The Mortgage - Product Price and Service

 

The Price

Mortgages are viewed by most consumers today as mere commodities. Often the only consideration is the price, while recognizing little, if any, differentiation between competing mortgages and mortgage lenders. While the price of a mortgage, the interest rate, is one of the most important factors when deciding on a mortgage company, consideration should also be given to the mortgage product and service issues.

In today's market it is possible to negotiate a rate that is better than the financial institutions current posted rates. Success depends on the type of property being mortgaged, your credit status, and access to complete information on all financing alternatives. Financial institutions may be willing to accept a lower rate on the mortgage if there is potential to begin a business relationship with a new client that will result in other opportunities. Your mortgage consultant can advise you of the best deals in the market to suit your circumstances, and can negotiate in your best interest.

 

The Service

Whether you are purchasing your first home, or are moving up - down - or across, it is essential that your mortgage consultant have the expertise and experience to assist you in the transaction. You'll need sound advice and attention to the details. A good mortgage consultant will work with your Realtor to ensure that the best financing plan is available on time and as agreed. Your mortgage consultant should have the knowledge to advise you on your mortgage financing options, mortgage insurance, legal issues pertaining to the mortgage, and government and private policies and programs. They must be familiar with the local real estate market and be able to work in concert with the other professionals involved in your purchase process. Most importantly they will have to commit the time to communicate with you, your family and your representatives.

During the course of the mortgage term your mortgage consultant should be available to advise you on mortgage management issues to save you money, time, and unwanted risk. You'll have questions, they'll have the answers.

 

The Mortgage Product

In recent years mortgages have become far more flexible. Product features such as accelerated repayment plans, mortgage portability options, and early renewal features, can save you thousands of dollars. Be sure to discuss these options with your mortgage consultant. If the mortgage is portable, is that nationally or only locally. If the mortgage is pre payable, what are the maximums and, more importantly, what are the minimums. Can you early renew, increase the mortgage, or extend the term out. Are equity lines of credit available so that your can access equity when you want without re application and additional legal fees. What fees will be charged now and for future services. Finally, discuss what payout penalties or late fees are charged, how are they calculated.

Getting Pre Qualified For a Mortgage

 

The Commitment

Many Lenders will guarantee an interest for a client while they are shopping for a home. The purchaser is then protected if interest rates rise during this shopping period. This can be an extremely important advantage, it will not only save the borrower money but could also save them from loosing their dream home when they finally find it.

When interest rates rise the amount of mortgage financing a borrower qualifies for can be reduced. It is possible that your maximum affordable mortgage could be thousands of dollars less after an unprotected interest rate spike. This reduction in available financing could very well require you to ante up a larger down payment. If you do not have the additional savings your maximum affordable home price could be reduced.

A rate commitment usually requires a full pre qualification of the applicant. Rate commitments vary from one mortgage lender to another. Some will guarantee the rate for 30 to 60 days or longer. If rates rise during the commitment period the borrower is assured of either the lower of the committed rate, or the rate one day before closing. Some mortgage lenders offer commitments that guarantee the lowest market rate during the commitment period, or the committed rate. Your Mortgage Consultant can pre qualify your with the right mortgage lender and insure your rate committment meets your needs.

 

Pre qualification

Pre qualification means that your lender has reviewed and verified all the available financial information detailed in your application and has determined the maximum amount of financing you can afford. A pre qualification is different from a simple rate commitment. A rate commitment is where the lender guarantees that "if" you qualify for a mortgage they will offer the agreed upon interest rate. Agreeing to an interest rate does not require the lender to complete the preliminary underwriting while a pre qualification does.

In order to complete a pre qualification the lender will require all of the information contained in their mortgage application. This will mean that you will have to provide them with most of the documentation necessary for a full mortgage approval. The effort is well worth it as you will then be assured of mortgage financing in the pre qualified amount.

The benefits of being pre qualified include the comfort of shopping for a home within your price range without the risk that complications will arise in the final hour. Also, there are the benefits of being able to make a stronger purchase offer without "subject to financing" conditions. This will allow your Realtor to negotiate harder and reach an agreement before a competing purchaser makes a better cash offer.

Pre qualifications are only subject to the lenders approval of the property, usually determined by an appraisal after a purchase offer has been agreed to. The borrowers income, expenses, credit history and verification of down payment have all been considered in advance.

 

 

Pre Quantification

A pre quantification is simply a calculation of the the amount of mortgage the applicant "may" qualify for. The gross income amounts used are not verified, nor is the applicants employment, credit history or net worth. Pre-quantifications are often confused with a full pre qualification and should be used as a preliminary guide only.

The calculation to determine your maximum mortgage financing is based on your income and expected expenses. Assume you and your co-applicant have a combined monthly gross income of $5,000. If the mortgage lenders maximum GDSR is 32% you can spend $1,600 on shelter costs. In this case your maximum shelter cost payment is $1,600. By subtracting the monthly heating costs, condo maintenance fees, and property tax cost from the applicants maximum payment the lender can then determine the maximum mortgage payment. As follows:

 

Gross Income	$5,000
Multiplied by 32% =	$1,600
Less: Property Taxes	$75
Less: Heating Costs	$50
Less:1/2 of Condominium Maintenance Fees	$60
Equals: Maximum Mortgage Payment	$1,415

Given this maximum mortgage payment figure the lender can easily calculate the maximum amount of financing you will qualify for based on your income. The procedure is simply the reverse of calculating a mortgage payment given the payment amount, amortization and interest rate.

GST and your New Home

The goods and Services Tax replaced Federal Sales Tax in 1991. Although the tax is collected at a rate of 7% on the sale price of goods and services, it doesn't apply to every type of home or every form of real estate service.

New home purchases are subject to GST but may qualify for a GST rebate. Resale homes are sold exempt from GST.

 

GST and New Homes

When you buy a newly constructed home, condominium or townhouse, the entire purchase price including land is taxable. If the property is to be rented to tenants, the full 7% GST is charged on the purchase price. However, if the home is going to be your primary place of residence, it may qualify for a partial GST rebate, depending upon the sale price.

For primary residences costing $350,000 or less, you will receive a rebate of 36% of the GST paid, to a maximum of $8,750. That means you pay approximately 4.5% GST (not 7%) on the purchase price.

Example #1
You buy a new home for $200,000. The 7% GST is $14,000, less a 36% rebate of $5,040. So, you pay $8,960 in GST.

The maximum rebate is $8,750. The rebate for new homes costing between $350,000 and $450,000 declines to zero on a proportional basis. Here is how it works.

For each $1,000 of purchase price above $350,000 the maximum rebate of $8,750 is reduced by 1%

Therefore if your purchase price is $370,000 you are $20,000 over and must reduce the maximum rebate by 20%. As such the maximum rebate of $8,750 reduced by 20% equals $7,000.

For a home priced at $370,000 the GST payable, at 7%, is $25,900.

The adjusted maximum rebate is $7,000 so the GST payable is $18,900.

Adjusting the maximum rebate continues until the rebate is reduced by 100%, there is no rebate, which occurs at homes priced at or above $450,000. New homes selling for $450,000 or more do not qualify for a GST rebate.

 

GST and the Resale Home

You do not have to pay GST on the purchase price of a used residential home. In other words, the purchase is "exempt" from GST.

Revenue Canada defines "used residential property" to include an owner-occupied house, condominium, apartment, summer cottage, vacation property or non-commercial hobby farm. They refer to "used" as residential property that has been occupied as a residence before you bought it.

Used property can also mean a recently built house that is substantially complete and has been sold at least once before you buy it. For example, if a new house is purchased and resold before being occupied, the home's resale price will normally be exempt from GST.

 

GST and the Real Estate Transaction

GST applies to most of the services provided in completing the real estate transaction. For example 7% GST is applied to the commission a Realtor charges for facilitating a sale. The tax is paid by the person responsible for paying the commission- usually the seller.

Realtor commissions are taxable even if the total GST owed is reduced by a rebate, or the sale of the property is exempt from GST. For example, if you sell a used home, the sale price is exempt from GST but the Realtor's commission is still taxable.

GST applies to many other services involved in the real estate transaction. These include legal fees, appraisals, surveys and legal assistance. Again, GST is charged on these fees regardless of whether the house you purchase is exempt from the tax.

 

GST and Rent

No GST is payable on residential rents. However, if you employ a Realtor or another professional to find and arrange a tenant for your rental property, GST applies to the fees and commissions they charge for providing this service. GST also applies to the fees charged to the landlord for property management, as well as repair and maintenance services. Monthly fees charged by condominium associations are not subject to GST.

 

Land Transfer Taxes

Along with the GST there are also other taxes that a purchaser must pay. Included is the Ontario Land Transfer Tax, and the BC Property Transfer Tax. These are Provincial taxes levied on the purchase of property.

Canadian Mortgage Payment Plans
Monthly - Bi Weekly - Weekly - Accelerated

 

Monthly Mortgage Payment

A typical monthly mortgage consists of equal monthly payments of both principal and interest. As payments are made the principal owing is reduced, each subsequent interest payment is also lower as a result. Over time more and more of the equal payment is applied to principal reduction, until the mortgage is completely repaid. A mortgage is usually calculated to be paid off over 25 years, however any repayment period (amortization) is possible. The amount of interest paid is a result of the interest rate, the compounding frequency and length of time it takes to repay the loan in full.

The following is a typical monthly mortgage repayment plan.

Mortgages have traditionally been paid on a monthly basis, same as rent. In recent years financial institutions have offered flexible payment options. These include the availability of Weekly, Semi Monthly, and Bi Weekly payment plans in addition to the conventional Monthly option.

There are no great savings in the amount of interest paid between the various payment plans, except for the accelerated options. When choosing a payment plan you should consider convenience and practicality. If your salary is paid on a monthly basis, a monthly payment is probably the way to go. If you are paid semi monthly or every second friday, the Semi Monthly or Bi Weekly options may be best.

The Following table shows the various payment options. Notice that, with the exception of the accelerated example, the annual sum of payments and the total interest paid amounts are very close. The interest savings between non accelerated payment options is minimal. TR.learn_title {font-size: 8pt; background-color: #FFCC00; text-align: center; font-weight: bold} TR.learn_row {font-size: 8pt; text-align: right; background-color:#D9D9D9} TD.learn_index {text-align: center}

	Monthly	Semi Monthly	Bi Weekly	Weekly	Accelerated Bi Wkly
Loan Amount	$111,796	$111,796	$111,796	$111,796	$111,796
Payment	$1,000	$498.98	$460.52	$230	$500
Annual Sum of Pmt	$12,000	$11,976	$11,974	$11,962	$13,000
# of Payments	12	24	26	52	26
Mortgage Free In	25 Years	25 Years	25 Years	25 Years	18.82 Years
Total Interest Paid	$188,204	$187,594	$187,548	$187,267	$132,964
Interest Savings		$610	$656	$937	$55,217

 

Accelerated Payment Plans

An Accelerated Payment Plan is a great way to save thousands of dollars of interest and be mortgage free years earlier. The savings are a result of the additional principal amounts paid each month. Any payment plan can be accelerated, simply by pre-paying an amount each month or decreasing your amortization. The most common accelerated plan is the Bi Weekly payment option due to the easy payment increase.

 

Accelerated Bi Weekly Payments

The above chart shows that the "Monthly" option requires a monthly payment of exactly $1,000. The annual sum of these payments is $12,000, calculated as twelve multiplied by $1,000. When choosing an Accelerated Bi Weekly payment plan the borrower agrees to pay one half (1/2) of the monthly payment 26 times per year. With the accelerated Bi Weekly plan the borrower will be paying the equivalent of one extra monthly payment, $1,000, each year. The result is faster repayment of the mortgage, "accelerated", and the consequent interest savings.

 

Here is why

There are 26 Bi Weekly payment periods in a year. The borrower agrees to pay $500, half the monthly payment, 26 times per year. As such their annual sum of payments is $13,000 (26 payments x $500 = $13,000). This is $1,000 more than the annual sum of monthly payments. This additional payment of principal is the reason for the spectacular savings in interest of $55,217 and the luxury of being mortgage free in only 18.8 years.

Blends, Extends And Early Renewal

Blends, Extends and Early Renewals   Early Renewal Some financial institutions will allow you to early renew simply by paying a small administration fee. This is your best option if you don't want to miss out on current low interest rates and intend to average down to a lower monthly payment. Assume your mortgage is at 10% for the next 2 ½ years and that current interest rates for a new five year term are 5%. If you were to early renew to a new five year term you would be extending your mortgage term back out to five years from the remaining 2 ½ years. Practically, you would still suffer the current rate of 10% for the first 30 months but thereafter you would enjoy 5% for the following 30 months. Rather than actually charge you this way your financial institution will "blend" the two interest rates into an average rate for the entire 60month term. Given that you will have half of the term at 10% interest rates and the other half of the term at 5% interest rates the average rate will be 7.5 %.   If your mortgage is $100,000 at 7.5% interest with 22 ½ year remaining until it is fully paid off, your new "blended" payment would be $761. At 10% your current payment is $894 so you are lowering your payments by $133. This is a great way to lock in current interest rates even if you are not up for renewal for several years. It's a no lose situation. If rates are higher in 2 ½ years you will have made a great decision. If they stay the same you will have paid the price of five year rates for the added 30 month term, usually a small price for the increased peace of mind. If rates are lower than your blend, early renew again. Check with your financial institution to determine your options   Increase and Blend If you've paid down your mortgage and / or your home value has increased, and you would like to release some of the equity, it may be possible to increase and blend. A blend allows you to increase your existing mortgage. The new funds you will receive will be at current prevailing mortgage rates. This rate will be blended with your current rate proportionally. Assume your home is currently valued at $200,000 and your mortgage is $100,000 at a 6.5% fixed interest rate with 3 years remaining until renewal. You want to take out $25,000 of your equity to finance some long overdue home renovations. Current interest rates for a 3 year term are now at 7.5%. As such, your lender will be able to offer you the $25,000 mortgage increase you need at 7.5% Once you have qualified for the increase you will be left with a new mortgage of $125,000 at a new blended interest rate. Given that you have $100,000 or 80% of the new mortgage at 6.5%, and $25,000 or 20% of the new mortgage at 7.5%, you new blended interest rate will be 6.7%. 80% x .065 = 5.2% 20% x .075 = 1.5% Sum 6.7% In many cases the mortgage lender will round this rate up to 6.75%, the nearest 1/8th or 1/4 of a percent.    Blend and Extend At the same time that you decide to increase your mortgage you may also be thinking of early renewing to a five year term. This is known as a blend and extend. If interest rates for a five year term are currently at 7.75%, and you now have a blended mortgage of $125,000 at 6.7% for a term of 3 years, the last step is to extend the mortgage to a new 5 year (60 month) term. Your new extended mortgage of $125,000 will have an interest rate of 7.12% for a new term of 5 years. This is the same calculation as the early renewal above. The mortgage is at 6.7% for the first 36 months and 7.75% for the remaining 24 months resulting in an average rate for the 60 month term of 7.12% 36 months divided by 60 months = 0.6 24 months divided by 60 months = 0.4 0.6 x 6.7% = 4.02% 0.4 x 7.75% = 3.1% Sum = 7.12%

Compound Interest & Mortgages

Simple Interest Simple interest implies that interest is charged, due and payable, only once during the life of the debt, and at the end of the term. As such, if you borrow $100,0000 at 10% per annum for five years you will owe 50% at the end of year five, or $50,000.     Compound Interest If the lender asks you to pay this $50,000 in equal annual installments of $10,000 this then becomes compound interest. The reason is that you are forced to part with your money early, i.e. before the end of the five year term. As such, you will lose the ability to earn interest on this money were you able to invest it until the end of year five. Similarly the lender gains the benefit of being able to invest the annual sums repaid and earn additional interest.   In examining the above charts you will notice that the only real difference between compound and simple interest is the frequency that interest payments are due. In both cases the Total Interest Paid figure is $50,000 however when compounded you are asked to pay the interest periodically during the course of the loan. Consider that if the lender reinvests the yearly interest payments of $10,000 at 10% p/a until term end they will earn an additional $11,051 of interest. Therefore total interest received is, $50,000 plus $11,051 = $61,051. Similarly the borrower loses the use of these funds after the amounts are paid and foregoes the opportunity to earn this $11,051 interest. This is interest earned on interest, and therefor compounded, even though it is not an accruing loan. If this were an interest accruing loan, one where the interest payments due go unpaid and are added to the principal amount owing each year, the balance in five years would be $161,051. The total interest paid is then $61,051, same as the compound interest example with the periodic payments reinvested.     Compounding is the earning of interest on interest For interest accruing loans the earning of interest on interest is explicitly apparent as interest due is added to the principal amount outstanding and earns interest itself in subsequent periods. Compounding loans that are not interest accruing still earn interest on interest due to the presumed reinvest of the periodic interest payments to earn additional interest. The above example explains why mortgage interest is compounded even though mortgages are not interest accruing loans. Remember that mortgage interest due each month is never added to the principal amount, it is always paid when due along with a principal amount sufficient to amortize the debt. Unless, of course, the borrower is in default of payment.   Mortgages Mortgage loans are calculated to be paid off within a specified period of time through the regular repayment of the principal outstanding. Each monthly installment results in the repayment of part of the outstanding balance. This balance is therefore lowered and subsequent interest charges decline accordingly.   Notice that the sum of payments each year is fixed at $10,734. In the first year the principal portion is only $979 and the remainder of the constant payment goes towards interest owed. As the balance declines the interest owed is reduced so that the interest payment constitutes a smaller portion of the constant payment. More and more of this payment is applied to the repayment of the outstanding balance each month until the loan is fully paid off (amortized). $100,000 @ 10% Interest - Compounded Semi Annually and not in advance - 25 Year Amortization The exact amount of the payment sufficient to pay off the loan is based on several factors including the pay back period (amortization), interest rate, and the loan amount. Most Canadian mortgages are "partially amortized" meaning that there is a fixed term at the end of which the outstanding balance is due. The payment is still calculated based on a full amortization period, say 25 years, but the mortgage contract with the lender extends for a shorter period. This period is called the mortgage term and can be 6 months to 10 years. At the end of the term the loan has been partially repaid (amortized). The balance outstanding is now due and can either be paid in full or the mortgage can be renewed, at then current rates and terms CMHCs New 5% Downpayment Program CMHC announced changes to their high ratio mortgage insurance programs on March 31, 1998. These changes are to take effect on May 11 1998. The bad news is that CMHC has done away with the First Home Loan Insurance (FHLI) Program that allowed first time buyers to purchase a home with as little as 5% down payment. The good news is that they have re engineered this program so that it is economically sustainable in the long run. Now anyone can purchase a home, whether it is their first, second, or third, with a 5% down payment. Essentially CMHC has simply dropped the requirement that applicants must be "first time home buyers" to qualify for this program. The FHLI program was originally only scheduled to run for 2 years, 1992 to 1994. The goal of the program was to provide Canadians with greater access to home ownership by reducing the high hurdle of a 10% minimum down payment. Since, 1992 the program has been adjusted and refined, it was ultimately extended to the year 1999. These changes are intended as a further refinement in an effort to extend the program indefinitely. The rules for the new CMHC 5% down payment program have remained substantially unchanged. The maximum home prices are still the same at $250,000, $175,000 and $125,000. CMHC is currently reviewing these maximums. Gross and Total debt service ratios remain the same as does the requirement that borrowers take a minimum mortgage term of 3 years, with qualification based on the 5 year rate. The increased fee will have a slight affect on maximum financing amounts as the payment to finance the fee is also considered in the maximum debt service ratio calculations. The only bad news is that in order to continue offering the program permanently CMHC has had to up the cost. The new fee is intended to fully compensate the increased risk of default and recovery this program has suffered. These added risks are attributed to the low amount of equity in the home. Prior refinements tackled a policy that allowed first time homebuyers to become more indebted, relative to income, than other borrowers. The fee for any person wishing to buy a home with a 5% down payment will be 3.75% of the mortgage amount after March 11, 1998. Currently the first time homebuyer fee is 2.5% of the mortgage amount. The mortgage insurance fee is a one time fee paid by the borrower to the mortgage insurer, it is usually added to the mortgage and financed. This means that if you purchase a $100,000 home with a $5,000 (5%) down payment your mortgage insurance fee will be 3.75% of the $95,000 mortgage required. The result is a fee of $3,562.50, which is typically rolled into the mortgage and financed over the full amortization. The current fee would be $2,375. The cost of this financing is substantial but so are the risks. Consider that with a $25,000 (25%) down payment, mortgage insurance would be avoided entirely. As such this $3,562.50 (3.75%) fee is the price paid for the additional $20,000 (20%) of financing required. The new fee is equal to 17.8% of this additional $20,000 of financing while the current fee is only 11.9% of the added financing required.   Opportunity cost of RRSP Home Buyers Plan Borrowers may want to take a closer look at all their options. Alternative sources of financing may be cheaper in some cases. Most financial planners warn of the high opportunity cost of using RRSP funds as down payment money. However, withdrawing a larger amount from an RRSP under the Home Buyers Plan could result in a lower mortgage insurance fee and lower overall costs. This may be the case if the amount withdrawn results in a down payment of 25% and the mortgage insurance fee is avoided. In addition, a down payment of 10% or 15% would reduce the CMHC fee from 3.75% of the mortgage amount to 2.5% and 2% respectively. In some cases the return expected on the RRSP may be less than the sum costs of this added financing.   Alternatives To Mortgage Insurance Borrowing the additional funds required from other sources in order to avoid, or reduce, the CMHC fees payable may also be a good move. Some mortgage lenders refer to this as the Family Financing Plan because the borrower uses the equity in their parents home to secure second mortgage financing that will constitute the down payment on their new home. Assuming the above home purchase example the borrower will be paying a mortgage insurance fee of 3.75% for an additional 20% of mortgage financing. If the borrower can secure a conventional mortgage of 75%, and the parents are willing to allow their son or daughter to mortgage their home for the balance of the funds required (20%), the mortgage insurance fee will be avoided entirely- and the cash down payment is still only 5%. The added financing received by insuring the mortgage is $20,000, at a cost of $3,562.50. The result is usually $23,562.50 added to the $75,000 conventional mortgage as most borrowers typically finance the mortgage insurance fee. This fee is a cost of this extra financing, and necessarily a form of interest. The effective interest rate can be calculated in order to compare the insured mortgage approach with alternative financing such as the "Family " approach. Assume an average interest rate of 8% for the entire 25 year amortization of the $23,562.50 debt. In reality we have $20,000 at an interest cost of 8% per annum plus an up front cost of $3,5621.50. The effective annual interest rate of the two costs combined is 10.07% The mortgage insurance fee has the effect of increasing the assumed average annual interest rate of 8% by two full percentage points on the additional financing. If the parents were to lend their son or daughter the $20,000 at this 10.07% rate of interest the monthly mortgage payments would be $179,83. Taking the CMHC approach, where $23,562.50 is financed at 8%, would also result in a monthly payment of $179,83. In either case the costs are the same and the borrower is equally indifferent to each alternative, from a financial perspective. However, the added cost of arranging this family financing must also be considered. These costs could include added legal fees and mortgage application fees. In many cases no other financing options are available, or are not available at a cost competitive with the insured mortgage approach. The 5% down payment program has helped hundreds of thousands of Canadians reach their goal of home ownership sooner than would have otherwise been possible. It remains an important option for homebuyers, first, second, and last, who require or prefer high ratio financing. Interest Rate Buy Downs   Developer Buy Downs Many developers "buy down" the interest rate on the arranged financing for their newly constructed housing units. They offer lower rates as an inducement to purchasers, particularly when market interest rates are high. The developer buys down the interest rate by paying an amount to the purchasers mortgage lender. Essentially they are paying part of the borrowers/purchasers interest for them in advance. When a property can be purchased with financing at rates better than the market is currently offering it is said to have beneficial financing. Beneficial financing can result when the vendor/builder buys down the interest rate or in cases where there is an assumable first mortgage with a beneficial contract rate. Calculating the value of the beneficial financing is necessary in order to compare alternative incentives or peg a purchase offer. The calculation is quite simple. The beneficial mortgage is calculated to find the monthly payment and balance at term end, and a mortgage at current market rates is calculated to find the same. The difference between the payments and the balances at maturity is then discounted to a present value at the going market rate. Assume that market interest rates are currently at 8% for a three year term. Your home purchase will require financing in the amount of $100,000. At market rates of 8% you will have a payment of $763/mo. and a balance at maturity in 36 months of $95,655. The builder of the home you wish to purchase has offered a number of incentives. One is a bought down the interest rate on your $100,000 mortgage to 6% for your three year term. The other is to offer an enhanced appliances package valued at $3,000. The question is which deal to take. The appliance package is pretty easy to value by shopping the items at retail stores. To determine the value of the interest rate buy down the mortgage must be calculated using the bought down rate of 6%. The monthly payment would be reduced to $640 and the balance at maturity would be $94,265. An interest rate that is 2% lower than current market rates results in a monthly payment that is $123 less each month and a balance at term end, in 36 months, that is $1,390 lower. Summed these savings equal $5,832, however in order to compare the value of these periodic savings in the future with an appliance package received immediately these benefits must be discounted to a present value. The present value of these savings is calculated at $5,044 discounted at the market rate of return of 8%. Now that the $5,044 value of the beneficial financing has been calculated it is possible to compare this offer with the appliance package incentive of $3,000. Deciding which offer to take depends on other consideration as well and may be shaped by non financial reasons.     Increased Affordability One of the reasons that rate buy downs are favored by developers and builders is the impact lower rates have on affordability. Buying down the rate means that the developer is effectively increasing the affordability of his residential project to all potential buyers. Assume that the builder has developed condominium units valued at around $175,000. Any conventional purchaser may require 75% financing in the amount of $131,250. This mortgage amount would result in a monthly payment of $1,002 at the current market interest rates of 8%. The purchaser would have to earn approximately $43,000* in gross income to be able to qualify for a mortgage of this amount in order to purchase the property. However, if the interest rate is bought down to 6% the monthly payment will be $839.75 for the next three years. The amount of gross income required to qualify for the mortgage at this interest rate is $35,989*. The interest rate buy down reduces the costs of financing this developers product. The developers condos are now affordable to home buyers with more modest income. Equally as important is the fact that more purchasers will be able to qualify for the mortgage because their shelter financial obligations are reduced to fit within the lenders target debt service ratios. It is interesting to note that the developer would have to reduce the price of the home by $28,296 to $146,704 in order to match the increased affordability of this 2% buydown. At this reduced price the conventional mortgage would be $110,028 at 8% interest for 3 years resulting in a mortgage payment of $839.75.....same as the bought down mortgage payment. The cost to the developer of increasing affordability, by bringing the mortgage payment to $893.75, is either a price reduction of $28,296 or a buydown cost of $5,044. In most cases the developer can only spend so much. Buying down the interest rate by $5,000 will have a far greater impact on affordability than will a price reduction of $5,000. In some cases an interest rate buydown can increase or preserve the sale price of the home, or increase the speed of sale, in comparison to alternative and similar properties. Qualifying at for a mortgage using bought down interest rates. Affordability is not always increased simply by buying down the interest rate. Mortgage lenders are all too aware of the risks of qualifying a borrower based on artificially lowered interest rates. Once the mortgage is up for renewal, in 36 months, the borrower will have to suffer the current market rates. This would mean a rate of 8% or higher if rates had climbed during the 3 year mortgage term. The monthly payments based on this mortgage rate may be unmanageably high for this homeowner placing them at a greater risk of mortgage default. Each mortgage lender treats interest rate buy downs differently. Whether they use the bought down rate and lower mortgage payment when qualifying the borrower for the mortgage depends on several factors. These include the length of the mortgage term, the amount of financing required, the loan to value ratio, the borrowers debt service ratio - with and without the interest rate buy down, and the reasonable potential that the borrowers earnings will increase within the term offsetting the increased mortgage payment. Each lender has their own policies but it is safe to say that all will weigh the interest rate buy down into the mortgage qualification decision if there reasonable cause. *Assumes a GDSR of 32%, taxes-heating-condos fees equal to 4% of gross income, and other financial obligations no more than10% of gross income. Mortgage lender policies will vary.   Incentives Interest rate buy downs are recognized by CMHC within their policy guidelines. This means that a low down payment purchaser can also benefit from an interest rate buy down. An interest rate buy down is one of the few incentives that CMHC does not classify entirely as a sweetener. If a developer was offering a new home entertainment center valued at $5,000 as an incentive to purchase their $100,000 condominium CMHC would adjust the lending value of the home. It must be assumed that the developer gets and gives nothing for free, what they give away in incentives they make up for in a higher sale price. It is also likely that you could forego the home entertainment package and negotiate the purchase price down to $95,000. Incentives that do not add lasting value to the real property equal to their cost are subtracted from the purchase price. CMHC will assume that you are paying $95,000 for a home and $5,000 for a home entertainment center. As such they will base the maximum financing on a lending value of $95,000. The result, for 5% downers, would be 95% financing of $95,000 rather than $100,000. The purchaser would have to ante up a down payment of $9,750 to buy this $100,000 condo/entertainment package which is a 9.75% down payment. Given this treatment of incentives by CMHC and their approved lenders most developers offer incentives that improve the value of the property and won't result in a lending value that is a discount to the purchase price. No developer wants to reduce the affordability of their product by increasing the required down payment to include the purchase of an incentive.   CMHC Most lenders will not recognize a lower than market interest rate for income qualification purposes if the benefit of the lower rate is short term. The lender will require that the rate be bought down for a period of at least a 3 year mortgage term. Some lenders will only recognize a portion of the beneficial financing amount. Canada Mortgage and Housing Corporation will also recognize interest rate buy downs provided that the following criteria are met. CMHC permits buying down the fixed rate of an equal payment mortgage loan to a lower level through payment of a lump sum to the Approved Lender. The Pre bought down interest rate must be consistent with general market conditions. The post buy down rate may be used for GDS TDS purposes if the buy down extends for at least 3 years. The maximum amount of the interest rate reduction will be: Pre bought - down rate (market rates) Maximum reduction recognized Less than 8% 0% Equal to 8% but less than 11% 1% Equal to 11% but less than 14% 2% Equal to 14% or greater 3% Therefore if market rates are less than 8% CMHC will not qualify the client using a lower bought down interest rate. If market rates are 8% up to 10.99% CMHC will only recognize a 1% buy down even if the bought down rate is 2% below the market. Mortgage lenders financing non high ratio properties have more liberal criteria and will likely recognize interest rate buy downs at all market rates if the overall risks of the financing can reasonably be determined as satisfactory. Comparing Mortgage Incentives & Discounts Better Mortgage Rates GETTING THE BEST DEAL The competition among mortgage lenders for business has resulted in rate discounting and other incentive offerings to attract clients. In many cases different lenders will offer different incentives, some may be offering cash back based on your mortgage amount, some may offer better interest rates, and some may offer to pick up some of your closing costs such as legal or home inspection fees. To find the best deal take the time to shop around. In order to compare the alternative incentives of each mortgage lender, calculate the beneficial financing of discounted interest rate offers and compare this with the value of cash offers or other incentives. Use the Canada Mortgage  Assume a mortgage of $100,000. Lender A is willing to offer 3/4 of a percent off the current posted interest rate of 8% Lender B is willing to offer cash back of 1.5% of your mortgage amount, a 3 year term is required. Lender C is willing to offer 1/4 of a percent off the 8% interest rate and will also pay $800 towards legal, appraisal, and inspection fees. The present value benefit of a 7.25% mortgage rate versus an 8% mortgage rate is $1,895. This is the savings in the mortgage payment and reduced balance at term end. Similarly, the 1/4 percent reduction from Lender C results in savings of $632, plus the $800 contribution to costs. The cash back offer results in $1,500 in your pocket to spend on closing costs or otherwise. The clear winner from a financial perspective is Lender A with the 7.25% mortgage rate. However, for first time buyers with little savings or down payment the advantage of receiving cash back to help with the seemingly endless closing costs may be a perfect fit. Incentives are not the only issue. A knowledgeable mortgage lender can help you successfully navigate the purchase and finance process. A flexible mortgage product can offer the potential for substantial savings by allowing pre payments of principal, early renewals or open options. See the Canada Mortgage Survey for information on posted mortgage rates and mortgage products. Tax Treatment of Moving Expenses   Who can deduct moving expenses? You can deduct eligible moving expenses from income you earn at your new location if you move tostart a job or a business, or attend courses as a full-time or co-operative student at a college, university, or other institution offering post-secondary education. Your new home must be at least 40 kilometres (by the shortest usual public route) closer to your new school or place of work than your previous home.   Are you employed or self-employed? If so, you can deduct eligible moving expenses from employment or self-employment income you earn at the new location: If your moving expenses are more than the income earned at the new location in the year you move, you can deduct the unused portion of those expenses from employment or self-employment income earned at the new location in the following year. You cannot deduct your moving expenses from any other type of income, such as investment income or Employment Insurance benefits, even if you receive this income at the new location. If you receive a moving allowance or grant, or are reimbursed for your expenses, you can only deduct your moving expenses if you include the amount you receive in your income, or if you reduce your moving expenses by the amount reimbursed   Expenses you can deduct You can deduct reasonable amounts that you paid for moving yourself, your family, and your household effects. Not all members of your household have to travel together or at the same time. Eligible moving moving expenses include: travelling expenses, including automobile expenses, meals and accommodation (remember to keep receipts) to move you and members of your household to your new residence transportation and storage costs (such as packing, hauling, in transit storage, and insurance) for household effects, including items such as boats and trailers costs for up to 15 days for meals and temporary accommodation near either residence, for you and the members of your household; the cost of cancelling a lease for your old residence, except any rental payment for the period during which you occupied the residence; the cost of selling your old residence, including advertising, notarial or legal fees, real estate commission, and mortgage penalty when the mortgage is paid off before maturity; legal fees for the purchase of the new residence, as well as any taxes paid (other than GST or property taxes) for the transfer or registration of title to the new residence, if you or your spouse are selling or have sold the old residence as a result of the move.   Expenses you cannot deduct Some of the moving expenses that you cannot deduct include: expenses for work done to make your home more saleable; any loss from the sale of your home; expenses for house hunting trips before you move; the value of items movers refused to take, such as plants, frozen food, ammunition, paint, and cleaning products; expenses for job hunting in another city (such as travelling expenses); expenses to clean or repair a rented residence to meet the landlord's standards; expenses to replace personal use items such as toolsheds, firewood, drapes, and carpets; expenses to disconnect and reconnect utilities; costs of transformers or adaptors for household appliances; mail forwarding costs; and costs incurred in the sale of your old home if you delayed selling for investment purposes or until the real estate market improved. You cannot deduct the cost of moving a mobile home. However, if you have personal effects in a mobile home when it is moved, you can deduct the amount it would have cost to move those personal effects separately. mail forwarding costs Mortgage Life Insurance Mortgage Life Insurance When you take out a mortgage, you're increasing the financial obligations of your family and your need for increased protection. When the primary income earner of the family dies mortgage payments may become unmanageable and lead to financial hardship and the necessity of selling the family home. Mortgage Life Insurance offered by a number of lenders and life insurance companies can help ensure that your family can keep your home, should you die before the mortgage is paid off. Most mortgage insurance policies will cover, at the date of your death, up to a maximum of $300,000 per mortgage. Usually both you and one co-borrower can be insured under joint coverage. In the event of a death the mortgage would be paid off leaving the family without the burden of these mortgage payments. Premiums are based on your age and the amount of your mortgage when you apply for coverage and what's more, premiums will not increase for the life of your mortgage because of increased age or changes in health. The cost of joint insurance is usually 30% to 40% more than the cost of single coverage and is based on the age of the older of the two co-borrowers. The premiums are usually added to your regular mortgage payments. Mortgage insurance is usually offered by the financial institution that holds your mortgage. The application process often involves a brief health questionnaire before approval is given and applicants generally have to be within the ages of 18 to 65 years. Costs of mortgage life insurance are usually based on a price per $1,000 of mortgage balance, increasing as age at the time of application increases. 30yrs to 35yrs= 12 cents / $1,000 36yrs to 40yrs= 18 cents / $1,000 41yrs to 45yrs= 26 cents / $1,000 46yrs to 50yrs= 40 cents / $1,000 51yrs to 55yrs= 60 cents / $1,000 56yrs to 60yrs= 80 cents / $1,000 61yrs to 65yrs= $1.00 / $1,000 The monthly premium per $1,000 of mortgage debt increases considerably as borrowers age. Assume you are 39 years of age with a $100,000 mortgage and 25 year remaining amortization. The cost per $1,000 of mortgage debt is only 18cents. Given the mortgage amount the monthly premium would be $18 / month. This is not a great deal of money in return for the comfort of knowing your family will be debt free in the event of your death. If you were to invest this same amount every month for the next 25 years at, say 4% annual interest you would have accumulated merely $10,700. For some this is a small opportunity lost for the peace of mind purchased. Mortgage life insurance is most appropriate when the income of the surviving spouse is insufficient to carry the entire mortgage debt. In such cases the loss of one spouses income would result in financial obligations that are unmanageable for the surviving spouse. Mortgage life insurance should only be purchased if there is a beneficiary to the mortgage being paid out on your death. If you are a single owner of your home, with no relatives or partners residing with you, and your death would not add greater financial hardship to others, it may be appropriate to decline mortgage insurance. In such cases the sale of the vacant home to satisfy amounts owing would not impact another. It also may be that accumulated wealth or existing life insurance policies benefiting you family will result in an adequate income to cover these mortgage payments without causing financial hardship. Speak to an insurance specialist to determine if mortgage life insurance is appropriate for your family but be sure that they are considering all of you other insurance coverage's and risks.   Term Life insurance as an alternative There are advantages to simply taking out regular term life insurance over mortage life insurance. Such as: It may be less expensive to purchase individual term life insurance for the outstanding value of the mortgage than it is to purchase creditor insurance through your mortgage lender. Creditor insurance with your bank or trust company covers the outstanding balance on the mortgage while you continue to pay the same premium. Personally held insurance remains level and can only be changed by you. With creditor insurance, the bank or trust company is the beneficiary, with personal life insurance you can choose your own beneficiary. The beneficiary can choose to pay off the mortgage or use the tax-free proceeds to pursue other opportunities that may not be available. If you move your mortgage to another lending institution, you may lose your creditor insurance and must reapply. You may not be eligible for new coverage. A personally owned policy is fully portable. It stays with you wherever you have your mortgage. Once your mortgage is paid you no longer have insurance, A personally held term insurance policy can be kept as long as you choose. As is the case with most life insurance products, they only really payoff when on death. This is hardly a comfort, so the topic is often avoided. While this is a sensitive issue to discuss, particularly when starting a new life in a new home, it is essential that these risks be addressed. There are many circumstances when employment income is interrupted for a period of time due to an accident or illness. Accident and Illness Mortgage Protection is available and will cover the mortgage payment, up to a set maximum, in the event that your income is interrupted. The qualification process is similar to mortgage insurance. Again, costs are usually based on your age, amount of coverage selected and in some cases employment risks. For more information on mortgage life insurance contact your Mortgage Consultant. Investing In Your Mortgage That old saying "A penny saved is a penny earned" is directly applicable to investment in your mortgage. There is no sense in earning 5% from a GIC if you have to pay 7% on your mortgage, your net shortfall is 2%. The wiser investment would be to invest the GIC amount into your mortgage, saving 7% and avoiding the 2% shortfall. Keep in mind that mortgage interest on your primary residence is paid with after tax dollars. Income tax is first deducted from your gross employment earnings and then mortgage interest payments are paid out of your remaining disposable income. Given that mortgage payments are paid with after tax earnings, investment into your mortgage results in substantial savings and excellent returns on investment. Think of it this way, if the effective annual interest you pay on your mortgage every year averages 7%, you will receive an after tax annual rate of return of 7% on all money invested into this mortgage. For each $100 of mortgage debt outstanding, you pay $7 of interest. Therefor each $100 reduction in mortgage debt will save you $7 in after tax payments every year. However, if you are paying taxes at a marginal rate of 40%, you will have to earn $11.66 of gross income to pay this $7 of interest. As such, for each $100 of mortgage prepayment you will save $11.66 in gross income every year. This example shows that the before tax rate of return is 11.66% and the after tax rate of return is 7% Compare this to the alternative rates of return a small sum, such as $100, would earn in a savings account. Investment into your mortgage is a great way to be mortgage free earlier and save thousands of dollars in interest. The same rules apply to investment in other debts. Credit cards are also paid with after tax earnings and usually are at much higher rates than your mortgage. The first line of attack should be against all higher interest debt such as credit cards and personal loans. Next, accelerated payment of your mortgage is a high return, risk free investment.   Balance Mortgage Investment with RRSP Investment A balanced approach is usually the best strategy in order to maximize returns. Invest into your RRSP and use the tax savings to make prepayments on your mortgage. Alternatively you can allocate fraction of your savings to regular monthly mortgage debt prepayment and the bulk of your savings to RRSP investment. While mortgage investment does not offer the tax deferal benefits that RRSPs do, they are a high and guaranteed return. Reducing mortgage debt can reduce exposure to risk and free up equity for investment in other assets with the potential for interest deductibility.   Plan your pre-payment Ask your mortgage lender for an amortization schedule, or go to the Canada Mortgage Schedule Calculator, detailing the mortgage payments, complete with the principal and interest amounts of each payment. By pre-paying the principal amount for a future month you will avoid paying the associated interest amount. This approach is a great way to motivate your family to stick to a prepayment strategy because it makes the benefits of each prepayment apparent. The benefits are the total interest savings received over the entire remaining period of the mortgage amotization.   Home Renovations - Loan or Line of Credit? Loan or Line of Credit? Renovation spending has taken a permanent lead over new construction according to the Canada Mortgage and Housing Corporation (CMHC) Renovation Market Outlook for 1997-1998. Spending is expected to grow to $23.4 billion in 1998, a 6.7 per cent increase over 1997. CMHC also found that in the first two years of ownership, buyers of resale homes spend over 50 per cent more on renovations and repairs than do either buyers of newly built homes or owners who don't move. If a homeowner decides to renovate, the first step in financing the project is determining how much it will cost. Homeowners should include a contingency to allow for unexpected expenses. Most people use savings to pay for renovations however, others may need to investigate their financing options. "When financing is needed for a home renovation, homeowners should get information about a loan and a line of credit,'' advises Bob Tillmann, Vice-President of Secured and Term Lending, Canada Trust. "Understanding the difference between the two will help people choose the option that best meets their needs.'' A line of credit is a cash reserve that a person can use at their own discretion. People can use as much or as little of their available credit as they choose. For example, a customer may be pre-approved for a $25,000 line of credit but may only use $15,000 for a home renovation. Interest would only be charged on the $15,000. Lines of credit can be secured or unsecured and can usually be accessed through cheques, telephone banking, credit cards, automatic banking machines or at branches. As long as you are within your limit and payments are up-to-date, a line of credit can be used over and over again. "A line of credit is a flexible financing option. You have instant access to funds when you need them and you only pay interest on the funds that you use,'' advises Tillmann. "A line of credit gives you complete control over your own spending decisions.'' A loan is a one-time advance of a specific amount of money with a fixed payment schedule. "A loan is designed for people who want to borrow a specific amount of money to meet a one-time need and pay it back over a designated time-frame. Because you choose the number of months or years during which you want to pay back the loan, you know exactly what your regular payments will be which can help with household budgeting,'' said Tillmann. "However, you may choose to pay off part or all of your loan at any time without penalty.'' "If you are looking for financing for a home renovation or another major purchase, it is important to speak to a financial adviser to determine whether a loan or a line of credit is the best choice for you,'' Tillmann advises. "A financial adviser can help you develop a manageable financing plan that meets your overall financial needs.'' For more infromation on this subject go the Canadian Home Builders Association.