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The first order of business, when looking to purchase a home, is to decide just how much you can afford to spend. Financial institutions look at two principal lending criteria: the Gross Debt Service (GDS) Ratio and the Total Debt Service (TDS) Ratio when deciding whether to approve your mortgage application.
These ratios, while useful for institutions, can be relatively difficult to calculate. For this reason, another set of factors can also be used: the annual income rule of thumb and the mortgage payment approach.
Of course, the above ratios are only part of the story. Homes, like most things, share the trait of costing more than you originally anticipate. As such, out of genuine concern, lenders will try to discern some things about your lifestyle. They may want to know if you take a lot of trips, or whether you are accustomed to eating out a lot. They may be especially interested in whether or not you save money on a regular basis. Offers conditional on financing Homes can sometimes turn from dreams to nightmares in a relatively short time - affecting your lifestyle dramatically. Generally, it is not the home that is the cause, but instead it is the amount of debt that needs to be paid that is usually the root of any problems. Below, we have created a hypothetical example of how mortgage debts can create financial problems through no fault of the borrower.
Are Joe and Jenny Jansen to blame here? At the time they bought their home, their mortgage, tax and all other housing costs amounted to less than 32% of their household income. But their household income didn't increase in line with their monthly costs. Believing that income increases will keep pace with the costs of home ownership can be a costly mistake. On the other hand, the value of the home increased dramatically in that period however a steadily increasing value in your home is of only limited value if you cannot make the payments to hold the asset. Generally, the problem that most first time borrowers encounter in regard to monthly payments is interest rate fluctuations. As we stated above, it is difficult to predict mortgage rates with any degree of accuracy. There is always a very real possibility of rates being much higher at the time a mortgage is renewed than when it is originally purchased. To that end, the Canada Mortgage and Housing Corporation (CMHC) offers the Mortgage Rate Protection Program (MRPP). The MRPP was put in place to give homeowners an opportunity to insure themselves against encountering an extraordinary and possibly unaffordable increase in interest rates at renewal. As with other forms of insurance, with the MRPP you pay a premium to buy coverage. If interest rates have risen by at least 2% when you renew your mortgage, CMHC reimburses you for a portion of the resulting increase in your monthly mortgage payments. In Joe and Jenny Jansen's case (above), the interest rate on the original loan was 6% while their rate at renewal was 9.95%. If they had purchased the MRPP, they would have been eligible for reimbursement from CMCH since their interest rate had risen by 3.95%. The other important consideration is, of course, the amount of money you intend to put down initially to purchase your home. The higher the down payment you put against your home, the smaller the mortgage loan. Lenders generally require between 10 and 25 per cent of the appraised or purchase price (whichever is higher) of your home to be placed in cash. How much you chose to put down is most often determined by how much you have saved up to buy a home. The type of mortgage you choose will also be partly determined by the amount of money that you are able to put down for a down payment.
Lenders do not generally refer to Conventional or High Ratio mortgages by their proper names. Instead, you will hear references to Loan To Value (LTV) Ratios.
High ratio mortgages This type of mortgage deserves a little bit of explanation. As we noted, a High Ratio mortgage involves financing more than 75% of the appraised value or purchase price of the home. Since this type of mortgage generally involves greater amounts of money, CMHC offers high ratio mortgage insurance to lenders. Essentially, the federal government, through the auspices of the National Housing Act, insures lenders against default by high ratio mortgage borrowers. In the event that a high-ratio mortgagee defaults on payments of this mortgage, the bank recovers the lost payments from CMHC. Interestingly, the mortgagee pays for this insurance but CMHC maintains all the powers of foreclosure in the event that the mortgagor defaults. High ratio loan insurance is like paying for an insurance policy that is held by your bank against default by you. Despite this fact, high ratio mortgage insurance is, in many cases, the only way that many people can afford to purchase their first homes. In cities like Toronto, even in the worst of times in the real estate market, the average price of a home is well above $200,000. There are very few homebuyers that can afford the $50,000 in cash that is necessary for the down payment. Most must choose the High Ratio mortgage and pay for the mortgage insurance.
A similar insurance program is available from a private company, the Mortgage Insurance Company of Canada (MICC) which offers a wider range of mortgage insurance to borrowers. Another type of mortgage insurance It is important to make the distinction between mortgage life and disability insurance and the types of insurance offered to lenders by MICC and CMHC. Mortgage life and disability insurance is insurance that is underwritten by an insurance company and offered via group rates through most financial institutions. Mortgage life and disability insurance offers mortgage payment insurance in the event that the borrower or his/her spouse becomes permanently disabled or meets an untimely death. Down payment amount Many borrowers are put in a curious dilemma when deciding how much money to put down on a home. There is no simple answer, but there are some general rules of thumb to keep in mind when considering how much money to place in a down payment. It is wise to keep in mind that on the day you close your home mortgage, there may well be a number of costs associated with the deal that you will be responsible for paying. These may include:
It is a good
idea to have at least three months of household income left in a daily
interest savings account or Guaranteed
Investment Certificate (GICs) after you have closed the deal on your
home. This money will provide a cushion against unforeseen circumstances
such as potential future job loss or unexpected emergencies. It is not
a good idea to scrape together ever last dime you have to make a hefty
down payment, in spite of the fact that a high down payment will save
you a lot of money in interest in the coming years. You should not financially
over-extend yourself in order to make a larger down payment.
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