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Mortgage Financing

Most Canadians need a mortgage to purchase a home. A mortgage is essentially a long-term loan used for buying a home. It is composed of two ingredients; the first is the principal, the amount borrowed and the second is the interest, the cost of borrowing. Each mortgage payment will consist of these two parts - covering the interest first and then, the balance of the payment will go to the principal. Interest is paid on the principal amount outstanding at a rate agreed to at the beginning of the term. The number of years that it takes to pay back the entire mortgage debt is known as the amortization period which is normally 25 years.

There are two major types of mortgages - Conventional Mortgage and High Ratio Mortgage.

Depending on the financial institutions, a conventional mortgage is placed when you have at least 25% or more of the purchase price available for a down payment. There is a minor exception which is if you prefer to deal with a credit union, this loan to value ratio can increase to 80% for a conventional mortgage depending upon which credit union you deal with. But, for the purpose of this article, we will consider less than 25% down payment to be referred to as a high ratio mortgage and it will require high ratio insurance. Under Canadian law, most lending institutions cannot provide the first mortgage financing with less than a 25% down payment unless it is insured. An insured loan essentially protects the lending institution against any mortgage default in the event that the homeowner is unable to make his/her mortgage payments over a period of time.

Since not all buyers have the required 25% of a down payment for a conventional mortgage, using mortgage insurance enables these buyers to enter the market sooner and to start building up equity in their home. The Canadian Mortgage and Housing Corporation (CMHC) is the most recognizable name in mortgage insurance. Their First Home Loan Insurance Program (FHLI), is a very popular option for first time buyers who can afford only a 5% down payment. Under this program, the price of the home must be under the maximum house price established by CMHC for the area in which the property is located. For example, the maximum housing price under the FHLI Program for the Greater Vancouver area is $250,000, and that for outlying areas is $125,000. If the buyer is not a first time home buyer, or if the desired house is over the maximum house price allowed, the maximum loan amount will be 90% of the first $180,000 of value and 80% of the balance over $180,000.

Like all insurance products, there is a cost involved in using mortgage insurance. CMHC charges its premiums at the same rates across Canada based on the amount of the down payment placed on the home. The lower the down payment the higher is the premium due to increased risk. With a 5% down, the premiums are at 2.5% of the loan amount. This amount decreases with an increased down payment placed on the home. Normally, the mortgage insurance premium is added to the amount of the mortgage and amortized over the life of the mortgage but, if the buyer so wishes, he/she may also pay the premium in one lump sum.

For those buyers planning a renovation to their home, they may also add on the costs of the planned renovation at the time they take out the mortgage, which allows them to benefit from the lower interest rates.

In general, to qualify for the FHLI Program, the buyer or spouse; 1) must not have owned a home as a principal residence in Canada within the past five years; 2) must be buying or building a home in Canada that will be their principal residence; 3) the payments for principal, interest, property taxes, heating and 50% of any condominium fees (if applicable) should not exceed approximately 32% of their family gross income; and 4) the total payments which include other debts such as car payments should not exceed 42% of their family gross income.

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