Owning a home is a lifelong dream of many Canadians. One of the most critical steps in a homebuyer’s journey is to find a mortgage that meets their requirements. With most lenders offering multiple product choices, homebuyers often feel overwhelmed. We have compiled a comprehensive guide about the mortgage rules for first-time homebuyers to guide them through the process.
Types of mortgages in Canada
Before choosing a mortgage, make sure it allows you to achieve your financial goals while maintaining your budget. Here are some of the commonly chosen Canadian mortgage options.
An open mortgage can be paid off, refinanced, or renegotiated at any time without the fear of penalties. An open mortgage is one of the most flexible mortgage option. Because of the high flexibility, open mortgages tend to have a higher interest rate and a shorter term. The loan term for open mortgages, in most cases, is 5 years or less.
Closed mortgages do not offer much flexibility to make regular extra payments or renegotiate the terms and conditions before the mortgage term ends. If you try to prepay your debt over the permitted amount, you’ll be charged a penalty. However, closed mortgages make up for their lack of flexibility by offering considerably lower interest rates.
Homebuyers who make a down payment of 20% or more are not required to buy mortgage default insurance. Such mortgages are called low-ratio mortgages.
A high ratio mortgage applies to homebuyers who make a down payment of less than 20%. In such a scenario, buyers must get mortgage default insurance.
If you choose a fixed-rate mortgage, the interest rate remains the same over the mortgage term. A fixed-rate mortgage is a good option if you have a fixed budget and want to make predictable payments every month. With fixed-rate mortgages, you are secured against interest rate changes until your term ends.
Variable-rate mortgages offer fluctuating interest rates depending on the bank’s prime lending interest rate. However, the payment is structured to pay your debt within the given tenure despite the fluctuating interest rates. The change in interest rates does not impact your monthly payment. If the interest rate increases, a higher portion of your monthly payment will go towards interest rather than the principal amount. If the interest rate decreases, a higher percentage of your monthly payment will go towards principal repayment rather than interest. Variable rate mortgages are often chosen by buyers who expect the interest rates to drop and want to take advantage of it.
The Canadian mortgage stress test
One of the factors that decide your eligibility for a mortgage is the Canadian mortgage stress test. The score in this test influences the kind of mortgage you will qualify for and your interest rate. As one of Canada’s most significant mortgage rules, the stress test is conducted to evaluate if a prospective buyer can handle an unforeseen increase in their mortgage rate. Canadians need to pass this test to be eligible for a mortgage from federally regulated banks. Buyers need to prove that they can afford to pay the qualifying rate, which is usually more than the original rate they will be paying. Buyers will be required to pay a qualifying rate of Bank of Canada’s five-year benchmark or the interest rate offered by the lender plus 2%, whichever is higher. Homeowners looking to refinance their loan, take out a secured line of credit, or switch lenders may also be required to undergo the stress test.
Other mortgage rules in Canada
Three other rules govern the qualification and grant of a mortgage in Canada. However, these rules are only applicable to first-time homebuyers. Homeowners who are renewing their existing mortgages are not required to abide by these rules.
As per the recent changes to the mortgage rules in Canada, you need to have a minimum credit score of 680 (instead of the previously required minimum score of 600) to qualify for a mortgage. If you buy a house with your partner, at least one of you needs a credit score of 680.
New homeowners in Canada are now required to pay their property’s down payment from their pocket. This means they are not allowed to use unsecured personal loans or unsecured lines of credit (i.e., a line of credit that isn’t secured against an asset) to finance a property purchase.
The revised mortgage rules for first-time buyers in Canada have lowered the amount of funds you can borrow against your gross income. According to the new regulations, prospective buyers can only spend 35% of their gross income on property investment. In addition, they cannot borrow more than 42% of their gross income, taking all the loans into account. Also, if you are paying less than 20% of the total price as a down payment, you will be required to get mortgage default insurance. However, the mortgage default insurance does not apply to properties that cost over $1 million. Canada has an extensive framework that governs the mortgage industry. The rules keep in mind the welfare of both the lender and the prospective buyer.
Canada has an extensive framework that governs the mortgage industry. The rules keep in mind the welfare of both the lender and the prospective buyer. Consider talking to our mortgage advisors at Mortgage Maestro to make this process easier. Contact us today!