25 Nov

RATE HOLD VS PRE-APPROVAL – A COMMON MISCONCEPTION

General

Posted by: Brad Lockey

mis-con-cep-tion (noun) – a view or opinion that is incorrect because it is based on faulty thinking or understanding; mistaken notion; an erroneous conception.

With not knowing how to start this particular blog post, I decided to look for some images that might summarize the topic best – What is the difference between a RATE HOLD and a PRE-APPROVAL?

I thought this picture 100% represented how these terms are perceived, you say one thing but you mean the opposite. For most people the term PRE-APPROVAL is more commonly used than the latter. The term RATE HOLD is generally only used in the broker/lender sphere.

Many years ago (seems like the ice age ago) one could place a phone call to their personal banker and lock in a mortgage, then it switched to only requiring a paystub maybe a bank statement and T4s.  Whereas now one requires their entire biography and proof of net worth followed by a blood sample… somewhat facetious, but there is more involved as lenders need to make an accurate risk assessment.

Times have changed and so should our line of thinking. Underwriting mortgages is not cheap and lenders have upfront costs that take years to recoup.

RATE HOLD

These are generally automated where nobody even looks at the application.  The system only analyzes basic criteria; beacon score, loan-to-value, name and birthdate. No documents are even reviewed. A rate hold is simply just that, a rate hold. It’s just a certificate guaranteeing the stated rate for a stated period of time, usually to a maximum of 120 days. Rate holds are mostly utilized for borrowers who are going to purchase or refinance in the near future.

PRE-APPROVAL

The pre-approval approach is generally a more detailed process, with all documents being reviewed, except for the subject property. The lender will have to approve the covenant based on the information provided such as employment, source of the down payment and credit history criteria. Approval of these three pillars is NOT a guarantee that the mortgage application will be approved. The lender still has to do its due diligence on the fourth pillar (subject property) as it must still meet all the lender’s and insurer’s guidelines if there is less than a 20% down payment.

THE MOST COMMON QUESTION YOU WILL HEAR DURING THE PURCHASE PROCESS IS, ARE YOU PRE-APPROVED?
I have to worked with numerous clients that thought they were PRE-APPROVED by their ‘bank.’ But during the subject removal timeline found out that they were NOT pre-approved, all for various reasons. Instead there should be a series of questions asked:

Have you consulted with your Mortgage Expert?
If so, when was the last time you had a conversation with her/him?
Is there a rate hold or pre-approval in place? Do you understand the difference(s)?
Have you sent her/him your complete package of documents that was requested?
Are there any changes to employment, credit, the down payment or the purchase price?
Have you discussed the ‘plan’ for this property? This will determine the term and mortgage product chosen.
…and much more…
As you can see, there is much more to consider than just, ARE YOU PRE-APPROVED?

No one mortgage is exactly the same as someone else’s. The mortgage process is a complex labyrinth of puzzle pieces that have to fit together perfectly. Note that the puzzle pieces are constantly changing in this industry.

Due to the steep underwriting costs of each mortgage application, most lenders are electing to follow the RATE HOLD process. By analyzing a complete 4 pillar mortgage application package (credit, employment, down payment and subject property), the lender is able to maximize dollars spent to acquire a new client. Navigating the RATE HOLD/PRE-APPROVAL process should be left up to your trusted Mortgage Expert.

The best PRE-APPROVAL is the one that comes from your Mortgage Expert because they can analyze and do a pre-underwrite even before doing a RATE HOLD. With their expert advice you can construct a strategy that is tailored specifically to your mortgage financing scenario.

If you have any questions, please don’t hesitate to contact us at Dominion Lending Centres!

24 Nov

Caution: Mortgage Penalties and Early Exit

General

Posted by: Brad Lockey

Okay so you have a mortgage. Let’s face it, it’s a contract with terms, conditions, rights and obligations for both you and the lender. However, now for whatever reason you need or want to break the contract before the end of the term. Many mortgage lenders will allow this provided they are compensated. You have a rate of x.xx%, the best they can lend to someone else right now is 1% less so they want the difference, known as Interest Rate Differential or IRD. Seems fair right? Right. However, as is often the case, the devil is in the details. It is the method of calculating IRD that borrowers should be aware of as not all mortgages are created equal.

Let’s look at a couple of methods commonly used with what we Mortgage Brokers call “A” business. A or AAA business is where everything on the file makes sense, good credit, documented income and a normal residential type property. This is the vast majority of mortgage business on the books in Canada.

Method A – Posted Rate Method

This method uses lender posted rates to arrive at the formula to calculate the penalty. Posted rates are generally used by major Banks and some Credit Unions. These are the mortgage rates you will see on their websites and you will recognize them because the rates will not appear reasonable. They subtract a discount from these rates to arrive at the actual lending or contract rate. Nobody pays posted rates. Let’s say the posted rate for a 5 year term is 4.90% but you are savvy, able to negotiate a discount of 2% and come away with an actual mortgage rate of 2.90%.

Everything is rolling along great for 2 years when, for whatever reason, you need to exit the contract. What will my penalty be you ask, hopefully of the lender, while silently begging for mercy? The answer; the greater of 3 months interest or IRD. Okay 3 months interest sounds good but IRD sounds scary! It can be scary as it is subject to a formula over which you have no control and can be easily manipulated. You have 3 years left on your contract, the lender says their “Posted Rate” for 3 year terms is 3.40%. You think great! My rate is 2.90% your rate is higher at 3.40%, no difference just 3 months interest and I’m outta here! Wait a minute…remember that 2% discount you negotiated? That’s right, it gets subtracted from the posted rate to arrive at the rate that will be used to calculate your penalty. So 3.40% – 2% becomes 1.40%. Who lends at 1.40%? No one. However, your contract rate is 2.90% – 1.40% equals a IRD difference of 1.50%, times 3 years left on the contract equals a penalty of 4.50% of your mortgage balance. Gulp! On a mortgage of $300,000 that is a $13,500 penalty.

The main underlying problem with this method is the fact the posted rates and /or the discounts, can be easily manipulated depending on the interest rate curve, to favour the lender. What happens in today’s interest rate environment with a gently sloping curve is that posted rates decrease from long term to short term however, so do the discounts. For example, a 2% discount on a 5 year fixed term is close to actual nowadays however, you would never get a 2% discount from posted on a 3 year term. Less than 1% would be more realistic.

Let’s look at another common and more favourable method.

Method B – Published Rate Method

This method uses lender published rates which are close to actual lending rates but do not include unpublished rates, which may only be available to Mortgage Brokers or Quick Close specials, among others. Generally these rates are used by Wholesale lenders, many of whom acquire all or most of their business from Mortgage Brokers. You will see these rates on the lender websites and will recognize them because the rates will appear reasonable. Let’s look at an example using the info above but let’s assume at outset you chose a Method B lender as opposed to a Method A lender and compare. Let’s assume your rate is 2.90%, which was the published rate at the time or a special your Mortgage Broker obtained for you. You want to exit the mortgage at the same 2 year point in time. What will my penalty be you ask, hopefully of the lender, while silently begging for mercy? The answer; the greater of 3 months interest or IRD. You have 3 years left on your contract, the lender says their “Published Rate” for 3 year terms is 2.60%. You think great! My rate is 2.90% your rate is 2.60%, not much difference…and you would be right! No discounts involved, just a straight up comparison. Your contract rate is 2.90% – 2.60% equals a difference of 0.30% times 3 years left on the contract equals a penalty of 0.90% of your mortgage balance. On a mortgage of $300,000 that is a $2,700 penalty. Much easier to swallow than $13,500!

Think these numbers sound too far apart to be real? Not at all. In the above examples I have used rates fairly close to actual. This means that in the time frame covered, above rates are and have been essentially flat or slightly declining. So even though rates are/have been roughly the same for the lenders at the time origination vs time of exit, which means there cannot be much harm accrued to the lender, one method produces a very punitive penalty. Doesn’t seem fair does it? The Government recently stipulated that lenders must better disclose their methods, be more transparent and use plain language. However, the Government did not mandate which methods are to be used. So it is buyer beware! As always, get independent professional advice. We here at Dominion Lending Centres can guide you through the maze.

Now the caveat: having said all that, we do in fact support the major banks and credit unions and send billions of dollars of mortgages their way each year. Why? Well, they have by far the widest product selection available in the marketplace. Mortgage products and structures that you simply cannot get anywhere else. This is important because the first question I am asked by a borrower is “can I get approved?” All else is secondary. When it comes to penalties, forewarned is forearmed! Best to know going in. A Mortgage Broker can advise what best options exist and will know which lenders use which methods or variations of them.

Moral of the Story: As always, get independent professional advice on which lender and options are right for you. Your local independent DLC Mortgage Broker can help.

Good to know tidbits:

A closed mortgage also works in your favour, after all, as long as you are not in default, the lender can’t call you up and say, listen we found someone else who is willing to pay a higher rate than you have and we want out, we would like you to repay us ASAP. Gasp!

Variable rate mortgages generally charge a penalty of 3 months interest, no IRD. However, this is not true of all. Again, get independent professional advice.

By law, if you have a mortgage term longer than 5 years and you exit after 5 years have elapsed, the maximum penalty is 3 months interest.

10 Nov

MORTGAGE vs HELOC – Do You Know the Difference?

General

Posted by: Brad Lockey

Today, with the Internet, we all have an abundance of information literally at our fingertips. Despite the information available many homeowners have limited knowledge about the mortgage process and products. Their lack of knowledge can turn out to be costly. Homeowners should know the difference between a conventional mortgage and a Home Equity Line Of Credit (HELOC).

A conventional mortgage is a registered charge against your home. There is a set term – 6 months to 10 years and an interest rate can be either a fixed or variable rate. Payments include principal and interest. Many homeowners choose a fixed rate as it is easier to set budgets knowing the interest rate won’t change during the term chosen. Variable interest rates will change as Prime changes. With a solid strategy in place, choosing an interest rate will be simple. If you have less than a 20% down payment (equity) the maximum amortization is 25 years. More than 20% down and a 30 year amortization is available. You can purchase a home with as little as 5% down (maximum purchase price $999,999).

A HELOC is a secured line of credit also registered as a charge against your home.  This charge can be in first position but generally is added after the fact behind a conventional mortgage. Some lenders will not permit another charge on title. Like any line of credit, a HELOC is fully open and you can borrow and re-borrow. The interest rate is tied to Bank Prime and may fluctuate. Government regulations stipulate that a HELOC cannot exceed 65% of the value of your home, unless in second position, in which case you can borrow to 80% of the value and qualifying must be done using the 5 year posted rate (4.64%) with a 25 year amortization. Payments can be as low as interest only but that is truly the never-never plan for repayment. Any spikes in interest rates can throw off the most dedicated budgeters!

If used responsibly and with a sound strategy, a HELOC can have many advantages. Purchasing investments with a HELOC creates a tax deduction for interest paid. Renovating your home with a HELOC allows you to draw from it when you need it, only paying interest on the money used. Your children’s education, buying a boat or the down payment for a recreation property can all be facilitated with a HELOC. A HELOC can be a great tool for investments, renovations and short term financing needs. Anything longer term, however, is often cheaper to choose a conventional mortgage with a variable rate. The difference in the lower interest rate outweighs the flexibility of the HELOC.

Most people when buying a home take a conventional mortgage with a fixed term and rate. The astute homeowner understands the power of a conventional mortgage combined with a HELOC. Understanding your needs together with a strong financial strategy can turn your largest debt into your greatest asset!

3 Nov

TOP 5 REASONS PEOPLE DON’T QUALIFY FOR A MORTGAGE

General

Posted by: Brad Lockey

I just had a great discussion with one of my favorite Realtors about qualifying for a mortgage. Even she wasn’t aware how tough it can be to qualify. That’s why it is SO IMPORTANT to talk to me when you are creating your plan and BEFORE you make an offer!

I receive calls every month from people who want to know how to qualify for a mortgage because they were declined by their bank. In many cases I can help them and in some cases they have to wait – but we identify what they need to do to get in a better situation to qualify.

Here are the top 5 reasons why people don’t qualify for a mortgage with their bank and come to see an independent mortgage specialist.

#5 Lack of a Down Payment or Equity

With the end of cash-back mortgages offered by the banks, borrowers now have to come up with the down payment on their own. They can receive it as a gift from a family member – but no more cash-back from the lender used for down payments. Minimum down payment is 5% for the purchase of an owner-occupied home or 20% for a rental property. Minimum 20% equity in the home if it is a refinance. This will help you qualify for a mortgage.

#4 Insufficient Income

With the high price of homes in the Toronto area, sometimes people simply don’t earn enough money to manage a mortgage payment, property taxes and strata fees along with existing consumer debt and still have a life. For some home buyers, the only other option is to access more money for a down payment (gifted) or try to purchase a home with suite income or look at alternative lenders who accept room and board and other sources of income to help you qualify for a mortgage. In some instances, home buyers will look for someone else to go on title to add income to the application.

#3 New Mortgage Rules

For those with less than 20% down payment, the new mortgage rules are adjusted to the debt servicing ratios and amortization for borrowers. The new rules for debt servicing apply to those with good credit scores and allow for a max of 39% (gross debt servicing – GDS) of gross monthly income to cover the mortgage payments, property taxes and 50% of the strata fee. In addition a max of 44% (total debt servicing – TDS) of gross monthly income is allowed to cover the same and other consumer debts such as loans, credit cards and lines of credit. The maximum amortization was also reduced from 30 years to 25 years – effectively tightening qualification for borrowers equivalent to a 1% interest rate hike.

#2 Credit Issues

Some people don’t realize if they are one day late on credit card payments, their mortgage or loan payments the lender will update the credit bureau agencies and the late payments will reflect on their credit report, lowering their credit score. Other items can also effect credit scores such as a collection (if you didn’t pay that parking ticket or fitness membership fee they can send to a collection agency) and those marks on your credit report make your score drop like a rock. Going over your credit card limit, and applying for credit often requiring your credit report to be pulled by the bank, auto dealership and credit card companies will lower your score. Finally, consumer proposal and bankruptcy will greatly impact your score, which can stay on your report for up to 7 years if real estate was involved as is the case with bankruptcy.

#1 Too Much Debt

There are a growing number of consumers doing … well, too much consuming. Credit card debt is on the rise and over use of lines of credit are putting some people in a debt overload situation. Some pre-home-buyers go out and purchase that amazing new truck, along with a large monthly payment, which pushes their total debt servicing (TDS) ratio over the limit. Nice new truck – no home with a garage. Some home owners have so much consumer debt that they are unable to refinance their home to consolidate the mortgage and the unsecured debt because the amount exceeds the maximum loan to value allowable (currently 80% of the value of the home).

Do you want more information for your next mortgage? Contact any of us here at Dominion Lending Centres – we’re here to help!

2 Nov

WHICH REPAYMENT OPTION SHOULD YOU CHOOSE?

General

Posted by: Brad Lockey

 

You’ve been approved for your mortgage and now you have yet another choice – how often do you want to make your mortgage payments? Your mortgage broker has advised you that your options are monthly, semi-monthly, bi-weekly and accelerated bi-weekly. We are all familiar with monthly payments but what do these other options mean? What’s the difference between bi-weekly and accelerated bi-weekly? And does it really make a difference which one you choose?

Yes it does. The repayment option you choose can impact how quickly you pay off your mortgage and how much interest you pay. Let’s explore the different options using this example: let’s say you are borrowing $150,000 to buy your home, the interest rate is fixed at 4% and your amortization is 25 years.

Monthly Payments – this option is pretty straightforward. You make your payment of $789.03 on the same day of each month. Each year you will pay in total $9,468. Over the 25 year amortization period you will pay a total of $236,751 so in addition to paying back the $150,000 that you originally borrowed you will pay $86,751 in interest.

Semi-monthly Payments – With this option instead of paying $789.03 monthly you will pay half that amount twice per month for example on the 1st and the 15th. The amount you save is vey small because the annual total is the same as before ($9,468). By paying semi-monthly you move your payments ahead slightly. Over 25 years you save $222 in this example… that’s not much.

Accelerated Bi-weekly – With this option, your regular payment is the same as the semi-monthly payment $394.52. But instead of paying twice a month, you pay it every two weeks. You end up making 26 payments instead of 24, this is equivalent to one extra payment per year ($10,257 annually). By making that extra payment every year you pay off your mortgage faster and save on interest. In this example your total interest payments would be reduced by $12,760 to $73,991 and your amortization would go down from 25 years to less than 22 years… Now we’re getting somewhere!

If you decide to go with biweekly payments rather than “accelerated” bi-weekly payments then the situation isn’t very different than the semi-monthly option. The annual payment would be the same and your interest savings would be similar to the semi-monthly option – very small.

The advantage of accelerating your payment is the savings on the interest. Therefore, if you can afford that little extra each year it makes sense to choose an accelerated biweekly schedule.

If you’d like additional tips on how you can pay your mortgage off quicker, I would be happy to assist!