it!
What is a mortgage?
A mortgage is a type of loan that is used to purchase a house. The house acts as a security for the mortgage. A typical mortgage is usually completely paid off over 25 to 30 years as mortgages in general tend to be for a large amount of money.
When you do get a mortgage, you basically agree to your lender to make regular payments to service this mortgage. The payments consist of two things: the principal amount and the interest.
When you make a payment, the first thing that gets taken care of is the interest, followed by the principal amount.
Check out our calculator to see how much you could borrow.
Ready to buy!
- You’ve got a stable stream of income from your business or your job.
- You’ve got your deposit set up.
- You’ve got a fair idea of what you want your home to look like and the neighborhood it should ideally be in.
It’s time to buy! So, what next?
The next step would be to approach a lender for a mortgage. A lender could be a bank or a credit union like Innovation.
What is the first thing a lender assesses when it comes to mortgages?
Any lender’s key priority is to make sure you can afford a mortgage in the first place. In Canada, they’ll look at two ratios:
- The Gross Debt Service Ratio (GDS): This ratio basically looks at how much monthly income is needed to completely cover all the expenses related to the house (mortgage payments, property taxes, and any other fees that might be applicable). The ideal GDS ratio that most lenders will be looking for, is below 39%.
- The Total Debt Service Ratio (TDS): A sister of the GDS ratio, the TDS assesses most of the same elements that the GDS does. It also considers any other debt that you might have. The ideal TDS ratio that most lenders usually look for, is below 44%
Quick Tip: Lenders will usually stress test you at a higher or inflated rate of interest.
What does a good interest rate look like?
A good interest rate strikes a balance between the rate and the term. When you’re evaluating the interest rates that your lender is presenting, check if you can find any benefits attached to that. Benefits like loyalty points that reward you for banking with them. Or cash back offers. See if you can get flexible repayment options as well. This way you’ll be able to pay off your mortgage faster without incurring a penalty.
Check out our mortgage payment calculator to see what your payments could look like.
For example, Innovation offers highly competitive mortgage rates. To top it off, all the benefits we mentioned above? We have them! Flexible options to pay off your mortgage faster, Member Rewards for simply having your mortgage with us, cash back offers, and affordable protection plans. We’ve got it all covered for you.
If you’re a first-time home buyer, we can also discuss the Government of Canada’s First Time Home Buyer Incentive with you. AND, you get up to $3,000 cash if you choose Innovation for your first home purchase. Get in touch with us and we’d be happy to guide you through the process of applying for a mortgage.
If you already have a mortgage, you can easily transfer it over to us and we’ll provide you with up to $1,500 to cover fees! Contact us today to start the process.
Now you’ve decided on a lender and you’re preparing to apply for a mortgage. What should you be aware of?
Things lenders will look at before approving you for a mortgage
Apart from GDS and TDS that we’ve mentioned above, there are several factors that a lender takes into account before approving your application. Most notably:
Down Payment | Income | Property | Assets & Debts
Down Payment: Lenders will want to usually have a look at your 90-day transaction history if your down payment rests in your bank account. If the down payment has been provided to you as a gift, the lender will request a signed letter along with evidence to see that the funds have been transferred to your primary bank account.
Income: A stable source of income is generally the most important thing that a lender will want to see. As an applicant for a substantial mortgage, you’ll have to prove that with your income, you will be able to make regular mortgage payments. Lenders may also ask for letters of employment and your most recent pay stubs for the last two years.
But what if I’m self-employed?
You can still get a mortgage if you’re self-employed. If you own a business, you’ll need to provide additional documentation to show your income. Ideally, you’ll need to have been in business for at least two years and provide Personal T1 Generals, Notices of Assessment, and financial statements.
Assets & Debts: You’ll have to declare any assets that you currently own even though they don’t technically get included in the calculation for a mortgage. To the lender it shows that you’re a responsible applicant and a certain trust factor can be established. Assets like savings and transactional/chequing accounts, TFSAs, RRSPs are some of the assets that are included.
While assessing assets, the other side of the coin at which the lender will most definitely look at is what kind of debts and credit do you have. A lender will usually also look at your credit score. Typically, you’d want to keep your credit score above 680.
Make sure you’ve been making all your debt payments on time so that you don’t raise any red flags.
Property: Depending on the type of property and the location, a lender might use an automated valuation model (AVM) to check the value of your property while some lenders may just request a full appraisal. What this does is confirms that the property is worth what you paid for it. This assessment will also tell your lender if the property is in a decent condition.
You’re now armed with the knowledge of the processes that surrounds a mortgage. However, you might have always wondered how the lender determines the interest rate on a mortgage. What is it really and why does it tend to fluctuate often? Let's address your interest in interest rates.
Interest rates are how lenders earn money. A mortgage is profitable to the lender because in the end, the borrower (you) is paying more in interest than what they (lender) paid to borrow the money themselves (funding cost). The lender's operating cost and the funding cost are the key factors that fuel the interest rates.
Local & Global Economy: The economic fallout from COVID-19 wasn’t as bad as the world expected. People didn’t stop spending money. In fact, people spent more money on buying property and renovating their existing homes. In general, strong economic growth will lead to a larger increase in interest rates and a slower or a weaker growth will lead to low interest rates in order to entice people to take up mortgages. If the economy is strong, interest rates are raised to keep inflation in check.
Another thing to keep in mind is that the world’s financial markets are all interconnected. Banks from one country also borrow money from and in other countries. Canada usually borrows from the United States. So, as these are all interconnected, any major changes will usually result in a ripple effect across the world. A good example would be the global interest rate drop in 2019 resulted in a drop in interest rates for 5-year fixed mortgages.
Bank of Canada: Armed with the power of policies, the Bank of Canada can affect interest rates. They don’t have the authority to set mortgage rates, but they are able to influence them. See this blog for further details.
Your Application: Global and national economies are not the only factors that affect your interest rate. Your income, the type of mortgage you’re applying for, the kind of risk you pose to your lender all affect your interest rate. If you’re going ahead with a 5% down payment, you may have to pay a higher interest rate than what you’d pay for if you went with a 20% down payment.
In a nutshell, the economy, your application, the mortgage type, and the mortgage amount will all affect your interest rate. For more information around your interest rates, please feel free to reach out to us. Our specialists would be more than happy to help guide you through this process.