Mortgage 101

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A mortgage is defined as a financial transaction where a legal agreement by which a creditor lends money at interest in exchange for taking the title of the debtor’s property.

The two main factors affecting the real estate market, hence the mortgage, are supply and demand. Supply is influenced by government actions, the availability of infrastructure, land-use regulations, and builders. Demand is influenced by demographics, the state of the economy, and consumer choices.

The main mortgage source is chartered banks and they hold about 78% of the total residential market. Other sources include trust companies, credit unions, private lenders, and alternative lenders.

Mortgage Ranking

Mortgages are categorized in terms of when they are registered against the title in the land titles database. The first mortgage registered on title is called the first mortgage, the second registered is the second mortgage, and so on.

The ranking affects the risk of a mortgage. When a borrower defaults and the property is sold to compensate the lenders, the first mortgage lender gets fully paid first. Any money left over goes to the second mortgage lender, but there may not be enough to fully compensate this lender. Because of the higher risk, second mortgages typically charge higher interest rates.

Key participants

The borrower in a mortgage transaction is also referred to as the mortgagor.
The mortgage originator often works on behalf of both the borrower and the lender.

  • Broker – A mortgage broker has the technical expertise to arrange mortgages between borrowers and lenders on behalf of a licensed broker/brokerage.
  • Agent – A mortgage agent arranges mortgages between borrowers and lenders on behalf of a licensed broker/brokerage, and typically, under the supervision of a senior-level broker.

The lender makes mortgage funds available and is referred to as the mortgagee.
The real estate agent acquires or disposes of real estate on behalf of somebody else.
The lawyer assists with the preparation of, and reviews, documents and ensures all closing documents have been prepared.
The mortgage servicer manages the administration of the mortgage once it has been approved and the funds disbursed.
The property inspector evaluates a property.
The appraiser determines the market value of a property and the lender relies on this value to decide the amount the borrower qualifies to borrow.
The mortgage insurer insures the lender against default on the mortgage.
The title insurer compensates the insured for losses from the title to property not being as stated.

Importance of Selecting an Exert Mortgage Brokerage

A mortgage brokerage is well aware of all the available sources of mortgage funding in the market and they have the right knowledge to broker the best mortgage solution for a client. Square Capital Management Inc. has the perfect expertise to assist in selecting the best lenders and products for their clients.

Lender Types

Prime Lending

Prime lenders are also called “A” lenders. Here, the borrower would qualify for mortgage financing at most major financial institutions. The lender believes that the borrower can repay the mortgage. The interest rate in prime lending is low because the amount of the mortgage is reasonable and the property is of good quality.

Alternative Lending

These mortgages are categorized as “B” deals and “C” deals. The borrower’s ability to repay may be seen as less certain. The interest rate is slightly higher as the amount of the mortgage relative to the value of the property may be too high and the property may seem to have a lower value.

Private Lending

Private lending is made available by private corporations and individuals. Private lenders often concentrate on lending areas that are under-serviced by institutional lenders. They may also lend to households that have difficulty qualifying for traditional mortgages due to special circumstances; they are new to the area, have a poor credit history, or are self-employed.

Mortgage Products

Conventional VS High Ratio Mortgages

Residential mortgages can be divided into two categories: conventional mortgages and high ratio mortgages. In a conventional mortgage, the borrower provides a down payment of 20% or more of the property’s value, leaving a loan-to-value ratio of 80% or less. A conventional mortgage does not normally require mortgage default insurance.

A high ratio mortgage is one where the borrower is contributing a down payment of less than 20% of the value of the property. The mortgage is considered to be a high ratio when the loan-to-value ratio is greater than 80%. If the lender is a federally chartered institution or an approved NHA lender, this mortgage must be insured against default. High ratio mortgages must be insured through one of the three mortgage insurance companies in Canada: Canada Mortgage and Housing Corporation (CMHC), Genworth Canada, or Canada Guaranty.

The insurance premium on high ratio mortgages is charged only when the mortgage funds are originally given to the borrower. Insurance premiums are calculated based on the mortgage’s loan-to-value ratio, the default insurers’ unique products, and the transaction type.

Closed VS Open Mortgages

A fully closed mortgage does not allow any prepayment or early repayment of the mortgage, except on the sale of the property and then incurring a large penalty. 

an open mortgage allows principal payments to be made in any amount, at any time, in addition to the regular mortgage payments. They usually have short terms of six months to one year. Interest rates on open mortgages are higher than on closed mortgages with similar terms.

Fixed VS Variable Rate Mortgages

In a fixed-rate mortgage, the interest rate is determined and stays the same throughout the term of the mortgage.  Typically, a fixed-rate mortgage for longer terms is popular when interest rates are low but are expected to rise in the future. The borrowers “lockin” their mortgages at existing, presumably lower than future, interest rates.

In a variable-rate mortgage, also referred to as an adjustable-rate mortgage, the interest rate charged on the mortgage loan will fluctuate as market interest rates move.

Pre-Approved and Pre-Qualified Mortgages

Pre-approved and pre-qualified mortgages allow potential borrowers to know how much money they can afford to borrow in order to buy a home or to draw equity from their properties in advance. The primary advantage to the borrower is that the lender guarantees an interest rate for the term that the borrower selects. The length of the guarantee can range between 30 to 90 days, although this can be as much as 120 days for a newly constructed home or a purchase of a property. Pre-approved and pre-qualified mortgages are available to the borrower with no obligation.

Pre-qualified mortgages are based solely on the information provided by the borrower with little or no documentation to support the borrower’s credit status and property value. All necessary documentation is included as part of the application only when there is a formal offer. On the other hand, a full application is processed by the lender in a pre-approval where the borrower’s qualifications are verified by reviewing supporting documentation as well as a credit report.

Mortgage Prepayment Plans

Blended Payment Loans

In this payment option, the payments are constant, made up of a combination of interest and principal, and paid in equal amounts over the life of the loan. Payments are made on a specified day and at a specified frequency.

Constant payment mortgages can be classified as either fully amortized or partially amortized. In a fully amortized mortgage, the entire amount of principal is repaid by periodic payments and the final regular payment repays the remaining principal balance and accrued interest. With a partially amortized loan, the regular payments of principal and interest are calculated to repay the debt over an amortization period that is longer than the mortgage loan term. A large payment is required to repay the outstanding principal at the end of the loan term.

Interest Accruing Loans

In an interest accruing loan there are no payments of interest and no repayments of principal during the life of the loan. The full amount of principal and all interest that accumulates during the term is payable when the mortgage contract expires. 

Reverse mortgages are a type of interest accruing loan and they are set up without payment requirements. These mortgages are designed for elderly borrowers with equity in their properties to draw out equity. The loan is typically paid out when the property is sold, or the borrowers move out of the property. The term of these mortgages is indefinite and there is no amortization. The initial loan balance is a relatively small percentage of the property value, and is dependent on the age of the borrower and thus life expectancy. The balance increases each month at the rate of accrued interest.

Interest Only Loans

In a common interest-only loan, the borrower makes regular payments of only interest to the lender. Another type of interest-only loan is a Home Equity Line of Credit (HELOC). The minimum repayment requirement is the interest payment made periodically. HELOCs are a form of revolving credit such that once the principal is paid down, that amount becomes available again.

Interest Plus Specified Principal Loans

In the interest plus specified principal loan, also known as a straight-line principal reduction loan, an equal amount of principal is repaid on every interest compounding period in addition to the interest that must be paid for that period. 

Types of Mortgage Transactions

Purchase, Refinance, Equity Take Out, Blend and Extended, Renewal, and Switch

The most common type of mortgage transaction is a home purchase. When a potential home buyer wishes to purchase a home but does not have all the money available to make the purchase, the buyer needs a mortgage loan to finance their purchase.

In a mortgage refinancing, the current mortgage financing is replaced with a new and increased loan. As the value of the home increase and/or the mortgage is being paid down, a mortgage refinance takes advantage of the increased equity in a home. A refinance can happen mid-term or preferably at maturity to avoid possible penalties to the borrower.

An equity take-out mortgage is very similar to a mortgage refinancing transaction. An equity take-out refers to obtaining a mortgage based on the equity in the property where there is no existing mortgage or, where the borrower is changing lenders while increasing their existing mortgage loan. 

If no additional funds are required and the client simply wishes to take advantage of lower market rates, borrowers can seek a blend and extend from their existing lender. The lender may blend the existing mortgage rate with the current lower mortgage interest rates, and extend the term as selected by the borrower. 

A mortgage renewal refers to the replacement of an existing mortgage with a new mortgage, for the same amount when the term of the first mortgage has matured or expired. When the end of the mortgage term arrives, either the outstanding balance can be paid in full, or a new mortgage loan is obtained at the same or a different lender. at this point, a new interest rate, term, and amortization period are negotiated. 

Mortgage renewals can either be arranged with the original lender or with an alternate lender. If the mortgage is arranged with a different lender, the transaction is called a switch or transfer mortgage.

Residential VS Commercial

The residential mortgages include both new and resale properties, such as detached houses, semi-detached houses, townhouses as well as condominiums. Residential properties may also include cottages, chalets, and small hobby farms.  

Residential properties may not necessarily be owner-occupied. When a house or a condominium is held for investment purposes by an owner who resides elsewhere, this residential property is viewed as an investment or a rental property. Residential properties that are also investment properties can include individual homes, condominium units, and small apartment buildings of up to four units. 

Commercial properties are those involved in commerce or trade and include residential properties with more than four units, individual stores, small shopping plazas, large shopping centers, office buildings, and similar buildings. Industrial properties can include buildings occupied by manufacturing firms, warehouses, or other special-purpose buildings. 

A builder’s or construction loan is a mortgage loan used to finance a building construction. It is different from a mortgage loan on an existing property where the loan is usually advanced in stages, also known as draws, at agreed-upon points in the construction process.  

A bridge loan is financing extended for a short period of time and it provides a “bridge” into the next stage of financing. A builder may need this short term financing between the period when a building is complete and a tenant moves in and starts paying rent.

Individuals also need bridge loans sometimes when they have sold their existing home but have not yet received the proceeds from the sale as the deal is yet to close. In the meantime, they may have found another home with an earlier closing date. A bridge loan would cover the funds required for the down payment on the purchase of a new home and would be repaid when the existing home is closed. 

References

  • Mortgage Professionals Canada [2016], Introduction to the Canadian Mortgage Industry, Fifth Edition