Mortgage Basics: The Ultimate Canadian Mortgage Guide

Here’s part 10 of my 10 step series on mortgage tips here at Financial Uproar every Wednesday.  Every step of the process will be covered from the application to qualifying to tips and tricks to save money on your mortgage and everything in between. To read all of these just click on the category Mortgage Basics.

Finally, the sweet, sweet end to this train wreck of a series. Are you sick of mortgages yet? Oh you aren’t? Good.

This post will be the combination of all the others, the massive how to guide for tips on Canadian mortgages. It’s your one stop shop about everything a borrower needs to know before signing their name on the bottom line of a mortgage contract. This guide is so awesome and huge that it actually has its own gravitational pull. It’s going to be legen -wait for it- dary!

How I Met Your Mother is the best.

Anyway, every step from the application process to money saving tips will be shared in this post. Be sure to bookmark it, since I’m sure you’ll be referring to it on an hourly basis for the rest of your life.

The Application Process

Chances are you’ll spend that initial meeting nervously waiting for the lender to approve you. You give the lender all of your information and they spend some time inputting that into a computer. Then you give them the information on the house you’re buying. At some point the lender pulls your credit report as well. If the lender likes the information, the borrower is approved. If not, borrowers are rejected and they probably cry. At least, that’s what I would do.

After that initial approval, a borrower must then prove to the mortgage lender that the information contained in the application is factual. If you’re dealing with your bank some of this verification comes easy; after all, they can just check your account to see whether you have as much money as you say. Other verifications are a little harder and might require some hustling on your part to get these things done.

A borrower will need several kinds of statements to prove their income, the source of their down payment and other paperwork such as information on the house being purchased, any child support or alimony payments (either paid out or received) and a copy of the purchase contract. Income is proven by paystubs and a letter from the employer for salaried borrowers, and by 2 years of  Notice of Assesssments for self employed borrowers.

With all the mortgage fraud that exists in the market, lenders remain extra cautious when it comes to confirming a borrower’s information. By the end of the process, most borrowers will be frustrated by the mountains of paperwork.

The Down Payment

To get a mortgage in Canada, a borrower has to have at least 5% of the property’s value for a down payment. The lender supplies the rest of the money to pay for the house and the borrower slowly pays back the lender. To avoid CMHC insurance premiums, a borrower must put 20% of the house’s value up as a down payment.

For the most part, any money you have sitting in any account can be used as a down payment. Money in a chequing or savings account obviously can. It’s the same thing with money or even securities sitting in a brokerage account, except the securities will have to be sold. Even a borrower’s RRSP can be used, providing the borrower pays that money back in 15 years. If the borrower doesn’t, that money will be taxed. You can even use your TFSA or equity in an existing property as a down payment.

The borrower has two options if they don’t have the cash available to cover the down payment. They can either borrow the money or get the money as a gift from a relative. A borrower can either borrower the money in the form of a unsecured line of credit, or use a cash back mortgage to repay a down payment loan. A cash back mortgage can’t be used directly for the down payment. Or, if a borrower has a relative that is willing to help them, they can get a gift from that relative, providing both parties sign a simple agreement that there is no expectation of repayment.

Canadian lenders are extremely flexible when it comes to down payments. If you can’t come up with the required down payment, then maybe homeownership should be rethought.

Income Qualifying

The two ratios that determine your maximum mortgage are gross debt service ratio (GDS) and total debt service ratio (TDS). The formulas are as follows:

GDS: Payment + Property Tax + Heat + ½ Condo Fees = less than 32% of gross income

TDS: Payment + Property Tax + Heat + ½ Condo Fees + All Other Debts = less than 40% of gross income

The formulas are much less complicated than they appear to be. If you made $72,000 per year (that’s $6,000) per month then all you’d need to do is multiply 6000 by .32 and .40 to get the maximums, in this case being $1920 and $2400.

What that means is $1920 per month maximum can go toward the mortgage payment, property tax, gas bills and half the condo fees (if applicable). This also gives the borrower a maximum of $480 per month of debt payments the lender will tolerate.

Depending on how high a borrower’s credit score is, GDS and TDS ratios can go higher. Any borrower with a credit score above 680 can have a GDS or TDS up to 44% of their gross income.

Let’s look at a real world example.

Couple A makes a combined $80,000 per year. What’s the maximum mortgage they’d qualify for? They have excellent credit (both above 700) and have a car payment of $400 per month. They’re looking for a 5 year fixed rate of 4.5%.

Income: $6666 per month

Debt: $400

Property Taxes (estimate) $400

Heat: $85

Condo Fees: N/A

So we multiply $6666 by .44 to get $2933.33. This is the maximum the couple can pay for their commitments.

$2933.33-$400-$400-$85 = $2048.33

$2048.33 is the maximum mortgage payment this couple can have. Plugging that back into a mortgage calculator, it means the couple can max themselves out at $370.087, assuming they take out a 25 year amortization. This couple could qualify for more if they extended their amortization to 30 years.

Of course, just because a borrower can qualify for a specific number, doesn’t mean they should max themselves out. I would recommend to everyone not surpassing the 32%/40% ratios, no matter what their credit score is. Ideally, I’d want a borrower to not spend 32% of their income on housing plus debt. However, I realize in many Canadian cities this isn’t very realistic.

CMHC Default Insurance

CMHC has all sorts of different homeowner products (more info on them can be found at CMHC’s website) that have different insurance policies depending on the size of the down payment and the length of the amortization. If you have a bigger down payment then the premium amount goes down. If you amortize the mortgage longer than 25 years then the insurance premium goes up. Basically anything a borrower does to make the loan more risky increases the premium amount.

CMHC insurance is mandatory for any mortgage with less than 20% down. Sometimes it required by the lender on properties with more than 20% down, especially rental properties. Once a borrower applies for a mortgage and the lender approves it, the lender then sends that mortgage into CMHC for their approval. CMHC receives the electronic submission and looks at two things- the borrower and the property.

Since so many homes have CMHC insurance, the system has a large database of similar homes in the very same neighborhood that it can use as comparables. Using the database, the system comes up with a value for the home, a number they will insure up to. Once the borrower’s credit is also verified CMHC will approve the property.

The premium is added to the principle owing the borrower doesn’t have to come up with the case for an insurance policy totalling thousands of dollars. Don’t confuse mortgage default insurance with mortgage life insurance. The only person mortgage default insurance protects is the lender. The borrower won’t see two dimes if the bank is forced to take back the house.

Fixed Or Variable Rate

Typically a borrower will save money if they go with a variable rate. According to mortgage guru Moshe Milevsky in a study published in 2001, variable rate mortgages came out ahead of their fixed rate counterparts 88% of the time since 1950. Those savings can really add up on a mortgage in the hundreds of thousands and over 25 years.

Advocates of fixed rate mortgages often cite the stability of the payment as the biggest advantage of having a fixed rate and they are absolutely correct. The borrowers who take on the standard 5 year fixed loan take comfort that their payment will be the same every month, no matter what interest rates do. For them, taking out the fixed rate hedges their interest rate risk.

Ultimately, a borrower needs to decide how much this payment certainty is worth to them before deciding on a fixed or variable rate mortgage.

There are other options for borrowers who can’t decide between a fixed or variable mortgage. They could take a short term fixed term (say 1 or 2 years) which will have an interest rate lower than a 5 year fixed. Lenders are also starting to offer hybrid products that combine a fixed and variable mortgage, giving borrowers a lower interest rate and increased rate protection if interest rates go up.

Which Should You Use? Broker or Banker?

The first advantage to using a bank employee is the lack of paperwork required. Of course, this advantage only applies if you use your own banker, and not one from a competing brand. Since the bank already knows a bunch of the borrower’s info, there’s no need to reprove that. When the borrower uses a mortgage broker, they have to prove everything they’ve stated in their application. The new lender asks for copies of bank statements, pay stubs, and the like, to prove the borrower has the required down payment, they make as much as they said, etc. For most people, the excess paperwork is annoying.

Other borrowers will value the relationship they have with their banker. They have fond feelings for their loans officer because they’ve borrowed from the bank before, or perhaps they just think she fills out her sweater nicely. Confidentiality plays an issue with this point as well. Most people don’t want all sorts of people knowing their financial information. They reason that their bank already knows all this stuff, so they aren’t giving that information to anyone else. This is one of the reasons mortgage brokers do better in large cities than in small towns.

Many mortgage brokers will tout the large number of lenders they have access to as a reason for using a broker over a banker. The reality is if the borrower fits into the standard mold, most brokers have two or three lenders they split the majority of their business with.

While the banks have gotten better in their rate transparency, the borrower still often won’t know if the rate being offered by the bank is the bank’s best rate or not. Banks still enjoy playing the posted rate game, offering naive borrowers a crappier rate, in an effort to make the bank more money. Brokers don’t play this game since they thrive on offering lower rates.

Mortgage brokers are generally more flexible than traditional bank employees. Brokers are usually willing to come over to a borrower’s house to do the application, pick up documents, etc. Banks have responded to this flexibility by introducing mobile mortgage specialists, who work out of their homes and will go visit borrowers when it’s convenient, not just during business hours.

Brokers are paid on completed deals only. Therefore, a broker is likely to try harder to get a deal done than a bank employee who is paid salary. If a borrower has a tough deal to fund, the tenacity of a broker is definitely an advantage.

Payout Penalties

A payout penalty is a fee the lending institution charges a borrower for breaking the mortgage early, typically because the borrower has sold their house. When a borrower repays their mortgage early, the lender gets this lump sum they have to lend out again, this time at a shorter term. Lenders build in a payout penalty in the mortgage to compensate them for such an event.

There are two types of payout penalties a borrower will get charged. The lender will charge whichever one gives them the most money. Isn’t capitalism great? Most mortgages give the borrower the right to prepay 20% of the total principle a year or increase their payment by 20% without a penalty.

The first penalty is three months interest. This one is pretty simple, the lender just charges the borrower 3 months worth of interest.

The interest rate differential (IRD) is somewhat complex to figure out, so let’s crack out our math. It’s essentially the amount owing, multiplied by the interest rate difference between the current rate and the rate on the mortgage for the amount of time left, multiplied by the amount of time remaining. The IRD is only charged when rates have come down, because the lender wants a borrower to remain locked in at a higher rate.

Let’s look at an example. A borrower owes $300,000, 2 years in on a 5 year fixed mortgage at 5.89%. 3 year rates are now 3.89%. How much would the payout penalty be?

$300,000 x 2% x 3 years = 6% of the mortgage balance = $18,000.

By the time somebody pays their real estate agent, that penalty can easily represent the entire profit from the sale of a house. Meanwhile, a borrower who is paying down their mortgage aggressively, will want to limit their yearly repayment at 19.9%.

Borrowers can minimize these fees by being smart. If they know they’re planning on selling soon, then they’ll want to take out an open mortgage, which allows any prepayment without a penalty.

Credit Scores

If a borrower has a credit score above 680, they’ll qualify for any mortgage product CMHC offers. Any credit score above 680 is considered an excellent score, at least according to CMHC. If a borrower has a credit score above 680, CMHC allows the borrower to spend up to 44% of their income on the mortgage, heat, taxes and any other debts. If the borrower’s credit score is below 680, the borrower can only go up to 42% of their income. Any credit score below 610 and a borrower is pretty much out of luck without a co-signer.

Lenders are also looking for at least 2 years of history on a borrower’s credit report, usually from a car loan or credit card. Someone can have a great 1 year old credit report, but still be declined for a mortgage. Alternate sources of credit will be considered for the CMHC New To Canada Program, since the borrower doesn’t have enough time to gain the credit history needed. Possible examples of this can include rent payments or any utility payment. A year of history is needed, with only one late payment accepted. This program applies to recent immigrants or Canadians with a short credit history.

Money Saving Tips

What a borrower needs to do is ask their lender for a bi-weekly accelerated payment. The bi-weekly accelerated payment would be exactly half of the monthly payment, except made every 14 days instead of 15 or 16. That one simple step can cut a mortgage from 25 to 21.9 years just by paying the semi-monthly payment every two weeks.

Remember, the borrower has to ask the lender for bi-weekly accelerated payments, not just bi-weekly.

Typically variable rate mortgages can be had at a 1.5% discount to the comparable fixed rate product. If a borrower knows they’ll stay in the same home for the next 5 years, a 5 year variable mortgage is a solid choice.

Alternatively, a borrower can take a shorter term fixed mortgage, from 1 to 3 years. If a borrower knows there’s a chance they’ll be selling the house in the next couple of years, a shorter term can save thousands in a mortgage payout penalty. The short term fixed products won’t have the same discount as the variable products, but they’ll still be cheaper than a 5 year or longer fixed mortgage.

Putting down 20% (to avoid CMHC fees) and aggressively paying down the mortgage are other easy ways to save thousands over the course of a mortgage. You can thank me by giving some of that money to me.

Shopping around at renewal time will usually get the borrower a better deal, since many lenders won’t offer their best rates in the renewal letter. Spending less on a house will also save the borrower money in interest over the long term.

Conclusion

Getting a mortgage in Canada isn’t an easy process, especially for a naive borrower who has no idea about the process. Hopefully this guide can serve to save borrowers some money and to make the whole process easier and lead to making this stressful experience a little easier.

As always, feel free to ask any questions in the comments.

Mortgage Basics #9: Money Saving Tips

Here’s part 9 of my 10 step series on mortgages here at Financial Uproar every Wednesday.  Every step of the process will be covered from the application to qualifying to tips and tricks to save money on your mortgage and everything in between. To read all of these just click on the category Mortgage Basics.

Part 9 of 10 today everybody. Only one more week remaining. This week, let’s discuss some tips on how to save money on your mortgage. If you have any that I’ve missed, feel free to add them to the comments.

Bi-Weekly Payments

The easiest and least painful way to save some significant coin over the life of your mortgage is to switch the payment frequency from monthly or semi-monthly to bi-weekly. Let’s look at a standard $300k mortgage, with a 5 year fixed rate at 4% and a 25 year amortization to see how much you’d save.

If you were to pay monthly, your payment would be $1578.06.

If the same mortgage were to be paid bi-weekly, the payment on the same 25 year amortization would be $727.69. The problem with a standard bi-weekly payment is that it pays off the mortgage at the same rate as a monthly payment.

What a borrower needs to do is ask their lender for a bi-weekly accelerated payment. The bi-weekly accelerated payment would be exactly half of the monthly payment, except made every days instead of 15 or 16. That one simple step can cut the above mortgage from 25 to 21.9 years just by paying $789.03 every two weeks.

Remember, the borrower has to ask the lender for bi-weekly accelerated payments, not just bi-weekly.

Pick The Right Product

As discussed in the fixed vs. variable debate, many mortgage borrowers pick the 5 year fixed term almost by default. They want the security of knowing that their payment will be the same throughout the term. Many borrowers overpay for this privilege, leading to many thousands of dollars in additional interest over a 25 year amortization.

The first alternative is to choose a variable rate. Typically these mortgages can be had at a 1.5% discount to the comparable fixed rate product. If a borrower knows they’ll stay in the same home for the next 5 years, a 5 year variable mortgage is a solid choice.

Alternatively, a borrower can take a shorter term fixed mortgage, from 1 to 3 years. If a borrower knows there’s a chance they’ll be selling the house in the next couple of years, a shorter term can save thousands in a mortgage payout penalty. The short term fixed products won’t have the same discount as the variable products, but they’ll still be cheaper than a 5 year or longer fixed mortgage.

If a borrower knows they want to sell their house soon, they should always take an open product. They’ll pay a little higher rate in interest, but avoid all payout penalties.

CMHC Fees

The higher the down payment, the more a borrower will save in interest over the life of a mortgage.

The other benefit to having a large down payment is the borrower will save in CMHC insurance fees. If the borrower puts down more than 20%, they can avoid the fees all together. If a borrower puts down 15.1%, they will pay 1.0% for their mortgage insurance. The premium gradually goes up, peaking at 2.75% for a 5% down payment. On a $300,000 mortgage, the 1.75% spread represents close to $6000. Avoiding CMHC fees in general by putting down 20% or more will save a borrower thousands.

Make Prepayments

This tip is fairly obvious. Most mortgages will allow a borrower to pay up to 20% of the balance each year, without paying a penalty. Many borrowers don’t take advantage of these, which can not only save thousands, but shave years off a mortgage.

The “no frills” mortgages don’t allow prepayments, so a borrower has to be careful to read the fine print if they choose this product.

Prepayments don’t have to be a huge number to make a huge difference. 2 extra payments per year can cut almost 5 years off a mortgage.

Shop Around At Renewal Time

When a mortgage term expires, the lender will usually approach the borrower about a new term, typically sending the borrower a letter outlining the various terms and rates available from the lender. Most borrowers pick another 5 year fixed term and move along with their lives.

Banks are well aware of this, and therefore don’t offer their best rates in the renewal letter, hoping uneducated borrowers don’t bother to shop around.

Buy Less House

If a house costs less to buy, it definitely costs less in interest.

Stay tuned next week, for the finale of the Mortgage Basics series.

 

Mortgage Basics #8: Credit Reports

Here’s part 8 of my 10 step series on mortgages here at Financial Uproar every Wednesday.  Every step of the process will be covered from the application to qualifying to tips and tricks to save money on your mortgage and everything in between. To read all of these just click on the category Mortgage Basics.

This week, we’re going to look at credit reports and the effect they have on someone’s ability to qualify for a mortgage.

What Affects Your Credit?

There are countless articles on the interweb about credit scores and what affects them, so I’m not going to spend too much time on what factors go into determining someone’s credit score.

Do you pay your bills on time? Do you have a reasonable amount of debt? Do you only have one or two credit cards? As long as you’re financially responsible, your credit report will be fine. Only those with large amounts of debt or a large number of accounts open have to worry. Credit reporting companies have complex formulas that are used to figure out credit scores. These formulas can easily be beaten by using common sense.

What Score Do You Need

As discussed in the CMHC insurance post, there are certain credit scores that a borrower needs to qualify for CMHC insurance coverage.

If a borrower has a credit score above 680, they’ll qualify for any mortgage product CMHC offers. Any credit score above 680 is considered an excellent score, at least according to CMHC. If a borrower has a credit score above 680, CMHC allows the borrower to spend up to 44% of their income on the mortgage, heat, taxes and any other debts. If the borrower’s credit score is below 680, the borrower can only go up to 42% of their income. A higher credit score can be the difference between a borrower qualifying and shivering homeless on the street.

Basically, a borrower needs a credit score of 610 to qualify for a CMHC insured mortgage. CMHC will insure a borrower that has a credit score of 580, only if that borrower is putting a large down payment of more than 20% on that mortgage.

When I was in the industry (this may have changed, correct me if I’m wrong) a borrower was pretty much screwed if they didn’t have a score of 650. Generally if a borrower has a score below 650, the lender will find some reason to decline the potential deal. If someone’s score is below 650, they’ll generally have some sort of problem with their credit report.

History Needed

Let’s look at a hypothetical example.

Borrower A has a credit score in the 700s. She has a very reasonable car payment, as well as one credit card that she pays off every month. She has never been a minute late with either. She has the required down payment, as well as enough income to qualify for the mortgage she wants. Her application should be a slam dunk, right?

Not so fast, grasshopper.

It turns out that this imaginary borrower doesn’t have enough of a credit history to qualify. In order to qualify for a mortgage, a borrower needs at least two years worth of history on either a credit card or a vehicle loan.

When someone first starts using credit, the score becomes very good, very quickly. That’s because there are no issues with such an account. A lender is looking for enough history to prove that the borrower is going to use credit responsibly while they have the mortgage.

Alternative Programs

There are alternate programs for Canadians who haven’t accumulated enough credit history to qualify for a mortgage.

For new immigrants to Canada, CMHC has a special New To Canada program. The borrower must be here legally, be gainfully employed, and so on. Alternate sources of credit will be considered for this program, since the borrower doesn’t have enough time in Canada to gain the credit history needed. Possible examples of this can include rent payments or any utility payment. A year of history is needed, with only one late payment accepted.

The same program can be used by Canadians without the credit history as well. Generally lenders will ask for utility payments, or maybe a cell phone bill, since most renters don’t bother to save their receipts from their landlord. If I had a bad tenant that wanted records so they could buy a house, I’d lie through my teeth telling the lender how awesome the tenant was, just to get rid of them.

I’m so bad!

Conclusion

First of all, stop trying to do things to manipulate your credit report. As long as someone is responsible with credit, they have nothig to worry about.

Most Canadians just need to worry about their other debt payments when it comes to qualifying, since most pay their monthly obligations on time. One of the reasons why longer amortizations became popular is because people needed the lower payments to qualify for their mortgage, since the average Canadian has so much other debt.

If someone’s credit is bad, only time can repair it. Tricks exist to give a credit rating a little boost, but only an extended period of time without a late payment will repair someone’s credit. If someone doesn’t qualify for a mortgage because of a substandard credit score, they should probably reconsider home ownership.

Mortgage Basics #7: Payout Penalties

Here’s part 7 of my 10 step series on mortgages here at Financial Uproar every Wednesday.  Every step of the process will be covered from the application to qualifying to tips and tricks to save money on your mortgage and everything in between. To read all of these just click on the category Mortgage Basics.

So you’ve been following my advice on the other mortgage basics posts, and are ready to get yourself a great mortgage at a low rate. There’s just a few more things you have to worry about before signing on the bottom line. This week, let’s look at the ins and outs of payout penalties.

What Is A Payout Penalty?

A payout penalty is a fee the lending institution charges a borrower for breaking the mortgage early, typically because the borrower has sold their house. Since the lending institution bases your rate on their cost of borrowing (plus a healthy markup of course) they’ve committed to borrowing the same amount of money you are, just from different lenders at a different rate. So when a borrower repays their mortgage early, the lender gets this lump sum they have to lend out again, this time at a shorter term. Lenders build in a payout penalty in the mortgage to compensate them for such an event.

Borrowers typically have the right to pay down 20% of their remaining mortgage balance each year, without paying any penalty. Lenders do want to encourage people to pay their mortgage, they just don’t want people to do it too fast. Borrowers can also increase their payment 20% per year as well. These prepayment privileges are referred to as 20/20 prepayments in the industry.

Certain other lenders offer 15/15 prepayment privileges. Lenders who are offering rock bottom rates (especially 5 year fixed terms) are starting to offer no prepayment opportunities for the borrower, and will only break the mortgage contract on a sale. Since less than 10% of borrowers take advantage of their prepayment rights, this isn’t such a bad deal for most borrowers.

Now let’s look at the two types of payout penalties. Keep in mind that the mortgage company will charge the borrower whichever penalty ends up costing the borrower the most.

3 Months Interest

This payout penalty is very straightforward. On the date of the closing of the house sale (or the lump sum payment) the borrower owes 3 months worth of interest as a penalty. On the average mortgage in Canada, it works out to about $5000 or so, assuming you pay out the entire mortgage.

Since most mortgage payout penalties are incurred when people sell, typically people are paying a penalty on the entire mortgage. I was always amazed when I was in the industry how people didn’t even blink when they’d be told it would cost them thousands to break their mortgage early.

Interest Rate Differential

After mortgage rates came down aggressively during the crisis of 2008-09, many borrowers thought they’d go down to their bank and get themselves a new mortgage at the lower rates. What appeared to be a great idea on paper got quickly squashed once the borrower found out their payout penalty would be in the tens of thousands.

The interest rate differential (IRD) is somewhat complex to figure out, so let’s crack out our math. It’s essentially the amount owing, multiplied by the interest rate difference between the current rate and the rate on the mortgage, multiplied by the amount of time remaining. The IRD is only charged when rates have come down, because the lender wants a borrower to remain locked in at a higher rate.

Let’s look at an example. A borrower owes $300,000, 2 years in on a 5 year fixed mortgage at 5.89%. 5 year rates have fallen to 3.89%. How much would the payout penalty be?

$300,000 x 2% x 3 years = 6% of the mortgage balance = $18,000.

By the time somebody pays their real estate agent, that penalty can easily represent the entire profit from the sale of a house. Meanwhile, a borrower who is paying down their mortgage aggressively, will want to limit their yearly repayment at 19.9%.

Avoiding Prepayment Penalties

There are a couple strategies borrowers can implement to avoid paying these penalties.

The first strategy is to take out shorter terms on their mortgage, especially if they’re not certain they’ll be in one spot for the next 5 years. If a borrower takes out a year or 2 year term at a time, then they can attempt to time a sale to avoid a mortgage payout. Shorter terms are also generally cheaper than 5 year terms. Borrowers are always willing to pay for security.

Even if a borrower can’t quite time the sale with the expiry of their mortgage term, they can always get themselves a short term open mortgage, allowing themselves the right to payout the mortgage without a penalty, in exchange for a slightly higher rate.

The other strategy is to take out an open mortgage. These products did dry up during the crisis, however they’ve been making a comeback lately. The borrower can take out a 5 year variable mortgage, at prime, which allows a payout with only an administrative fee of a couple hundred bucks.

Stop Paying These Already

Canadians pay millions of dollars in payout penalties that can be avoided with a little planning. If a borrower isn’t certain they’ll be staying in a house for 5 years, then don’t go with the 5 year products (either fixed or variable). 1 or 2 year terms are cheaper than 5 year terms, plus they give the borrower a certain amount of flexibility when they want to sell.

Or, if a borrower knows they’ll be moving in 2 or 3 years,then maybe renting may be the way to go. House prices don’t always go up, combined with fees from Realtors and mortgage penalties could make owning a home a very expensive short term decision.

Mortgage Basics #6: Broker or Banker?

Here’s part 6 of my 10 step series on mortgages here at Financial Uproar every Wednesday.  Every step of the process will be covered from the application to qualifying to tips and tricks to save money on your mortgage and everything in between. To read all of these just click on the category Mortgage Basics.

Traditionally, the process for getting a mortgage was the same for all borrowers. You went down to the bank, had a talk with your friendly neighborhood banker, and he either gave you the mortgage or told you to go pound dirt. As time went on and Canadians got more choice, mortgage brokers started gaining popularity. They’ve gained approximately a third of market share, putting a significant dent in the dominance of traditional banks.

Which should you use, a mortgage broker or banker? Each have their own advantages and disadvantages.

What’s a Mortgage Broker?

For those of you unaware, a mortgage broker is a middleman in between the borrower and the lender. The borrower approaches the mortgage broker, the broker takes all the borrower’s information and then shops that deal to a lender. The broker has access to lots of lenders, including some lenders that will fund deals a traditional bank won’t touch. Once the lender gets the deal, they either say yay or nay, usually accompanying an approval with a list of conditions. The broker collects all the paperwork needed to satisfy those conditions, and the deal gets done.

Advantages To Using A Banker

The first advantage to using a bank employee is the lack of paperwork required. Of course, this advantage only applies if you use your own banker, and not one from a competing brand.

When the borrower uses a mortgage broker, they have to prove everything they’ve stated in their application. The new lender asks for copies of bank statements, pay stubs, and the like, to prove the borrower has the required down payment, they make as much as they said, etc. As a former broker, I know that getting all this paperwork from a disorganized borrower can be a pain in the ass. I also know that lenders will often be very cautious with their paperwork, sometimes rejecting paperwork they don’t find satisfactory.

When the borrower applies at their local branch, a lot of this paperwork isn’t required because the bank already has it on hand. This can make the mortgage process much easier. Many borrowers will take the path of least resistance, especially during the stressful time of buying a house.

Other borrowers will value the relationship they have with their banker. They have fond feelings for their loans officer because they’ve borrowed from the bank before, or perhaps they just think she’s cute. For whatever reason, many borrowers feel a loyalty to their bank. Confidentiality plays an issue with this point as well. Most people don’t want all sorts of people knowing their financial information. They reason that their bank already knows all this stuff, so they aren’t giving that information to anyone else.

Many mortgage brokers will tout the large number of lenders they have access to as a reason for using a broker over a banker. The reality is if the borrower fits into the standard mold, most brokers have two or three lenders they split the majority of their business with. The broker will often have an assigned underwriter they work with, someone who they feel does a good job. Like a lot of borrowers, most brokers take the path of least resistance too, sometimes sacrificing the best deal for the customer in the interest of an easier deal.

Advantages To Using A Broker

While the banks have gotten better in their rate transparency, the borrower still often won’t know if the rate being offered by the bank is the bank’s best rate or not. Banks still enjoy playing the posted rate game, offering naive borrowers a crappier rate, in an effort to make the bank more money. A borrower who isn’t mortgage savvy really has no idea whether they’re getting the best deal or not. Mortgage brokers are much more transparent in their rates, each borrower sent to the same lender gets the same rate.

Mortgage brokers are generally more flexible than traditional bank employees. Brokers are usually willing to come over to a borrower’s house to do the application, pick up documents, etc. Brokers often meet clients after supper and on weekends, getting a head start on deals outside of traditional business hours. The banks are starting to combat this advantage by introducing mobile mortgage specialists, commission based salespeople who have the flexibility of mortgage brokers, only offering one bank’s products.

Brokers are paid on completed deals only. Therefore, a broker is likely to try harder to get a deal done than a bank employee who is paid salary. If a borrower has a tough deal to fund, the tenacity of a broker is definitely an advantage.

Which Should You Use?

Being that I’m not a broker anymore, use whichever you want. It’s not like I care anymore. 🙂

Each borrower has to figure out whether they value the relationship with their existing bank (at the cost of perhaps paying more) or the flexibility of a broker (at the cost of more paperwork). Each path has its own advantages and disadvantages, leaving the borrower to decide which is best for them. Brokers continue to gain market share, a growth that might decline as banks do a better job competing with the advantages a broker brings to the table.