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You had your best-laid plans and then COVID-19 came along and hammered the entire economy. But you’ve got this – if you have the right information. Join Rob Carrick and Roma Luciw on Stress Test, a podcast guiding you through one of the biggest challenges your finances will ever face.

ROMA: Housing costs almost certainly consume the biggest chunk of your income. If you’re a homeowner or want to be one, you probably have questions about mortgages.

ROB: This week, we’ve got answers. Consider this episode your Mortgage 101 course.

ROMA: Welcome to Stress Test, a personal finance podcast for Millennials and Gen Z.

ROB: I’m Rob Carrick, personal finance columnist at the Globe and Mail.

ROMA: And I’m Roma Luciw, personal finance editor at The Globe.

ROMA: Whenever we run stories about mortgages, Globe readers devour them. They’re regularly some of our best-read PF content. People are hungry for impartial advice on how to get the so-called “best” mortgage, a contract where you borrow money from a lender in order to buy a property. You pay them back the amount plus interest, usually over a couple of decades.

ROB: About 200,000 people buy their first homes in Canada annually, according to the latest Statistics Canada data. Millions more owners need to renew their mortgages every year. That means a lot of questions about how to get a mortgage - with the lowest possible costs.

ROMA: And with interest rates rising - and more hikes predicted ahead, we’re getting even more questions about whether to go with a variable or fixed rate.

ROB: Today, mortgage planner and Globe and Mail columnist Robert McLister joins us to discuss mortgage basics and the changing interest rate environment. Later in the episode, we get more perspective from a B.C.-based mortgage broker.

ROMA: Let’s get started with Mortgage 101. So, Rob. A first time mortgage shopper, what are the options for where they can go to try to find a mortgage?

ROB MCLISTER: If you include the credit unions, there’s about over 300 lenders in Canada. And that includes banks, non-bank, mortgage finance companies, credit unions, non-prime lenders, private lenders, mortgage investment companies, there are a bunch of them.

ROB: Is there any benefit to getting a mortgage at your home bank or credit union? If I’m thinking, you know, it’s a familiar name, my checking account is there, as I go online and take money from one to the other super easy, and I’m totally dealing with people in an institution I’m familiar with. Does that have any weight?

ROB MCLISTER: Yeah, so you know, the bank channel’s the most popular, right? Banks dominate in Canada, it’s not like in the US, we got like 4000 banks. In Canada, you know, you got the Big Six, and then some, some others. And so they have your checking account, typically, and, you know, people like to do business all in the same place if they can help it. And so, you know, the banks have a big penetration. And so, you know at the end of the day, it’s all about borrowing cost. What is your lowest overall borrowing cost, and you know, what’s the least amount of stress to get the mortgage. You know that balance is what you have to think about when choosing between a bank or a broker. So, if you go to a broker, then you’re going to have much more selection?

ROMA: What would be the difference between getting a mortgage at a bank or through a mortgage broker?

ROB MCLISTER: So you go to a bank, and you get one lender’s products, you go to a broker, and you have a choice of a whole bunch of different lenders. And so why does that matter? Well, you know, at any given time, one lender could have significantly better options or costs than another lender. So choice is better, in general, for that reason. And so, you know, if you, you know, go to your bank, and, you know, because you want to keep all of your finances at the same place, that’s okay. Just make sure that the mortgage you’re getting has what you need. And you know, what most people need is the lowest possible borrowing cost with the least amount of stress. And the least borrowing cost entails not only the interest rate, but the features of the mortgage. So big banks are notorious for things like brutal prepayment penalties, you know, limitations on some of the features like refinancability and, and stuff like that. You know, the big banks are not known for giving you outstanding rates when you ask them to refinance your mortgage. And so, you know, you got to take all these things in consideration, and a mortgage broker can show you a whole bunch of different options. And at the very least, everyone should talk to a mortgage broker just to compare what their existing lender’s offering.

ROB: What should you consider when consulting a mortgage broker?

ROB MCLISTER: So mortgage brokers get paid a commission, you don’t pay it out of pocket, but the lender pays it. And so there may be incentives to steer you to one place or another. You know, at the end of the day, you want a broker that is very experienced, that deals with a lot of different lenders, not just you know, one or two lenders who for 90% of their business, you know, you want choice. You got to ask the right questions, how long you’ve been in the business, how many lenders did you deal with last year? You know, to offer the lowest rates possible? Do you buy down rates from your commission, which means you should trade some of your commission for a better deal. Now, those things pertain to prime borrowers, okay, these are we’re talking about borrowers here that can get approved at any bank, for example. If you’re a non-prime borrower, that, you know, you maybe you have bad credit, or you can’t prove your income or whatnot, or you have a super high debt ratio, then that’s when brokers are much more helpful because they’re the ones that have the widest access to the most non-prime lenders. And in that case, maybe the interest rate isn’t the main factor anymore. Maybe it’s getting approved period.

ROMA: So the big question that most first time buyers have is how much can I afford? So how do lenders calculate that?

ROB MCLISTER: So lenders look at a lot of things, the main thing that they look at is your debt ratio when it comes to affordability. And so that’s basically your monthly obligations divided by your gross monthly income. And the result needs to be below a certain threshold. So say 44%. And that determines generally how much you can qualify for obviously, you got to have good credit. And there’s a whole bunch of other things that go in the underwriting process. But that’s the big one.

ROB: And what can I do to give myself the best shot at a good mortgage rate? I’m thinking what credit score do you need to have, in order to qualify for the top rates out there?

ROB MCLISTER: Well, you know, assuming you have the minimum downpayment, and, you know, you don’t even need to have the out of pocket, I mean, you can get, you know, if you have parents that are generous enough to gift you the money, that’s an option, you can actually even borrow the money theoretically off your credit card. I don’t recommend that, but I’ve seen it done. So step one is having a down payment. Assuming you have a down payment, then, you know, to get the best terms, you need good credit. So you want to aim for a credit score of 720 or better. You need consistent reliable income, provable income, you need a reasonable debt ratio. So if your monthly obligations are like, you know, 75% of your gross income each month, including your mortgage payment and all your other debt payments and stuff. You know, you’re gonna find it very difficult to get a mortgage unless you have a lot of assets behind you or some other mitigators

ROMA: So speaking of down payments. Conventional wisdom is that you should put down as much as possible, or 20%. What are the advantages of putting down that amount? And, is that what you see most people doing?

ROB MCLISTER: Well, down payments can vary widely depending on how much money you have, how badly you want to buy a home. Because first of all, you’ve got to figure out if homeownership is for you, right if it is and you only have 5% down which is the minimum in Canada for a good rate. I And then, you know, you, maybe that’s all you can afford, maybe that’s all you should put down. Maybe you should get in the market now. So that, you know, home prices don’t run away from you, because your average home price is about 800,000. If it even if it goes up with the long term rate of inflation, which is 2%, that’s 16 grand, more expensive the house gets if you wait another year. Now, we’re in a different market now. Prices are weakening. So people have their you’re not under the same pressure you were a year ago or so. But anyway, you know, with respect to down payments, if you want to avoid default insurance fees, you have to put down 20%. I wouldn’t get too hung up on that. With the insured mortgage, you actually get a much better rate most of the time. So it kind of offsets too much extent the mortgage insurance fee that you pay. And not only in your first mortgage, but your second mortgage, too. If you switch to another lender and your mortgages is insured, you can often often get a better rate on that switch.

ROB: People are really fixated on their interest rate when getting a mortgage, what are the other important things they should keep in mind?

ROB MCLISTER: Yeah, so mortgages are not just about rate they’re about reducing your borrowing cost as much as possible. And like I said before, having a stress free experience, I mean, you can go to a bank and you know, you have all your checking there. They know you. They see everything that goes in your account, in and out of your account every month, and it might be easier to get a mortgage there. And you might be willing to pay an extra 10 or, or point one or point two percentage points higher rate for that, you know, smoother experience. Or you might go to a mortgage broker, and they’ll find you maybe a quarter point savings on your mortgage, which significantly adds up over the years for an average Canadian mortgage. And so that’s the rate part of it. In terms of the other stuff, that’s important, there’s a lot of other stuff that’s important that can affect your borrowing cost long after you close the mortgage. You know, for example, the lender’s portability policy. Let’s say that you get a mortgage and you want to move to a new house three years from now, you want to keep your great rate because interest rates have soared. But the lender only allows you 30 days to move the mortgage. That’s one example of a feature that can work against you. You might be forced to break the mortgage and pay a penalty, and penalties can be very high in this country. It’s not like the US where mortgages are generally open. In Canada, your penalties can be you know, 2, 3, 4 or 5% of your principal, sometimes depending on the market and the lender. So you want to look at these features that are going to save you money after closing. And then you got to figure out what’s my probability of needing this feature? How likely am I to move for example, you know, how likely am I to need more money. If you need more money in the lender has very restrictive refinance policies that could cost you a penalty, it could cost you know, you might have to move, you might have a lender that doesn’t have good rates, and that tries to stick you with a rate that’s, you know, three tenths of a percentage point above the market, you got to think of all these things. And that’s where a kind of a broker comes in handy, where these rates sites online come in handy, you know, you’ve got to do a lot of comparison shopping.

ROMA: Can you run through some of the fees associated once you’re getting a mortgage?

ROB MCLISTER: Well ya, the big fees are, you know, legal fees, registration fees, you have to register the mortgage on title, appraisal fees. If you’re switching lenders, there’s a discharge or assignment fees. And you know, legal fees might be 500 or 2000 bucks depending on what type of mortgage it is, whether using a title company or a lawyer. Appraisal fees can be anywhere from 250 to 500 or more depending on the property type and location. The discharge or assignment fees can be you know, 75 to 400 bucks depending on province and type of deal is and lender.

ROB: One of the things we’re hearing a lot about today is the anxiety about whether to get a fixed or variable rate mortgage. Can you run through the difference between the two?

ROB MCLISTER: Yeah, so a fixed mortgage has a set rate, and set payment for the full term. Contrasting with that is a floating rate mortgage, and there’s two flavors of floating rate mortgages that a lot of people don’t realize this. You have the variable rate mortgage that has a fixed payment. So you know, prime goes up two percentage points, your payment’s gonna stay the same. What happens is you end up paying more interest and less principal. So you know, you’re not paying your mortgage off as quick. The other flavor of a floating rate is an adjustable rate mortgage. That’s where the rate and the payment move up and down with prime rate. The benefit with that is you stick to the same repayment schedule, so you’re paying off your mortgage in the same amount of time.

ROMA: If you’re a first time mortgage shopper, you might like the idea of the predictability and the security of a fixed rate. But you’ve heard that you can do better with a variable. What are the things to consider when making a decision on which way to go?

ROB MCLISTER: So this is a very personal decision. So, you know, there’s all kinds of things that go into determining whether you should be in a fixed rate or a floating rate. But generally, the big ones are your financial profile, you know, can your family budget handle potential 25 or 30% increase in the payments each month or in the interest cost? Spreads, which means the difference between fixed and variable rate, that’s what we call the spread. That matters. You know, if that gap is two percentage points, it’s a lot different conversation than if the gap is, you know, point one percentage points. Right, the bigger the gap historically, the more likely you are to do better in a floating rate mortgage. The position in the business cycle that we’re in matters too. I mean, if you, you know, last year was a good example, you know, we’re at the bottom of a rate cycle, you know, we have the market expecting higher rates in you know, 12 to 24 months. At that point, you’re much safer you know, other things equal, to be in a super discounted fixed rate. So that you know, when rates start going up, your mortgage payment and interest costs will not. And, you know, two other things real quick, the five year five year plan if you’re, you know, you don’t want to be in a five year fixed mortgage if you’re moving next year, right? Because like I said earlier, there’s big penalties involved and whatnot. And lastly, your mindset right? So you know, are you gonna get heart palpitations every time the Bank of Canada increases rates 25 basis points? Those are the big factors that you have to consider.

ROB: Roughly speaking, what is the split between people who choose fixed rate or variable rate?

ROB MCLISTER: Historically, most people have a fixed rate mortgage, about two thirds of Canadians. But interestingly, in the last year or so, actually, in the last six months, that I just did a story on this, the number of people or the percentage of people getting variable was 54%. That’s really high. That’s more than double the long term average. And that’s a function of, you know, people wanting to save money. They have that gap between fixed and variable got, you know, is pretty wide. And so, you know, people are conditioned to think that Bank of Canada is going to keep inflation near 2%, rates aren’t gonna go to the moon. So they’re gonna take a chance on the variable, given that big spread. Will they be proven right? You know, only time will tell. But you know, when you have inflation that is three times normal, and still rising, you have much more risk and a variable rate mortgage today than we’ve had in a while.

ROMA: Let’s say that I have a variable mortgage rate, and I’m seeing all these increases in rates, can I, you know, flip a switch and move to a fixed mortgage?

ROB MCLISTER: Yeah, you can convert a variable rate mortgage to a fixed rate, usually, anytime, at no fee. You know, there’s pros and cons with that, sometimes you just gotta lock in, because you just can’t take the stress of rates potentially going up, or your family budget, just, you know, something’s changed in your life, and you can’t take that risk. But you know, the problem with converting variable rate to a fixed rate is that you’re generally going to get a subpar rate from your lender, because it knows you’re a captive audience and knows you got to pay a penalty to get out of the mortgage early. So you’re not going to get a great rate to convert most of the time. But most lenders you’re gonna get a pretty shabby rate to convert. Secondly, you know, it’s hard to time, like, you know, assuming that you’re converting your variable to a fixed on a, just because you think it’s a good timing to do so. It’s hard to be right. Right, like, try, try trading bonds in the bond market and see, if you make money after a year. It’s hard to predict interest rates even for, you know, over a short timeframe. So, you know, I’d caution most people, almost everyone, almost everyone against getting a variable rate mortgage because you think you’re going to time the market, right, and lock in at the best time.

ROB: What are the penalties for breaking a mortgage before renewal?

ROB MCLISTER: If you have a closed mortgage, which means that you know, you’re locked in for a certain term, and if you want to get out, you have to pay a prepayment penalty. That penalty, depending on what type of mortgage you have, can be significant. So on a variable rate mortgage, generally candy, your penalty is three months of interest, which isn’t too bad. If you’re in a fixed rate mortgage, your penalty is the greater of three months interest or what they call the interest rate differential. So that just means that, you know, the lender wants to make sure it’s getting what it thought it was gonna get when it loaned you the money. And so it’s going to charge you that difference between what you actually paid it and what you know, it planned on getting. So that differential, that formula is not standardized. It can vary dramatically. And the big six banks have, you know, for as an example, have horrendous interest rate differential penalties. And these IRD penalties kick in, you know, significantly when rates are falling. In many cases, depending on the lender, you know, your IRD penalty can be significant, even if rates are falling, even if they’re going sideways. Generally, the only time that IRD penalties aren’t a big risk is when rates are going up materially.

ROMA: Rob, is there anything else you feel people fundamentally don’t know or perhaps misunderstand about getting a mortgage or this process?

ROB MCLISTER: You know, I think people get so hung up on the interest rate, I think that, you know, you really need to understand all the bad things that can happen to you if you’re in the wrong mortgage after closing. And that’s where features come in, right? You want a mortgage that has the most flexibility possible, for the least amount of cost. And, you know, there’s some, some features that people don’t think about that can really help them out. One example is readvancability. So let’s say that, you know, you have at least 20% equity, you know, instead of getting a regular mortgage, you can get a readvancable mortgage. So that’s mortgage and a line of credit all in one. So as you pay down the mortgage principal, it creates a bigger line of credit that you can use in the future for investment purposes, emergency purposes. You know, readvancable mortgages make great emergency funds. You know, we have, you know, the financial experts out there tell you to keep an emergency fund? Well, most people, you know, they’re told to keep that in like a safe savings account or whatnot. Well, long term that doesn’t benefit you. If you have a readvancable you can instead invest that money in a different suitable investment, maybe index funds or whatever is suitable for you earn a higher return, and still have that money available through the HELOC portion of your readvancable mortgage anytime in an emergency.

ROB: You just mentioned HELOCs. Can you clarify for our listeners what that is?

ROB MCLISTER: A home equity line of credit. So that’s basically a secured facility where you can borrow money From your home equity. That’s just one example. Right? There’s all kinds of other things, you got to think about too. Well, okay, so let’s say you have a regular variable, and you have to pay that three month interest penalty, because you broke the mortgage in year four, right, all of that those benefits have a value to them. And so that’s why it’s important to comparison shop, figure out the mortgage that has the lowest overall borrowing cost. You know, assuming that, you know, given the the contractual terms of the mortgage.

ROMA: Thanks to Rob McLister for joining us. After the break, we’ll have a mortgage broker answer more of your questions.

ROB: To get another perspective on mortgages, we spoke with a mortgage broker – someone who works with different lenders. Angela Calla has 20 years of experience and is based in Port Coquitlam, B.C.

ROMA: Let’s talk a bit about pre-approvals, the practice of going to a lender to get a rate locked in before you want to buy. Why do I need one? And at what point should I get it?

ANGELA: They’re critical. If you are thinking of buying a home in the next five years, you need to start thinking about your pre-approval now because you need to understand based on today with where my income is, and where my credit is, what plan am I going to put in place to ever buy a home? How much income do I need to show? As an example in today’s market $100,000 In provable income qualifies you for a $400,000 mortgage. So what does that mean for you? What type of property does that look at? What type of down payment do you have? How are you getting a downpayment. Financial planning is critical, and you can’t create a plan without a map. The biggest mistake people make is as soon as they get a job, they go out and buy a car. Well, if they have a $800 a month payment that takes away $200,000 in mortgage qualification. So if homeownership is one of your goals, then way before you even think you’re gonna need it, you need to understand how your income, debt and how you can save for a down payment to plug every dollar in the best possible place to get you a return, not only on your taxable income, but you know in every single way to make sure that you are setting yourself up for success. Because this isn’t something that you just think, okay, I need to move next month I need to go get a pre-approval. It’s a plan and so you need to start way before you think you do so you can set up a plan and make sure that you’re plugging your money in the best places.

ROB: Can you tell us a little bit more about getting a rate hold? How long can I get a rate held for me? I mean, I see rates rising almost week by week, month by month, how long can I lock in for?

ANGELA: Some lenders will do up to 120 days, is the average. Now again, with the variety of lenders that are out there, some lenders that have the best rates don’t do pre-approvals at all. Some lenders do pre-approvals for 120 days, some lenders do pre-approvals for 90 days. There’s a cost to that, you know, there’s a why behind everything in the banking and mortgage and finance industry. And when you think about that, why? You know it, it costs money for the lenders to hold money. Pre-approvals, only about four out of every 10 pre approvals go live. So for the banks to be holding money at a lower cost when they can lend out money at a higher cost or it no longer becomes available to them. There is a cost to that.

ROMA: Let’s talk a bit about self-employed workers or those in the gig economy. My understanding is that lenders like to see two years of consistent income, and that should be the goal if you’ve recently become self-employed or you’ve switched jobs in the pandemic.

ANGELA: Correct. And again, it’s about piecing it together. So if you’re in the same industry, and maybe you have contracts with these with specific vendors will then if we can piece it together, and it makes sense. So if the numbers make sense, and the story makes sense, and it’s the same type of industry, but you’ve just kind of shifted a little bit about how you get compensated, then there are lenders that have exception to that. So again, when you get when you invest the time to invest in yourself and see exactly what you need to do and where you need to go to get there, you’re going to have the clear picture that’s applicable to you. But you have to invest the time and it’s document heavy.

ROB: Let’s talk a bit about interest rates, which are now rising. Buyers are subject to a stress test when they’re getting a mortgage. For people who are applying for a mortgage, can you tell us how that works?

ANGELA: Yes, you are tested for a mortgage at an on average 2% higher interest rate than what you’re actually paying. So that test is put there because it’s anticipated that they want you to be able to qualify for the mortgage should rates go up on average 2% from the time in which you got it. So knowing that that’s the plan that all the lenders have in place, all of us Canadians should be navigating our mortgage and financial plans for that. And then for whatever reason, if rates go down, or they don’t go up as anticipated, you are the only winner because you have that access to the equity in your home, that you have protected yourself with in the event that things did change. And you know, you can do that in several different ways. You can either do that with your payment, or I recommend doing that on the side so if you have an emergency come up, then you know you don’t have to go into debt outside your mortgage at a higher rate to be able to navigate that. And so while it’s important to look at, you know your mortgage, you have to also consider how you plan your budget and navigate that to be able to have the most freedom in changing times.

ROB: Angela, I’ve talked to mortgage brokers over the years and continually been surprised by their stories about how many people break their mortgage before the renewal date? What happens if I break my mortgage?

ANGELA: Seven out of 10. That’s why I recommend a variable as well, because the variable is consistent, you’re always going to have only a three months interest penalty. And you know, we don’t know what’s going to happen with discounts. If rates go up, sometimes discounts go down. You know, maybe that’ll be the time where people can make their move, because you know, properties are not going to multiple offers anymore or whatnot. So if you adapt the fixed rate mortgage with a traditional bank, your penalty is going to be much higher, four or 5% to get out of. And that’s the thing, you can’t guarantee the timing of when you’re going to need something. And that’s why seven out of 10 Canadians end up breaking their mortgage early. So are you going to be someone who fits within that seven out of 10 or you know, are we going to be lucky and not have any changes in circumstances. I know that I like to set myself up for the most amount of success to control what I can, so. You know, we can’t foresee the future we don’t know, are our relationships guaranteed to last? Is that person going to be the same forever? Am I going to change jobs? Am I going to be blessed with a pregnancy? You know, like you can’t guarantee all those things in life, we get a lot of curveballs. So I like to set myself up to be as successful as possible utilizing every option that’s out there.

ROMA: Let’s finish this off with some rapid fire questions. What do you consider an ideal downpayment?

ANGELA: There is no ideal downpayment. It’s whatever you can afford to get in the market ASAP.

ROB: Okay, if I have extra money, and I want to pay down my mortgage, how does that work?

ANGELA: Easy. You either just email or call your lender. But don’t do that until you are sure that you have six months of emergency expenses aside, and that you can’t plug that money into somewhere else to get a tax refund or more cash on hand. Make sure what you do is in your best interest and no one else’s. It’s a one way street when you put money down on your mortgage.

ROMA: Okay, on the flip side, what happens if I’m homeowner, I’m short money, and I need to miss a payment.

ANGELA: That’s why you keep the money in your account to have six months of emergencies, emergency expenses. You know, some lenders have that in their policy, some don’t. You contact them, you work it out, they’re gonna take care of you. But different lenders are different. That’s why when you say gig economy, I know some are terrible for gig economy. And some lenders are really good at it and allow you to skip some payments, and especially like if unions go on strike, and so forth. So again, interview the people you work with, make sure they get your lifestyle style and goals.

ROB: How do you get financing if you’re teaming up to buy a house with a friend or a sibling, instead of following the traditional path of going solo or buying with partner,

ANGELA: Very risky. You need to document it up the ying yang, and I can tell you the good, the bad, the ugly, I’ve done it myself, I wouldn’t do it again. And um you know, I would do it with a spouse or no one at this point. But you know, you’ve got a lot to consider because not everybody is exactly who they are and influenced by the same people in 5,10 and 20 years and you can’t guarantee if you will or will not qualify down the road. So you need to have a real hard thought about if you really want to do that what your outs are.

ROB: We’ve covered a lot of ground in the mortgage space. Ultimately, we want you to know there are options out there when it comes to getting a mortgage - and it’s about finding the right one for you.

ROMA: That’s especially true as interest rates start to rise along with anxiety about how much your mortgage payments could rise. Everyone’s situation is different - so as always, do your own research before you make your decision.

ROB: With that, here are our takeaways.

  • Always get a couple of quotes on a mortgage rate - your usual bank, a credit union?ADD and a mortgage broker are a good start.
  • There’s more to a good mortgage than a low rate: Ask about penalties if you need to break your mortgage early, and about how much you can pay down every year.
  • Get moving right now to lock in a mortgage rate and a pre-approval - Even if you’re just browsing in the housing market, it’s important to have an idea of how much you can borrow and what your payments would be. With rates on the rise, locking in a rate is vital.

ROMA: Thank you for listening to Stress Test. This show was produced by Kyle Fulton, Emily Jackson and Zahra Khozema. Our executive producer is Kiran Rana. Thank you to Rob and Angela for joining us this week.

ROB: You can find Stress Test wherever you listen to podcasts. If you liked this episode, please share it with a friend and leave us a five-star rating.

ROB: Next up on Stress Test - usually homebuyers are couples or single people. But some Millennials and Gen Zs are teaming up with siblings or friends if they can’t crack the market alone. We speak with some of these non-traditional buyers and discuss the risks – and rewards – of going this route.

ROMA: Until then, find us at the Globe and Mail dot com. Thanks for listening.