Welcome to part 3 of 15 things you didn’t know about mortgages. If you didn’t catch part 1 or part 2 make sure to check them out and don’t miss anything!
let’s get right into it.
15 things you didn’t know about mortgages
1-Paying interest at the start
2-Mortgage rates change all the time
4-You can still buy a house with low credit
6-It doesn’t always have to be 20% down
7-Pre-approval helps when placing an offer on your house
8-It’s more difficult for the self-employed VS the employee
9-Renewal should be treated as a new mortgage. Other companies may have better rates
10-A 30 year mortgage can be cheaper even though you spend more money.
11-You maybe buying a liability not an asset
12-Banks don’t want to foreclose, they lose money
13-You can get longer than a 5-year term
14-Banks look at where the money goes not just how much you have
15-Getting credit between Pre-approval and house purchase may affect mortgage approval
You may be buying a liability not an asset
It is becoming more and more common for younger adults to purchase their first home.
In Canada, we have a first time home buyer grant which is helping lots of new investors become homeowners sooner.
Owning your own home is great! It gives you pride that you own the home you live in. You will want to take care of the house or apartment but, some expenses go along with the house. Mortgages utilities, hydro/water. So is your home an asset?
According to dictionary.com, an asset is: “Items of ownership convertible into cash”
With that, we can reasonably assume that a house would be an asset. Now, if assets are good things why are there so many expenses associated with house ownership and should this affect your view of your house being an asset? Is your home an asset for you, or an asset for someone else?
Any expense/debt is viewed as a liability.
Dictionary.com defines liabilities as:
1. moneys owed; debts or pecuniary obligations (opposed to assets).
2. Accounting. liabilities as detailed on a balance sheet, especially in relation to assets and capital.
So we are now at a crossroads of sorts. Your house falls into both categories. On one side your house is an asset because it can be converted into cash but on the other side, your house is a huge expense for everyone who owns their private residence.
If a house is an asset then when does it become one? When you get a mortgage for a house you don’t own the house, the bank does. So after purchasing your house, you don’t have an asset yet because even if you sold the house it doesn’t produce cash for you. It produces cash for the bank to repay your mortgage. Except, for your down payment of course but if you didn’t buy the house you would have the down payment either way. Therefore it didn’t produce you any cash.
Ok. so, after a 5-year term is your house an asset?
After 5 years with a $100,000 mortgage, you will have around $18,500 in equity with your down payment. But, you will have paid around $20,000 in interest to the bank to achieve that. You should have some appreciation where your house has gone up in value and that’s where some cash may come from if you were to sell the house. But, if your house went up in value so did all the other homes in your area. So, if all the houses went up proportionately to each other did you make any money? Or just spend $20,000 in interest?
Alright, after 25 years and now the house is completely paid off. Is your home an asset then?
After 25 years you will have paid $100,000 to own your house and close to $57,000 in interest. At this point, the appreciation will have increased hopefully as well. Maybe, your house is worth $200,000 is it an asset? If you sell the house at this point yes you will have $200,000. But again, appreciation happens on everyone else’s property as well. Your house doubled in price and so may have everyone else’s. So unless you sell your property and think you can get a better deal than you had 25 years prior you haven’t come out on top.
There will always be a cost to having a place to live. Either renting or buying a home will cost money. Understanding that your house costs money and even with appreciation generally doesn’t produce money will help you to make informed decisions on your residence and expenses.
For me, I prefer to own my house. I may not come out on top in the end and make money from my house but I know that there will be some recoup of potential losses from any sale of the property.
Banks don’t want to foreclose, they lose money
Banks and lenders do a really good job of making sure that when someone borrows money from them that they are in a financial position to be able to afford the mortgage. It is in their best interest to go through this process because it’s very expensive to foreclose on a mortgage and a lot of time a bank just simply tries to break even on the costs associated with foreclosures.
When a bank forecloses on a property, the borrower has missed payments and the bank then seizes the property to try and recoup losses. Even though the bank takes over control of a property they end up losing money. A few of the ways the bank/lenders lose money are:
-Loss of long term interest
When someone forecloses on a mortgage in Canada, after 15 days without a payment the lender can issue a notice of sale. This is the first step in Power Of Sale by the bank. After this, the bank then gives the appropriate information to its legal team to start the process. You can foreclose on a property and be able to purchase the property back but you will normally have to pay all outstanding balances plus all of the legal fees up to that point.
Before the bank can fully start a Power Of Sale the notice must go out and a waiting/redemption period must happen. In Ontario, this period is 37 days. 37 days is not a long time before you can lose your house because of missing a payment. After the waiting period, the lender issues a statement of debts owing on the property and a possession of ownership. All this time the bank is creating more and more fees and legal bills. As the process continues the bills get higher and higher.
After possession, the bank is required to have the upkeep done on the property especially since they want to sell the property to recoup losses. Cutting the grass, cleaning out the house, lots of people just abandon the homes and leave them in very poor shape. The bank has to pay for this expense. Snow removal in some areas needs to be done as well. These are all expenses that the lenders must pay for.
Loss of long term interest
When you foreclose and miss payments you can end up losing the house and mortgage. The payment you would have made over the life of the mortgage is a loss of revenue to the lenders. Also in the meantime, while the legal parts of possession are being dealt with the bank will usually try and work with the borrower to reinstate their mortgage because it can cost upwards of $50,000 to foreclose on a property fix and maintain it and sell the property.
You can get longer than a 5-year term
One of the most common mortgages on the market is a fixed term mortgage. This is a mortgage where you agree to pay your principal amount plus a set interest rate for a fixed period. These periods typically can vary from 1-5 years for most lenders. But, there are many options out there that can lock your payments in for longer than a 5-year term.
Now, most of the time when you lock your payment in for a fixed term mortgage your interest rate will increase slightly the longer the term. The reason this happens is that interest rates fluctuate over time. The banks and lenders can’t guarantee that in the future the interest rate won’t increase past what you are paying right now.
Interest rates in the ’80s at one point were up around 18% since then we have had a fairly steady decline and now the interest rates are low and have been low for a long time.
Right now some lenders offer a 10 year fixed rate mortgage where you can lock in your payments for 10 years. The good things about having a 10 year fixed mortgage are.
You won’t have to worry about your monthly payments changing for 10 years.
Your payments will be the same each month as if it was a 2 year fixed mortgage but, you get the benefit of stable payments for longer.
You won’t have to worry if the prime/index rate for the lender increases.
Because you lock your mortgage rate in for 10 years if the prime/index rate increases you won’t be affected. Your payments will still be the same and the interest you pay will be the same. The prime/index rate is the base borrowing rate that banks use for calculating interest on loans.
You will only pay the mortgage fees once for the term.
If you use a 1 year fixed mortgage and have to continually renew your mortgage you will also have to continue to pay any fees that may be associated with the renewal process. With a 10 year mortgage, you will only pay these fees once.
So there are defiantly some positives to having a 10-year mortgage such as consistent payments which will help with making an awesome budget but there are always downsides to a longer-term such as.
You will be locked in for 10 years.
This can be good or it can be a potentially bad thing as well. There are normally hefty fees when you want to end a mortgage agreement early. Therefore, if you are locked in for 10 years you will have a harder time taking advantage of the housing market. If your property value goes up and you want to take advantage and sell your house to make a profit you may not be able to.
You won’t be able to take advantage of lower rates until renewal.
Without paying the fees associated with refinancing your 10 year fixed rate mortgage you will have to stay with the rate that you agreed upon for the 10 years. If mortgage rates drop during that time you won’t be able to take advantage of these lower rates, you will be stuck with your current rate.
If your life or family changes, you will have to face charges to move.
Because you are locked in for 10 years. If during that time you need a new home, you will have to deal with the fees of refinancing to buy a new home. This can make it difficult for a lot of people who may want children, children take up a lot of space and most people want a bigger house once they start having kids. Locking in for a 10 year fixed rate mortgage will make buying a bigger home more difficult.
Your payments will be higher.
Normally, the longer the fixed-rate mortgage term, the higher the interest rate. This is still true with a 10 year fixed mortgage rate as well. Right now a 10 year fixed mortgage rate is hovering around 2.89%-3.04% while a 2 year fixed mortgage rate is 2.49%. The added expense of paying more interest over the 10 years can add up to a lot of extra money being paid.
There are defiantly some advantages in locking into a 10 year fixed rate mortgage and having stable payments, not having to worry about the fluctuations in interest rates and not paying fees multiple times. Make sure to consider all the options that are available and think ahead. What is your family going to look like in 10 years? Will there be kids? Will grandma be living with you? Making a 10-year commitment needs to be an educated decision.
Banks look at where the money goes not just how much.
When a bank starts the pre-approval process for you to get a mortgage they may want to see bank statements and get more information on your financial history. This is especially true for someone self-employed.
There needs to be a consistent source of income and the lenders want to see these revenues. The banks also look into where your money is going and what you are spending your money on not just how much money you have going into your pockets. If you are out at the bars all the time or constantly spending large amounts on eBay the lenders may not like the over expense on unnecessary items.
The lenders are looking for a consistent financial background that shows little risk for their money. Someone who is out at the bars 4 days a week may not fit well into the lenders’ risk assessment. It’s not that you can’t go out and you need to watch every penny just keep in mind that what you spend your money on is going to affect the outcome of the Pre-approval process.
Getting credit between Pre-approval and house purchase may affect mortgage approval
So you have made it through the Pre-approval process for your mortgage congrats! Now what? There’s a great credit card out there I’m sure, right?
Applying and getting any type of credit between the Pre-approval and purchase of a house can greatly affect the amount that you can borrow as well as the Pre-approval you have already gotten.
This is something to keep in mind because sometimes it can take a long time to found that one house that’s just for you in your price range. Then once you finally find the house even though you have been pre-approved you may need to have another check done before the final mortgage agreement. If a lender finds that you have applied and gotten a loan or another credit card, this can change the amount that the lending is willing to give you toward your house. This may mean you can no longer afford the home you wanted.
Lenders only like to give individuals a certain amount of credit. Usually, this amount is around 40% of what they can afford. Even though you have that credit card for $5000 and there isn’t any debt owed on it, the lenders are going to go through the pre-approval process assuming it is maxed out at $5000.
Lenders want to know what your payments will be with all the debt you have maxed this way they can get a better understanding of what you can afford. This is a good thing for you as well because sometimes life happens and you need to use a credit card if it ever happened that your credit card was at $5000 and you have the mortgage you will hopefully be able to afford both.
And there you have it, a break down of the 15 things you didn’t know about mortgages. Hopefully, you made it all the way through. don’t forget to check out part 1 and part 2.
Understanding and learning as much as we can help everyone. Always be learning, never stop!