Renting a Home
The choice of whether to rent or own follows the pattern of life stages. People rent early in their adult lives because they typically have fewer financial resources and put a higher value on mobility, usually to keep more career flexibility. Since incomes are usually low, the tax advantages of ownership don’t have much benefit.
As family size grows, the quality of life for dependents typically takes precedence, and a family looks for the added space and comfort of a house and its benefits as an investment. This is the mid-adult stage of accumulating assets and building wealth. As income rises, the tax benefit becomes more valuable too. Often, in retirement, with both incomes and family size smaller, older adults will downsize to a condo, an apartment, or a smaller house, shedding responsibilities and financial commitments. Home ownership decisions vary: some people do not want the responsibilities of ownership, while some just want to own their home.
Finding an apartment or house to rent is much like finding a home in terms of assessing its attributes, comparing choices, and making a choice. Landlords, property managers, and agents all rent properties and use various media to advertise an available space. Since the rent for an apartment is a regular expense, financed from current income (not long-term debt), you need to find only the apartment and not the financing, which simplifies the process considerably.
Once you decide to own your home, you must choose which home to own.
There are single- and multiple-unit dwellings, for example. A multiple-unit dwelling can be used to create rental income or to house extended family members, but this choice imposes the responsibilities of being a landlord and also limits privacy.
There are previously owned, new, and custom-built homes. Previously owned homes may require some renovation to make them comfortably modern and convenient. New and custom-built homes typically have more modern features and conveniences and require less maintenance and repair expense. Custom-built homes are built to the homeowners’ specifications.
Mobile homes are large trailers fitted with utilities connections and they can be installed on permanent sites and used as residences. A mobile home may also be situated in a trailer park or mobile home community in which the owner rents a lot. Mobile homes are often referred to as manufactured homes, and other examples of manufactured homes are prefabricated or modular homes, which are moved to a foundation site by trailer and then assembled.
In a condominium, the homeowner owns a unit in a multiple-unit dwelling, but the common areas of the building are owned and managed by the condominium owners’ association. Condo owners pay a fee to cover the costs of overall building maintenance and operating expenses for common areas.
Co-operative housing is a unit in a building or complex owned by a non-profit association or a corporation for the residents’ use. Residents do not own the units, but rather own shares in the co-operative association, which entitles them to the right to dwell in its housing units.
Personal factors such as your age, family size, health, and career help you to answer some of the following key questions:
- How large should the house be? How many bedrooms and bathrooms?
- Which rooms are most important: kitchen, family room, or home office?
- Do you need parking or a garage?
- Do you need storage space?
- Do you need disability accommodation?
- Do you want outside space: a yard, patio, or deck?
- How important is privacy?
- How important is energy efficiency and other “green” features?
- How important are design features and appearance?
- How important is location and environmental factors?
- How important is proximity to work? Schools? Shopping? Family and friends?
After ranking the importance of such attributes, you can use an attribute-scoring matrix to score your choices. After understanding exactly what you are looking for in a home, you should begin to think about how much house you can afford.
Canada Mortgage Housing Corporation
The Canada Mortgage Housing Corporation (CMHC) is a Canadian government agency and Canada’s authority on housing. According to the CMHC, the agency aims to “contribute to the stability of the housing market and financial system, provide support for Canadians in housing need, and offer objective housing research and advice to Canadian governments, consumers and the housing industry” (CMHC, 2017a).
Many of the resources that are provided throughout this chapter are derived from the CMHC website and are important to review before you set out to purchase a home.
Before looking for a house that offers what you want, you need to identify a price range that you can afford. Most people use financing to purchase a home, so your ability to access financing or get a loan will determine the price range of the house you can buy. Since your home and your financing are long-term commitments, you need to be careful to try to include future changes in your thinking.
For example, Tamiko and Anthony are both twenty-five years old, newly married, and looking to buy their first home. Both work and earn good incomes. The real estate market is strong, especially with mortgage rates relatively low. They buy a two-bedroom condo in a new development as a starter home.
Fast forward five years. Tamiko and Anthony are expecting their second child; while the couple is happy about the new baby, neither can imagine how they will all fit in their already cramped space. They would love to sell the condo and purchase a larger home with a yard for the kids, but the real estate market has slowed, mortgage rates have risen, and a plant closing last year has driven up unemployment in their area. Tamiko hasn’t worked outside the home since their first child was born two years ago; they are just getting by on one salary and a new baby will increase their expenses—making it even more difficult to think about financing a larger home.
A lender will look at your income, your current debts, and your credit history to assess your ability to afford a mortgage. As discussed in Chapter 7 “Financial Management,” your credit score is an important tool for the lender, who may also request verification of employment and income from your employer.
Before looking for a home, the CMHC recommends reviewing its guide Homebuying Step by Step.
As Tamiko and Anthony consider buying a home, an important first step is identifying how much they can afford to spend on homeownership in order to ensure they have enough money to cover all of their other expenses, such as food, clothing, and other debts and payments.
According to the CMHC, there are two rules Canadians should follow in order to assess whether they can comfortably manage a home and to verify whether a lender will approve them. The first affordability rule is to determine your gross debt service (GDS). To figure out your GDS, you must determine the principal and interest that make up your monthly mortgage payment, as well as taxes and heating expenses. The acronym “PITH” (principal, interest, taxes, and heating) can help people to remember these expenses. A condominium purchase must also take into consideration half of the monthly condominium fees. GDS is determined by adding up your total monthly PITH payments and calculating what percentage of your average gross monthly household income is made up of PITH payments (CMHC, 2016). GDS ratios are calculated by using the following equation:
Gross debt service (GDS) = PI + T + H x 100%
GDS should not be more than 35 per cent of your gross monthly income. The CMHC online Debt Service Calculator can help you to compare your monthly debt payments and housing expenses to your gross household income.
The second affordability rule is to calculate your total debt service (TDS) in order to determine how much of your gross income is already going toward debt payments. TDS is the percentage of your income needed to cover all of your debts. The ratio for this is the same as that of the GDS, except all of your monthly payments, such as car payments, credit cards, and any loans, must be considered (CMHC, 2016). TDS ratios are calculated by using the following equation:
Total debt service (TDS) = PI + T + H + D x 100%
For lenders to consider you for a mortgage, your TDS should not be more than 42 per cent of your gross monthly income.
If you would like to determine the monthly mortgage payments (principal and interest) of a home by inputting different down payments, house prices, and interest rates, the CMHC’s should be of assistance.
These kinds of calculations give both you and your lender a much clearer idea of what you can afford, and they are part of the pre-approval process for a mortgage. You may want to sit down with a potential lender and have this discussion before you do any serious house hunting so that you have a price range in mind before you shop.
Searching for a Home
After understanding exactly what you are looking for in a home and what you can afford, you can organize your efforts and begin your search.
Typically, buyers use a realtor, real estate agent, or broker who has to be licensed to trade real estate in Canada and realty listings to identify homes for sale. A realtor is a person or business that serves as an agent for the sale and purchase of buildings and land. A real estate broker is a manager of a brokerage firm who supervises real estate agents. Brokers are given broker’s licences by provincial real estate associations when they have completed additional training for their added responsibilities. Brokers add value to your search by providing information about the house and property, the neighbourhood and its schools, recreational and cultural opportunities, and costs of living. A real estate agent serves as an intermediary between people selling a property and those who want to buy real estate, and they are often employed by a real estate broker in a registered real estate brokerage.
Remember, though, that the broker or its agent, while helping you gather information and assess your choices, is working for the sellers and will be compensated by the seller when a sale is made. Consider paying for the services of a buyer’s agent, a fee-based real estate broker who works for the buyer to identify choices independently of the purchase. The real estate industry is regulated by provincial, territorial, and federal laws as well as by self-regulatory bodies, and real estate agents must be licensed to operate.
Increasingly, sellers are marketing their homes directly to save the cost of using a broker. A real estate broker typically takes a negotiable amount of the purchase price, often in the range of 3 to 7 per cent, from which it pays a commission to the real estate agent, which is then split with the buyer’s agent. Some brokers will charge a flat rate. There is no set rate of commission for real estate agents nationally or in individual provinces and territories and the rate is often negotiable (Tersigni, 2017). “For sale by owner” sites on the Internet can make the exchange of housing information easier and more convenient for both buyers and sellers. For example, websites such as comfree.com serve home sellers and buyers directly. Keep in mind, however, that sellers acting as their own brokers and agents are not licensed or regulated and may not be knowledgeable about federal and provincial laws governing real estate transactions, potentially increasing your risk.
Mortgage Pre-Approval and Qualifying for a Mortgage
Mortgages can be obtained from several types of lenders, such as:
- credit unions or caisses populaires,
- mortgage companies,
- insurance companies,
- trust companies, and
- loan companies.
It is important to talk to several lenders during the pre-approval process to make sure you’re getting the best rates and conditions for your mortgage needs. A pre-payment penalty can be charged if you switch lenders after signing a mortgage contract, so it is important that you are comfortable with and understand the terms and condition of your mortgage contract.
Mortgage lenders look at one’s finances (GDS and TDS) in order to determine the maximum amount of a mortgage they will lend you, what tentative interest rate they will charge, and what your estimated mortgage payments will be. But the pre-approval, while it represents the maximum amount you may get, does not guarantee you will receive that mortgage loan amount (FCAC, 2017).
In order to get pre-approved, the FCAC (2017) provides an overview of the information (your total assets and debts) required by your lender or mortgage broker (an intermediary between a borrower and a lender who determines the borrower’s ability to secure financing), including:
- proof of employment,
- proof you can pay for the down payment and closing costs,
- information about your other assets, such as a car, cottage, or boat, and
- information about your debts or financial obligations.
Proof of employment may require that you provide:
- proof of current salary or hourly pay rate (for example, a current pay stub and a letter from your employer),
- your position and length of time with the organization, and
- notices of assessment from the CRA for the past two years, if you’re self-employed.
Proving that you can pay the down payment may require that you provide recent financial statements from bank accounts or investments.
Your lender or mortgage broker will also require an overview of your debts or financial obligations, which may include:
- credit card balances and limits, including those on store credit cards,
- child or spousal support amounts,
- car loans or leases,
- lines of credit,
- student loans, and
- other loans.
The FCAC recommends asking the following questions when getting pre-approved:
- how long the lender or broker will guarantee the pre-approved rate
- whether you automatically get the lowest rate if interest rates go down while you’re pre-approved
- if the pre-approval can be extended (FCAC, 2017).
Even if you’ve been pre-approved, you could be refused a mortgage by your chosen lender. A lender will need to verify that your property meets certain standards; this is determined by each lender and therefore varies. If you are turned down for a mortgage, it is important to ask about other options that are available (FCAC 2017).
After you narrow your search, receive mortgage pre-approval, and choose a prospective home, you have the home inspected to assess its condition and project the cost of any repairs or renovations. Home inspections are strongly recommended before signing a purchase agreement or as a condition of the agreement. A standard home inspection checklist, based on information from Desjardins Insurance, is shown in Table 9.1.2.
Floors, Walls, Ceilings
Data Source: Desjardins Insurance, 2016; table created by Bettina Schneider, 2018
As with a car, it is best to hire a professional (a structural engineer, contractor, or licensed home inspector) to do the home inspection. A professional will be able to spot not only potential problems but also evidence of past problems that may have been fixed improperly or that may recur—for example, water in the basement or leaks in the roof. If there are problems, you will need an estimate for the cost of fixing them. If there are significant and immediate repair or renovation costs projected by the home’s condition, you may try to reduce the purchase price of the property by those costs. You don’t want any surprises after you buy the house, especially costly ones.
You will also want to do a title search, as required by your lender, to verify that there are no liens or claims outstanding against the property. For example, the previous owners may have had a dispute with a contractor and never paid his bill, and the contractor may have filed a lien or a claim against the property that must be resolved before the property can change hands. There are several other kinds of liens—for example, a tax lien, which is imposed to secure payment of overdue taxes.
A lawyer or a title search company can do the search, which involves checking the municipal or town records where a lien would be filed. A title search will also reveal if previous owners have deeded any rights—such as development rights or water rights, for example, or grants of right-of-way across the property—that would diminish its value.
Identifying the Market
Housing costs are determined by the price of the house and by the price of the debt (i.e., the interest rate payments) that finances the house. House prices are determined by forces of supply and demand, which in turn are determined by macroeconomic circumstances.
When the economy is contracting and incomes are decreasing, and especially if unemployment rises and incomes become uncertain, buyers are hesitant to add the significant financial responsibility of new debt to their budgets. They tend to continue with their present arrangements or may try to move into cheaper housing, downsizing to a smaller house, an apartment, or condo to decrease operating expenses. When the economy is expanding, on the other hand, expectations of rising incomes may encourage buyers to be bolder with their purchasing decisions.
A house represents not only a housing expense but also an investment that can serve as a store of wealth. In theory, if a contraction creates a market with declining asset values, investors will seek out alternative investments, abandoning that market. In other words, if house prices decline, the house’s value as an investment will decline. Investors will seek other assets in which to store wealth to avoid the opportunity cost of making an investment that does not generate returns.
Housing markets are local, however. If the local economy is dominated by one industry or by one large employer, the housing market will be sensitive to the fate of that industry or employer. If a location has value independent of the local economy, such as value as a vacation or retirement location, that value can offset local concerns. In that case, housing prices may be less sensitive to the local economy.
Since a house is an investment, the homebuyer is concerned about its expected future value. Future value is not easy to predict, however, as housing markets have some volatility. In extreme periods, for example between 2004 and 2009 in the United States, there was extreme volatility. Thus, depending on how long you intend to own the home, it may or may not be realistic to try to predict price trends based on macroeconomic cycles or factors. Some areas may seem to be always desirable, but a severe economic shock or boom can affect prices in those areas as well. While a house may be used to store value, it may not generate a real increase in wealth.
Since the early 2000s, however, housing prices have soared. Many economists attribute this to a sustained period of low mortgage rates and slow economic growth. In recent years, many have been concerned that Canada is close to the level at which America’s housing bubble topped out in 2006. In the United States, the housing bubble burst in 2007 as the economy slumped into a recession. Housing demand and prices fell, even with low mortgage rates, creating a real buyer’s market. Many economists attribute the severity of the slump to the banking crisis that froze the credit markets, because most housing purchases were financed with debt.
Ability to buy a house rests on the ability to finance the purchase, to provide a down payment, and to borrow. That ability is determined by the buyer’s personal situation (e.g., stability of employment or income, credit history) and by macroeconomic events such as interest rate levels, expected inflation, and liquidity in the credit markets. If interest rates and inflation are low and there is liquidity in the credit markets, it will be easier for buyers to borrow than if inflation and interest rates are high and the credit market is liquid. Demand for housing thus relies on the availability of credit for the housing market.
- Different building structures are:
• single-unit or multiple-unit dwellings or mobile homes, and
• previously owned, new, or custom built.
- Different ownership structures include:
• conventional ownership,
• condominium, and
• co-operative housing.
- The buyer’s inspection checklist includes:
• structural elements,
• exterior elements,
• systems for plumbing, electrical, heating/cooling, and
• outdoor buildings and features.
- Lenders assess income, current debts, and credit history to determine the borrower’s creditworthiness.
- A mortgage affordability estimate uses an estimate of PITH and other debt payments as a percentage of gross monthly income and of the down payment as a percentage of the purchase price.
- Housing prices may be affected by business cycles as they affect
• unemployment and income levels, and
• inflation, which affects not only the cost of houses but also interest rates and the cost of home financing.
- Housing prices are affected by the availability of home financing, which in turn depends on:
• interest rates and inflation, and
• liquidity in the credit markets.
- Perform an attribute analysis of your projected wants and needs as a homeowner. Begin by prioritizing the following personal and microeconomic factors in terms of their importance to you in deciding when to buy a home:
• How large should the house be? How many bedrooms and bathrooms?
• Which rooms are most important: kitchen, family room, or home office?
• Do you need parking or a garage?
• Do you need storage space?
• Do you need disability accommodation?
• Do you want outside space: a yard, patio, or deck?
• How important is privacy?
• How important is energy efficiency or other “green” features?
• How important are design features and appearance?
• How important is location and environmental factors?
• How important is proximity to work? Schools? Shopping? Family and friends?
- In your journal, describe hypothetically your first or next home that you think you would like to own, including its location and environment. Predict how much you think it might cost to own such a home in your province. Then look through realty news and ads to find the asking prices for homes or housing units similar to the one you described. How accurate is your prediction?
- Discuss with classmates the ins and outs of being a tenant and the ins and outs of being a landlord. Develop a comparison chart of benefits, drawbacks, and risks.
- Do you live in a dorm or at home with parents or other relatives? What needs to happen for you to have a place of your own? Research websites that aid students in finding independent housing. Develop a flexible plan and timetable for finding and financing a place of your own and record it in your personal finance journal.
- Investigate the real estate market in your area. How do local housing availability and pricing differ from other cities, towns, and provinces or territories? How stable or volatile is your real estate market? Is it a buyer’s market or a seller’s market, and what does that mean? To what local factors do you attribute the differences you find? Share your findings with classmates.
- Identify and analyze the macroeconomic factors that are affecting your local real estate market. In what ways or to what extent does your local economy reflect macroeconomic factors in the national economy?
Canada Mortgage and Housing Corporation. (2016). “Housing for Newcomers.” Retrieved from:.
Canada Mortgage and Housing Corporation. (2017a). “About CMHC.” Retrieved from:.
Canada Mortgage and Housing Corporation. (2017c). “History of CMHC.” Retrieved from:.
Desjardins Insurance. (2016). “4 Important Home Inspection Tips and a Checklist.” Retrieved from:.
Financial Consumer Agency of Canada. (2017). “Getting pre-approved and qualifying for a mortgage.” Retrieved from:.
Tersigni, J. (2017). “How Much Are Real Estate Commission Rates in Canada?” MoneyWise, May 31. Retrieved from:.
9.2 IDENTIFY FINANCING
- Define the effects of the down payment on other housing costs.
- Calculate the monthly mortgage payment, given its interest rate, maturity, and principal balance.
- Distinguish between a fixed-rate, variable-rate, and an adjustable-rate mortgage and explain their effects on the monthly payment and interest rate.
- Distinguish between a rate cap and a payment cap, and explain their uses and risks.
- Identify potential closing costs.
- Define First Nations housing on reserve.
Just as your house may be your most significant purchase, your mortgage may be your most significant debt. The principal may be many times one year’s disposable income and may need to be paid over fifteen or thirty years. The house secures the loan, so if you default or miss payments, the lender may foreclose on your house or claim ownership of the property, evict you, and resell the house to recover what you owe.
Banks, credit unions, finance companies, and mortgage finance companies sell mortgages. They profit by lending and competing for borrowers. It makes sense to shop around for a mortgage, as rates and terms (i.e., the borrowers’ costs and conditions) may vary widely. The Internet has made it easy to compare; a quick search of “mortgage rates” yields many websites that provide national and provincial averages, lenders in your area, comparable rates and terms, and free mortgage calculators.
Keep in mind that the costs discussed in this chapter, associated as they are with various kinds of mortgages, may change. The real estate market, government housing policies, and government regulation of the mortgage financing market may change at any time. So when it is time for you to shop for a mortgage, be sure you are informed of current developments.
Mortgages require a down payment, or a percentage of the purchase price paid in cash upon purchase. Most buyers use cash from savings, the proceeds of a house they are selling, or a family gift.
In Canada, the minimum down payment required is 5 per cent if the home costs $500,000 or less. If the price of the home is greater than $500,000, one will need a minimum of 5 per cent down on the first $500,000 and 10 per cent on the remainder (CMHC, 2018). The size of the down payment does not affect the price of the house, but how much you put down will affect the cost of the financing (a larger down payment = a smaller mortgage and lower monthly payments).
Buyers with a down payment between 5 and 20 per cent must be backed by mortgage insurance, which insures the lender against the costs of default. Mortgage loan insurance is mandatory for federally regulated lenders in Canada when the buyer of a home puts down less than a 20 per cent down payment.
The CMHC is a public mortgage insurer and as such has “a mandate to provide service in all parts of the country and for a range of housing forms” (CMHC, 2017a). A conventional mortgage is a loan for no more than 80 per cent of the purchase price (or appraised value) of the property, and it must meet the 20 per cent down payment CMHC requires in order to not have to purchase mortgage insurance. A high ratio mortgage is a loan for more than 80 per cent of the purchase price (or appraised value) of the property. A high ratio mortgage must be insured by the CMHC, Genworth Financial Canada, or Canada Guarantee.
A significant portion of the CMHC’s mortgage loan insurance business is in markets or for housing options that are not served or less served by private mortgage insurers. In addition to being the primary insurer for housing in small and rural communities, the CMHC is the only insurer of mortgages for multi-unit residential properties, including large rental buildings, student housing, and nursing and retirement homes (CMHC, 2017a).
The down payment can offset the annual cost of the financing, but it creates opportunity cost and decreases your liquidity as you take money out of savings.
The Home Buyers’ Plan is an important source of money for a down payment. The Home Buyers’ Plan “is a program that allows you to withdraw up to $25,000 in a calendar year from your RRSPs to buy or build a housing unit in Canada for yourself or for a relative with a disability” (Government of Canada, 2016).
Cash will also be needed for the closing costs or transaction costs of this purchase or for any immediate renovations or repairs. Those needs will have to be weighed against your available cash to determine the amount of your down payment. Expenses for moving, new furniture, and other related moving expenses should be considered as well.
Monthly Mortgage Payment
The mortgage payment is the ongoing cash flow obligation of the loan. While monthly mortgage payments are common, other options are available, such as biweekly and semi-monthly payments. If you don’t meet this payment, you are in default on the loan and may eventually lose the house with no compensation for the money you have already put into it. Your ability to make the monthly payment therefore determines your ability to keep the house.
The interest rate and the maturity (lifetime of the mortgage) determine the monthly payment amount. With a fixed-rate mortgage, the interest rate remains the same over the entire maturity of the mortgage, and so does the monthly payment. A variable-rate mortgage (VRM) requires a constant monthly payment, but the amount paid toward the principal balance will fluctuate as interest rates fluctuate. Lower interest rates mean that more of the monthly payment will go towards the principal balance, while higher interest rates mean that more of the payment is allocated to the interest. VRMs generally offer lower initial interest rates compared to fixed-rate mortgages, which are attractive to borrowers. However, borrowers, not lenders, are at risk if future interest rates increase. VRMs are more often issued outside of the United States. Conventional mortgages can be fixed-rate mortgages or variable rate.
A fixed-rate mortgage is structured as an annuity: regular periodic payments of equal amounts. Some of the payment is repayment of the principal and some is for the interest expense. As you make a payment, your balance gets smaller, and so the interest portion of your next payment is smaller, and the principal payment is larger. In other words, as you continue making payments, you are paying off the balance of the loan faster and faster and paying less and less interest.
Mortgage amortization is a schedule of interest and principal payments over the life of the loan—that is, the length of time it will take you to pay off your entire mortgage. The maximum amortization period on CMHC-insured mortgages is twenty-five years. The longer the maturity, the greater the interest rate, because the lender faces more risk the longer it takes for the loan to be repaid.
In the early years of the mortgage, your payments are mostly interest, while in the last years they are mostly principal.
With an adjustable-rate mortgage (ARM), the interest rate—and the monthly payment—can change. This differs from a variable-rate mortgage in which only the interest rate can change; only the amount paid towards the principal balance varies, not the actual monthly payment. If interest rates rise, the monthly payment will increase, and if they fall, it will decrease. A rate cap is a limit on an adjustable-rate mortgage. Most rate caps rise 1 to 2 per cent in a year and no more than 5 percentage points during the life of a loan (Kapoor et al., 2015). Homeowners with ARMs are at risk of seeing their monthly payment increase, but can limit this interest rate risk with a rate cap.
ARMs are much more commonly offered in the United States than in Canada. “80% of U.S. mortgages issued in recent years to sub-prime borrowers were adjustable-rate mortgages” (Kapoor et al., 2015). The sub-prime mortgage crisis in the United States came about due to an increase in mortgage foreclosures, largely sub-prime mortgages (loans given to less creditworthy borrowers). Many mortgage lenders and hedge funds in the United States failed due to this crisis. It also negatively impacted the global credit market as risk premiums increased and capital liquidity decreased (Kapoor et al., 2015). The global financial crisis, ignited by the sub-prime mortgage crisis in the United States, began in 2007, resulting in a recession in many parts of the world, including Canada. The Canadian recession of 2008–2009, while considered milder than what was experienced in the United States and Europe, was still harsh enough that a number of changes to mortgages—insured and uninsured—were made.
The Insured Mortgage Purchase Program (IMPP) was introduced by the federal government, which allowed banks to exchange “illiquid mortgage assets for bonds issued by the Canadian Mortgage and Housing Corporation. . . . Since CMHC debt is backed by the federal government, these assets were more readily accepted as collateral for short-term lending. This exchange did not affect the government’s risk exposure to the mortgage market: only mortgages that were already insured by the government were eligible for the IMPP” (Gordon, 2017).
A payment cap limits the amount by which the mortgage payment can increase or decrease. That sounds like it would protect the borrower, but if the payment is capped and the interest rate rises, more of the payment pays for the interest expense and less for the principal payment, so the balance is paid down more slowly. If interest rates are high enough, the payment may be too small to pay all the interest expense, and any interest not paid will add to the principal balance of the mortgage.
In other words, instead of paying off the mortgage, your payments may actually increase your debt, and you could end up owing more money than you borrowed, even though you make all your required payments on time. This is called negative amortization.
There are mortgages that combine fixed and variable rates—for example, offering a fixed rate for a specified period of time, and then an adjustable rate. Another type of mortgage is a split- or multi-rate (hybrid) mortgage that allows one to split the borrowed amount into three to five parts, each with different term lengths, rates, and rate types. A hybrid mortgage allows a borrower to take advantage of the low rates inherent in a variable-rate mortgage when different parts of the mortgage are renewed at different times.
As an asset, a house may be used to secure other types of loans. A home equity loan or a second mortgage allows a homeowner to borrow against any equity in the home. A home improvement loan is a type of home equity loan. A home equity line of credit (HELOC) allows the homeowner to secure a revolving line of credit, or a loan that is borrowed and paid down as needed, with interest paid only on the outstanding balance. The advantages of HELOCs are easy access to a line of credit and the ability to repay at any time without pre-payment penalties. The disadvantages of HELOCs are the fees attached to these loans and the fact that you could lose your home if you are unable to make your loan payments.
Do-it-yourself mortgages are for self-employed people who may often have inconsistent income. For such borrowers, there are two options: 1) apply for a stated income loan, which are based on the income the borrower reports (these loans are often riskier unless the applicant has a high credit score or can provide a large down payment), and 2) regular loans with income documentation, which requires applicants to provide one to two years of tax returns (Kapoor et al., 2015).
A reverse mortgage is designed to provide homeowners with high equity a monthly income in the form of a loan. A reverse mortgage essentially is a loan against your home that you do not have to pay back for as long as you live there. To be eligible for most reverse mortgages, you must own your home and be sixty years of age or older. A set payment schedule is not required, as it is with a traditional mortgage; you or your estate repays the loan when you sell the house or die. Reverse mortgages need to be considered with caution. For more information on what people need to think about when considering this choice, see the FCAC overview of Reverse mortgages on the Government of Canada website.
Other costs of a house purchase are transaction costs—that is, costs of making the transaction happen that are not direct costs of either the home or the financing. These are referred to as closing costs, as they are paid at the closing, when the ownership and loan documents are signed and the property is actually transferred. The buyer pays these closing costs, including the appraisal fee, title insurance, and filing fee for the deed.
The lender will have required an independent appraisal of the home’s value to make sure that the amount of the mortgage is reasonable given the value of the house that secures it. The lender will also require a title search and contract for title insurance. The title company will research any claims or liens on the deed; the purchase cannot go forward if the deed may not be freely transferred. Over the term of the mortgage, the title insurance protects against flaws not found in the title and any claims that may result. The buyer also pays a fee to file the property deed with the township or municipality. There may also be a land transfer tax, a one-time tax levied by most provinces and territories that is the responsibility of the buyer. PST on the mortgage insurance and legal/notarial fees must also be paid in cash as part of the closing costs. For more information on closing costs in Canada, see the .
Closings may take place in the office of the title company handling the transaction or at the registry of deeds. Closings also may take place in the lender’s offices, such as a bank, or an attorney’s office and usually are mediated between the buyer and the seller through their attorneys. Lawyers who specialize in real estate ensure that all legal requirements are met and all filings of legal documents are completed.
First Nations, Métis, and Inuit Housing
According to Chris Maracle, “First Nations have always owned and maintained their own homes. Prior to contact with European Canadians some First Nations lived in communal settings while others lived nomadic lives. One thing is certain: we owned the dwellings we lived in” (CREA, 2018, p. 3). Today, First Nations governments are responsible for providing and managing on-reserve housing. First Nations communities that receive annual funding from Indigenous Services Canada for on-reserve housing can use these funds for a variety of housing needs, such as:
- lot servicing,
- debt servicing,
- planning and managing their housing portfolio, and
- mould remediation. (INAC, 2016)
The Government of Canada also invests annually in other housing programs, such as the CMHC’s On-Reserve Non-Profit Housing Program and the First Nation Market Housing Fund.
Other Government of Canada departments have programs available to support housing on reserve. For example, the CMHC works closely with other federal partners, provinces and territories, and Indigenous organizations to attempt to address housing needs in Indigenous communities by funding different programs. The CMHC’s funding supports the following:
- the construction of new rental housing,
- the renovation of existing homes,
- ongoing subsidies for existing rental social housing, and
- an investment in capacity-building for First Nations people living on reserve. (CMHC, 2017b)
The CMHC also has an On-Reserve Non-Profit Housing Program, which assists First Nations in the following areas: the construction, purchase, rehabilitation, and administration of suitable, adequate, and affordable rental housing in First Nations communities. The CMHC provides a subsidy to the project to assist with its financing and operation (CMHC, 2017b).
According to Judith Sayers (2013), the following points regarding First Nations housing should be noted:
- Reserve housing systems vary across the country.
- Some First Nations provide homes to members if they can afford it.
- Others provide homes that are built by the First Nation with a mortgage and the mortgage is paid off with the rental moneys.
- Depending on the individual First Nation’s policy, rental homes can be transferred to the member to own after the mortgage is paid out.
In addition to the points mentioned, rent can be charged by First Nations and rental revenue can be used to construct new housing and “renovate, repair or maintain existing homes” (Kiedrowski, 2014). However, it is important to note that some may see the collection of rent as a threat to treaty rights. Some First Nations, such as Six Nations and Kahnawake, have revolving loan funds for members; these First Nations provide mortgages to members who want to build or buy (CREA, 2018). Despite restrictions within the Indian Act, First Nations and financial institutions have developed innovative financing options with regard to mortgages on reserve.
There are off-reserve housing supports as well that are available to all Indigenous peoples. Provinces and territories deliver the vast majority of federal housing investments in these cases. Indigenous housing providers off reserve also have access to the CMHC’s Affordable Housing Centre, “which works with the private, public and non-profit sectors to develop affordable housing solutions that do not require ongoing federal assistance” (CMHC, 2017b). According to the CMHC, the Investment in Affordable Housing, new federal funding that has been available since 2011, provides provincial and territorial governments “the flexibility to provide programs that meet their community’s housing needs” through agreements with the federal government (CMHC, 2017c). Support may be provided in the form of proposal development funding and/or seed funding to assist in getting projects started. Indigenous housing providers off reserve can also access the Direct Lending Program for federally assisted social housing projects.
An example of an off-reserve Indigenous housing provider is Namerind Housing Corporation in Regina, Saskatchewan, which has been 100 per cent Indigenous owned since 1977. Its mission “is to provide safe, affordable, quality housing and economic development opportunities for Indigenous People” (Namerind Housing Corporation, 2018). Silver Sage Housing Corporation is another Regina-based non-profit that provides affordable housing options to First Nations peoples living in urban centres.
An example of a Métis-owned housing corporation is the Métis Urban Housing Corporation, which provides “affordable, adequate, and appropriate rental housing for low and moderate income Aboriginal families within the urban centers of Alberta” (Métis Nation of Alberta, 2018).
The Nunavut Housing Corporation (NHC) delivers a public housing program in all twenty-five Nunavut communities, the majority of which are Inuit. Management agreements between the NHC and the Local Housing Organizations (LHOs) provide “the financial resources and professional support needed to provide ongoing public housing services” (NHC, 2015).
The CMHC also provides the Housing Internship Initiative for First Nations and Inuit Youth (HIIFNIY) for First Nations and Inuit youth who would like to pursue employment in the housing industry.
The CMHC supports Habitat for Humanity’s efforts to make its home ownership model available to more Indigenous people, and it is the founding national partner for Habitat for Humanity Canada’s Indigenous Housing Program (CMHC, 2017e).
- The percentage of the purchase price paid up front as the down payment will determine the amount that is borrowed. That principal balance on the mortgage, in turn, determines the monthly mortgage payment.
- A larger down payment may make the monthly payment smaller but creates the opportunity cost of losing liquidity.
- A fixed-rate mortgage is structured as an annuity; the monthly mortgage payment can be calculated from the mortgage rate, the maturity, and the principal balance on the mortgage.
- A fixed-rate mortgage has a fixed mortgage rate and fixed monthly payments.
- An adjustable-rate mortgage may have an adjustable mortgage rate and/or adjustable payments.
- A rate cap or a payment cap may be used to offset the effects of an adjustable-rate mortgage on monthly payments.
- Closing costs are transaction costs such as an appraisal fee, title search and title insurance, filing fees for legal documents, transfer taxes, and sometimes realtors’ commissions.
- You are considering purchasing an existing single-family house for $200,000 with a 20 per cent down payment and a twenty-five-year, fixed-rate mortgage at 5.5 per cent. What would be your monthly mortgage payment? When should you consider an adjustable-rate mortgage? Why should you be cautious about adjustable-rate mortgages?
- Do you presently rent or own your home or apartment? What are your housing costs? What percentage of your income is taken up in housing costs? If your housing is costing you more than a third of your income, what could you do to reduce that cost? Record your alternatives in your personal finance journal.
- As a prospective homeowner, what would be your estimated PITH? Would a bank consider that you qualify for a mortgage loan at this time? Why or why not? What criteria do lenders use to determine your eligibility for a home mortgage?
- Can you afford a mortgage now? How much of a mortgage could you afford? Answer these questions using the Mortgage Calculator found on the CMHC website. If you cannot afford a mortgage now, how would your personal situation and/or budget need to change to make that possible? Establish home affordability as a goal in your financial planning. Write in your personal finance journal how and when you expect you will reach that goal.
- Read about the closing process in the following article from the Real Estate Wire, “Eight Steps to Closing the Purchase of Your New Home.” Who attends the closing? What legal documents are processed at the closing?
- Re-review local real estate, condo, or apartment listings in the price range you have now determined is truly affordable for you. For learning purposes, choose a home you would like to own and clip the ad with photo to put in your personal finance journal. Record the purchase price, the down payment you would make, the mortgage amount you would seek, the current interest rates on a mortgage loan for fixed- and variable-rate mortgages for various periods or maturities, the type of mortgage you would prefer, the rate and maturity you would seek, the amount of monthly mortgage payments you would expect to make, and the names of lenders you would consider approaching first.
Canada Mortgage and Housing Corporation. (2017a). “Mortgage Loan Insurance.” Retrieved from:.
Canada Mortgage and Housing Corporation. (2017b). “First Nations Housing.” Retrieved from:.
Canada Mortgage and Housing Corporation. (2017c). “Affordable Housing in Canada’s North.” Retrieved from:.
Canada Mortgage and Housing Corporation. (2018). “What is CMHC Mortgage Loan Insurance.” Retrieved from:.
Canadian Real Estate Association (CREA). (2018). First Nations Homeownership. Retrieved from: https://www.crea.ca/wp-content/uploads/2018/10/First-Nations-Homeownership.pdf.
Gordon, S. (2017). “Recession of 2008–09 in Canada.” Retrieved from:.
Government of Canada. (2016). “What is the Home Buyers’ Plan (HBP)?” Retrieved from:.
Indigenous and Northern Affairs Canada. (2016). “Roles and responsibilities in First Nations housing.” Retrieved from:.
Kapoor, J., L. Dlabay, R. Hughes, and F. Ahmad. (2015). Personal Finance. Toronto: McGraw-Hill Ryerson.
Kiedrowski, J. (2014). “Rents on reserves.” National Post, October 20. Retrieved from: https://nationalpost.com/opinion/john-kiedrowski-rents-on-reserves.
Métis Nation of Alberta. (2018). “Métis Urban Housing Corporation (MUHC).” Retrieved from:.
Namerind Housing Corporation. (2018). “About Namerind.” Retrieved from:.
Nunavut Housing Corporation. (2015). “Public Housing.” Retrieved from:.
Sayers, J. (2013). “Private Property Ownership On Reserve: A Strange Concept.” First Nations BC Knowledge Network. Retrieved from: https://fnbc.info/blogs/judith-sayers/private-property-ownership-reserve-strange-concept.
9.3 PURCHASING AND OWNING YOUR HOME
- Identify the components of a purchase and sale agreement.
- Explain the importance of a capital budget in determining capital spending priorities.
- Identify the financing events you may encounter during the maturity of a mortgage.
- Define the borrower’s and the lender’s responsibilities to the mortgage.
- Explain the consequences of default and foreclosure.
The Purchase Process
Now that you’ve chosen your home and determined the financing, all that’s left to do is sign the papers, right? Not quite.
Once you have found a house, you will make an offer to the seller, who will then accept or reject your offer. If the offer is rejected, you may try to negotiate with the seller or you may decide to forgo this purchase. If your offer is accepted, you and the seller will sign a formal agreement, often called a purchase and sale agreement or a residential form of offer to purchase, specifying the terms of the sale. When the purchase and sale agreement is signed, you will be required to pay a non-refundable deposit, also known as earnest money, which counts toward your down payment.
The purchase and sale agreement might include the following terms and conditions:
- A legal description of the property, including boundaries, with a site survey contingency;
- The sale price and deposit amount;
- A mortgage contingency, stating that the sale is contingent on final approval of your financing;
- The closing date and location, mutually agreed upon by buyer and seller;
- Conveyances or any agreements made as part of the offer—for example, an agreement as to whether the kitchen appliances are sold with the house;
- A home inspection contingency specifying the consequences of a home inspection and any problems that it may find, if not already completed and included in the price negotiation;
- Possession date, usually the closing date; and
- A description of the property insurance policy that will cover the home until the closing date.
Any problems with the property must be legally disclosed, and the method of doing so varies by province.
After the purchase and sale agreement is signed, any conditions that it specified must be fulfilled before the closing date. If those conditions are the seller’s responsibility, you will want to be sure that they have been fulfilled before closing. Read all the documents before you sign them and get copies of everything you sign. Do not hesitate to ask questions. You will live with your mortgage, and your house, for a long time.
A house and property need care; even a new home will have repair and maintenance costs. These costs are now a part of your living expenses or operating budget.
If you have purchased a home that requires renovation or repair, you will decide how much of the work you can do immediately and how much can be done on an annual basis. A capital budget is helpful to project these capital expenditures and plan the income or savings to finance them. You can prioritize these costs by their urgency and by how they will be done.
For example, Sally and Chris just closed on an older home and are planning renovations. During the home inspection, they learned that the old stone foundation would need some work. They would also like to install more energy-efficient windows, paint the walls, and strip and refinish the old wood floors.
Their first priority should be the foundation on which the house rests. The windows should be the next on the list, as they will not only provide comfort but also reduce the heating and cooling expenses. Cosmetic repairs such as painting and refinishing can be done later. The walls should be done before the the floors (in case any paint drips on the floors).
Renovations should increase the resale value of your home. It is tempting to customize renovations to suit your tastes and needs, but too much customization will make it more difficult to realize the value of those renovations when it comes time to sell. You will have a better chance of selling at a higher price if there is more demand for it, if it appeals to as many potential buyers as possible. The more customized or “quirky” it is, the less broad its appeal may be.
Two financing decisions may come up during the life of a mortgage: early payment and refinancing. Some mortgages have an early payment penalty, also referred to as “closed mortgages”—whereby the borrower is fined for repaying the loan before it is due—but most do not. If your mortgage does not have an early payment penalty—this is often referred to as an “open mortgage”—you may be able to pay it off early (before maturity), either with a lump sum or by paying more than your required monthly payment and having the excess payment applied to your principal balance.
If you are thinking of paying off your mortgage with a lump sum, then you are weighing the value of your liquidity, the opportunity cost of giving up cash, against the cost of the remaining interest payments. The cost of giving up your cash is the loss of any investment return you may otherwise have from it.
You also need to weigh the use of your cash to pay off the mortgage versus other uses of that cash. For example, suppose you have some money saved and you are thinking of paying down the mortgage. However, you also know that you will need a new car in two years. If you use that money to pay down the mortgage now, you won’t have it to pay for the car two years from now. You could get a car loan to buy the car, but the interest rate on that loan will be higher than the rate on your mortgage. If paying off your mortgage debt forces you to use more expensive debt, then it is not worth it.
One way to pay down a mortgage early without sacrificing too much liquidity is by making a larger monthly payment. The excess over the required amount will be applied to your principal balance, which then decreases faster. Since you pay interest on the principal balance, reducing it more quickly would save you some interest expense. If you have had an increase in income, you may be able to do this fairly “painlessly,” but then again, there may be a better use for your increased income.
Over a mortgage as long as thirty years, that interest expense can be substantial—more than the original balance on the mortgage. However, that choice must be made in the context of the value of your alternatives.
You may think about refinancing your mortgage if better mortgage rates are available. Refinancing means borrowing a new debt or getting a new mortgage and repaying the old one. It involves closing costs: the lender will want an updated appraisal, a title search, and title insurance. It is valuable to refinance if the mortgage rate will be so much lower that your monthly payment will be substantially reduced. That in turn depends on the size of your mortgage balance.
If interest rates are low enough and your home has appreciated so that your equity has increased, you may be able to refinance and increase the principal balance on the new mortgage without increasing the monthly payment over your old monthly payment. If you do that, you are withdrawing equity from your house, but you are not allowing it to perform as an investment—that is, to store your wealth.
If you would rather take gains from the house and invest them differently, that may be a good choice. But if you want to take gains from the house and use those for consumption, then you are reducing the investment returns on your home. You are also using nonrecurring income to finance recurring expenses, which is not sustainable. There is also a danger that property value will decrease and you will be left with a mortgage worth more than your home.
Default, Foreclosure, and Fraud
If you have a change of circumstances—for example, you lose your job in an economic downturn, or you have unexpected health-care costs in your family—you may find that you are unable to meet your mortgage obligations as planned. A mortgage is secured by the property it financed. If you miss payments and default on your mortgage, the lender has recourse to foreclose on your property, evict you and take possession of your home, and then sell or lease it to recover its investment. Under normal circumstances, lenders incur a cost in repossessing a home, and usually lose money in its resale. It may be possible to renegotiate terms of your mortgage to forestall foreclosure. You may want to consult with a legal representative, or contact federal and/or provincial agencies for assistance.
You may believe you are having trouble meeting your mortgage obligations because they are not what you thought they would be. Lenders profit by lending. When you are borrowing it is important to understand the terms of your loan. If those terms will adjust under certain conditions, you must understand what could happen to your payments and to the value of your home. It is your responsibility to understand these conditions. However, the lender has a responsibility to disclose the lending arrangement and all its costs, according to federal and provincial laws (which vary by province). If you believe that not all the conditions and terms of your mortgage were fairly disclosed, you should contact local consumer advocacy groups that will help clarify the laws and explore any legal recourse you may have.
Just as your lender has a legal obligation to be forthcoming and clear with you, you have an obligation to be truthful. If you have misrepresented or omitted facts on your mortgage application, you can be held liable for mortgage fraud. For example, if you have overstated your income, misled the lender about your employment or your intention to live in the house, or have understated your debts, you may be prosecuted for mortgage fraud, intentional misrepresentation or omission of facts perpetrated by a borrower in the process of obtaining mortgage financing. Other forms of mortgage fraud are more elaborate, such as inflating the appraisal amount in order to borrow more.
During the recent housing bubble in the United States, mortgage fraud was aggravated by low interest rates that encouraged more borrowing and lending, often when it was less than prudent to do so.
- The purchase and sale agreement details the conditions of the sale.
- Conditions of the purchase and sale agreement must be met before the closing.
- A capital budget can help you prioritize and budget for capital expenditures.
- Early payment is the trade-off of interest expense versus the opportunity cost of losing liquidity.
- Refinancing is the trade-off between lower monthly payments and closing costs.
- Both borrowers and lenders have a responsibility to understand the terms of the mortgage.
- Buyers, sellers, lenders, and brokers must be alert to predatory lending, real estate scams, and possible cases of mortgage fraud.
- Default may result in the lender foreclosing on the property and evicting the former homeowner.
- According to this chapter, what information is included in a purchase and sale agreement?
- Use the mortgage refinance calculator from Loans Canada to find out if you would save money by refinancing your real or hypothetical mortgage at this time. What factors should you take into consideration when deciding to refinance?
- Sample consumer advocacy groups online at . What kinds of help can you get through such organizations?