Mortgage Guide for First-Time Home Buyers in Canada
February 3, 2022 | Posted by: Ronice Harrison
The mortgage is the fuel that makes every first (or 50th) home purchase possible. Learn all the insights into the mortgage process with this Mortgage Guide for first-time home buyers in Canada.
In this guide, we’ll cover everything from:
- the core structure of a mortgage,
- the types of loans you can qualify for,
- the new ‘mortgage stress test’,
- variable vs fixed interest rates, and
- what is special about your FIRST mortgage.
So, to start, what is the core structure of a mortgage?
How a Mortgage Works
You need to buy a home, but you don’t have enough money.
Is that a problem? Not necessarily!
With a mortgage lender, you can get the money you need (a huge loan), lots of time to pay it back (up to 25 years), and a super low interest rate while doing so (as low as 1.45% in Ontario).
Wow, ‘those lenders are angels’, you might think! Do they do this out of the kindness of their hearts?
Spoiler alert: They do not. It benefits them, too.
Mortgages are a win-win situation for all the parties involved, as long as they follow the mortgage process:
1) To you, the mortgage lets you buy that amazing home you have your eye on. To the lender, that home you’re buying will serve as “collateral” for your huge loan. If you ever fail to make your mortgage payment, the lender can foreclose on your home and sell it, making a profit in the process. This offers safety to the lender.
2)Yes, mortgages have very low interest rate, and they’re a good deal for you in that regard. But lenders only feel comfortable offering low rates because they feel safe to loan you money.
3) Mortgages can vary in length, have fixed or variable interest rates, and either require a lot of cash upfront or not much at all. But in all of these scenarios, the property is collateral.
4) When you take out a mortgage, you take a big bill and spread it out over a long time. You (or you and your partner if buying a home jointly) rely on the strength of your income(s) to make yourself appealing to a lender.
5) Each month, you make consistent payments toward this big bill, including some money going to all these PITI categories.
Principal of the loan (paying this builds your home equity)
Interest on the loan (the fee for borrowing)
Taxes on the property (property taxes, school taxes, etc.)
Insurance (which isn’t necessary but highly recommended for homeowners)
Now let’s dive into the details.
Here’s what a first-time home buyer should know about mortgages.
Conventional vs. non-conventional loans
Another name for these loans is ‘uninsured’ vs ‘insured’ mortgage loans.
Simply put, a conventional mortgage is any mortgage where the borrowed amount makes up 80% or less of the property’s value. In other works, it’s a mortgage where you offer at least a 20% down payment.
Conventional mortgage loans are the most common type of loan in Canada, accounting for 60% of all mortgages. They are uninsured (which reduced your cost to borrow), but require larger down payments.
Non-conventional loans, on the other hand, have to be insured, but they allow you to put down payments as little as 5% of the home’s value.
Non-conventional (or insured) mortgages are generally a better fit for first-time home buyers.
Mortgage stress test rules
Starting in 2018, all Canadian buyers applying for a mortgage are now required to undergo the OSFI Mortgage Stress Test, including those who put a 20%+ down payment. As mortgage interest rates hit their all-time lows, this test basically requires buyers to prove their ability to make mortgage payments, even if interest rates go back up.
Instead of getting your mortgage based on your monthly payment at the current interest rate, you’ll undergo the stress test using the Bank of Canada qualifying rate of 5.25%.
However, if the current interest rate rises above 3.25%, then your bank will test you at the mortgage interest rate plus 2%.So if the current rate rises to 3.4%, you will actually be tested for your ability to pay at a rate of 5.4%.
How to know if you will pass the mortgage stress test?
There are a few simple tests you can do at home to see if you will pass the current mortgage stress test.
1) Gather data
Find out the following:
- the cost of the home you want to buy
- how much you can offer as a down payment
- the current interest rate
- your current monthly expenses (outstanding loans and monthly bill payments)
2) Calculate your monthly payment at the stress test rate.
Use the Bank of Canada qualifying rate of 5.25% to calculate your monthly mortgage payment. You can use our mortgage calculator to figure this out.
For example, for a home worth $500,000 with a 20% down payment, your loan amount would be $400,000. For a loan that size over a 25-year period, your monthly payment would be $2,384.
3) Calculate your debt service ratio.
All your monthly expenses together shouldn’t exceed 32% of your gross monthly income.
If your pay your mortgage plus another $500 for taxes, insurance, utilities, etc., then you will pass the stress test for a $500,000 home with a monthly income of $9,000 or higher.
Fixed-Rate or Variable Loans for First-Time Buyers?
This is the most common mortgage structure. Fixed-rate mortgages are just that: fixed in place with an interest rate that doesn’t change over the life of the loan (whether over a 3-year term, 10-year term, or even 15-year term).
The main benefit to the borrower here is that you know exactly what your mortgage payment will be each month.
If you plan on living in your first home for seven to 10-plus years—which is pretty average for the first-time home buyer—a fixed rate is probably the best route.
You’ll build equity a bit slower than with variable-rate loans, and you’ll pay slightly higher interest costs over the long run, but the predictability of mortgage payments and the sense of security from locking in a set interest rate are immensely attractive.
The variable rate is determined using the prime rate of Canada. It fluctuates with the prime rate of the Bank of Canada and will change every time the prime rate fluctuates.
Variable rate mortgages are less predictable, so they aren’t the best option for a first time buyer looking for stability. But if you are okay with some risk, you stand to save more money in comparison to a fixed rate depending on what’s happening with the prime rate from the central bank.
This is because as the prime rate lowers, the interest rate on your mortgage lowers. This means more money can go toward paying off the principal, and building your home equity.
A variable mortgage also gives you more freedom. You can re-finance, cancel, or change the terms of your mortgages with a lot fewer penalties than those paying at a fixed rate.
However, if the prime rate goes us (as it is likely to do since it’s currently at an all-time low) then your monthly interest payments will rise. People who go for variable-rate mortgages need to have financial stability to be able to handle this risk.
Using First-Time Home Buyer Incentives in Canada
The federal government has several beneficial measures to help Canadians secure their first mortgage.
- The Home Buyer’s Plan allows first-time homebuyers to withdraw funds from their Retirement Savings Plan (RSP) to use towards their first home.
- The Home Buyer’s Amount is a $5000 non-refundable income tax credit that can be applied to certain qualifying homes.
- The First-Time Home Buyer Incentive enables first-time homebuyers to reduce their monthly mortgage payment without increasing their down payment. Borrowers who meet the criteria can apply for a 5% or 10% shared equity mortgage with the Government of Canada.
- The GST/HST New Housing Rebate offers qualifying homebuyers a GST/HST rebate on the purchase price of a home.
These incentives are only in place for first-time home buyers. So use them now, or lose them forever!
In conclusion, think about tomorrow.
Start planning for the future. Consider discussing your mortgage options with your lender. AQRE Lending can help you navigate the mortgage types, stress tests, and lender rules of Canada.
Whether you have good credit or bad, a large down payment or just 5%, we can always find a lender that will fulfil your needs.
Now is also a good time to start preparing for your first home!