A logical starting point when buying a home is to determine how much money you have to spend. Most first-time buyers don’t have enough money to pay cash for their home so they need a mortgage.

      A mortgage is a lien or charge recorded against the home in favour of the lender. It is an agreement or contract between a borrower (i.e., home buyer) who wants to borrow money in order to purchase a home and a lender (i.e., lending institution or person) willing to loan the money. The mortgage contains terms that the borrower agrees to with the lender. In return for the loan, the lender wants something to assure that the borrower will pay back the money — this is called collateral, which is normally the home that is purchased.

      The lender also wants a promise that the borrower will pay back the money. The lender evaluates the risk in lending the money. Although the lender has the home as collateral, it really doesn’t want your home (it’s not in the business of collecting property that is in default of the owner’s mortgage payment). Lenders want you to repay the borrowed money with interest. Lenders, more specifically financial institutions, make a profit by borrowing money from their customers through deposits, such as Guaranteed Investment Certificates (GICs), and other interest-bearing products at one rate then turning around and lending this money to borrowers at a higher rate. The profit is the difference between the interest rate paid by the lender to use the funds on deposit and the interest rate it charges the borrower (the “spread”), less the costs to originate and service the mortgage.

      The lender underwrites the loan by starting with a credit check on the borrower. This gives the lender insight about borrowing and repayment track records and how the borrower uses credit. It tells the lender whether a borrower regularly and historically pays bills on time. This is important because if a borrower has a poor repayment history, the lender may think that he or she will not repay the mortgage loan on time, so the lender may either charge a higher interest rate to offset the risk or decline the loan.

      If your credit report confirms that you have a good repayment history, the lender will classify you as good or an “A” customer and will want to see proof that you have a job. The lender will request a letter from your employer outlining your salary and stating how long you have been employed there.

      If you are self-employed, this makes things a little trickier. In this case, depending on the lender, you will be requested to provide the past two or three years’ worth of notices of assessment, and possibly tax returns and/or financial statements.

      1. Understanding Mortgage Products

      Mortgages are products, and they contain different options, terms, and conditions. The type of mortgage product you choose will depend on your individual short- and long-term financial goals and plans. It is difficult to be aware of all the different types of mortgage products on the market (keep in mind that the banks and lenders are always trying to impress upon you why their mortgage products are the best). There is more to a mortgage product than just comparing the interest rate and the term. Let’s start with a general overview of the types of mortgage products that are available.

      1.1 Conventional mortgage

      A conventional mortgage is a mortgage loan that is equal to or less than 80 percent of the lending value of the property (i.e., the purchase price or market value, whichever is less). In other words, the down payment is at least 20 percent of the purchase price or market value. Most buyers use savings or a combination of investments and savings to make up the down payment. However, there may be other options to source or arrange for a portion of the down payment (more on this in Chapter 4).

      1.2 High-ratio mortgage

      If your down payment is less than 20 percent of the lending value or purchase price, whichever is less, your mortgage will be considered a high-ratio mortgage, which usually requires mortgage loan insurance. The insurance insures the lender against default. You, the borrower, pay for this insurance; your lender usually adds the mortgage loan insurance premium to your mortgage, or it can request that you pay it in full on closing. Note that applicable provincial sales tax is charged to the default insurance premium; however, the sales tax will not be added to the mortgage amount — it is payable on closing as part of your closing costs.

      There are a couple of insurers that provide mortgage loan insurance: Canada Mortgage and Housing Corporation (CMHC) and Genworth Financial Canada.

      1.3 Second mortgage

      The second mortgage sits behind the first mortgage; the home is normally used as collateral. This means that if the home is sold, the proceeds of the sale pay off the “first” mortgage first, and the balance pays the “second” mortgage. As a point of interest, property taxes and condominium fees rank ahead of the first mortgage and upon sale are paid out first before the mortgage or any other junior liens.

      Typically a second mortgage carries a higher interest rate and is for a shorter time frame than the first mortgage. Occasionally, secondary financing is used to assist a home buyer with coming up with a portion of the down payment. You will still be required to qualify to carry the two mortgages; however, utilizing a first and second mortgage may be advantageous when a buyer is very close to reaching a conventional financing down payment. Doing this will offset the mortgage insurance premium. This is something to discuss with your lender if you find yourself very close to meeting the 20 percent down payment required for conventional financing. A comparison of the interest rate cost, combined with any other legal and registration expenses versus the cost of mortgage default insurance will determine if this strategy is worthwhile.

      1.4 Vendor Take Back (VTB)

      Occasionally, a seller is willing to hold a portion of or possibly the entire mortgage. In this case, on closing, the seller secures the mortgage amount (the debt) on the property similar to what a bank or financial institution does (i.e., the home is used as collateral). The interest rate and terms of this type of mortgage are negotiated between the seller and the buyer. This type of mortgage is less common than traditional bank financing; however, in some cases the seller may offer or be willing to hold a mortgage. Some sellers who do not need the equity in their real estate (especially