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Financing a Home Purchase

Purchases of houses are typically paid over time through financing from a mortgage with a bank or other lending institution or through financing by the seller based on an agreement for sale. It is important to understand the obligations you take on when you finance the purchase of a house and also the possible consequences if you do not live up to the terms of the financing.

When reading a mortgage document, the person borrowing the money is the mortgagor (borrower), and the lending institution is the mortgagee (lender).

Mortgages

The most common way to finance a house purchase is through a mortgage. A mortgage is a loan of money usually from a lending institution such as a mortgage company, trust company, bank or credit union. To make sure that the lending institution will get back the money it lends, it registers the mortgage on the title of the property. This does not mean that the bank owns the house. A mortgage, when registered, serves as notice to all persons who deal with the property that the lender has a claim against the property because money is owing under the mortgage. The property acts as a kind of collateral or guarantee, helping ensure that the lender will get back the money loaned.

Robin needs a $150,000 mortgage to purchase a house. Robin chooses to amortize the mortgage over fifteen years. Interest rates have been dropping so Robin negotiates an initial term of one year. Robin does not expect to be able to make any additional payments during this one year term, so decides to take a closed mortgage. Robin knows that each time the term of the mortgage is renegotiated there will be the option of choosing an open or closed or modified-closed mortgage at current interest rates.

Term of a Mortgage

The term of a mortgage is the length of time a mortgage runs before it is due and must be renewed. Interest rates vary depending on the term the borrower chooses. The term of a mortgage can be open or closed. An open mortgage allows you to make additional mortgage payments or to pay out the balance of the mortgage without penalty. In a closed mortgage, only the payments specified in the mortgage agreement can be made. A closed mortgage may be modified to permit early payout or additional payments with an interest penalty.

Amortization Period

Mortgages will also have an amortization period. This is the total length of time it would take to pay back all the money borrowed plus interest, and in most cases it will be a much longer time than the term. If you require mortgage insurance, the amortization period cannot be more than 25 years. The interest rate and the amortization period together determine the amount of the monthly payments.

Mortgage Default Insurance

Any mortgage where the borrower's down payment is less than 20% will need to be insured by the Canada Mortgage and Housing Corporation (CMHC), or a private insurer such as Genworth Financial Canada or Canada Guaranty. Lenders require this insurance because mortgages with less than 20% down are considered high-risk or high-ratio and the insurance will pay the lender if the borrower stops paying. The minimum down payment, even with mortgage insurance, is 5% for property valued at $500,000 or less and 10% for any remainder over that amount. The maximum purchase price must be below $1,000,000.

Some restrictions apply to qualifying for mortgage insurance. The mortgage must not result in the household having a debt to income ratio higher than the maximum set by the government. Before approving the mortgage the lender will arrange to have an appraisal of the property done. The borrower has to pay the appraisal fee, even if the mortgage is not approved. Sometimes lenders charge a non-refundable fee to process an application for a mortgage with insurance.

The borrower pays a fee for mortgage insurance. Generally, the fee is a percentage of the loan amount. The percentage varies depending on the size of the down payment and other risk factors. The fee is usually added to the mortgage payments based on the amortization period.

Assuming an Existing Mortgage

It is sometimes possible for buyers to assume an existing mortgage, depending on the seller's mortgage contract with the lender. When a mortgage is assumed, the buyer agrees to take over the seller's obligation to repay the lender. Often a buyer assumes an existing mortgage because its terms, for example the interest rate, are better than those the buyer could negotiate for a new mortgage.

Second Mortgages

A second or third mortgage is basically the same as a first mortgage. The amount of money available to the borrower for a second mortgage depends on the amount of equity in the property. The equity is the difference between the value of the property and the amount still owing on the first mortgage. Lenders charge a higher rate of interest on second and third mortgages. Second mortgages are often obtained to finance major renovations to the property or to raise money for a down payment on another piece of property. A second mortgage gives the lender a claim to any money left over from a sale after the first mortgage has been paid.

Rights and Responsibilities of Lenders and Borrowers under Mortgages

Taking on a mortgage is often the biggest loan a person will ever have and it is important to know what can happen when the terms of the mortgage are not being met.

Default Under a Mortgage

The lender has a right to get back all money lent, together with interest. As discussed earlier, this is why a mortgage is registered against the title to the property. The registered interest in the property gives the lender certain rights if the borrower defaults. A borrower defaults on the mortgage if they break certain terms in the loan agreement. Examples are when payments are not made or are late, the property is uninsured, or the taxes are not paid.

Foreclosure

If a borrower defaults on the mortgage, the lender has a right to foreclose. Foreclosure is an action taken by a lender to collect all the money owed on the mortgage or, alternatively, to obtain title to the mortgaged property.

It may seem strange that the lender can get all the money owing simply because the borrower missed one payment. However, all mortgage documents contain an acceleration clause. This clause means that if the borrower defaults, the full amount owing to the lender is accelerated, that is, it all becomes due immediately.

Foreclosure must be done through the courts. It can take several months to complete. A foreclosure is completed when the court issues a final order for foreclosure. A final order for foreclosure allows the lender to become the registered owner of the property. The lender can then sell the property and keep the proceeds.

Special rules apply to a foreclosure of farm land. Persons facing any type of foreclosure should seek legal advice.

Redeeming the Mortgage

After defaulting, borrowers can have the opportunity to pay the lender all arrears of principal, interest and taxes, plus any costs to the lender as a result of late or missed payments. This must be done before there is a final order for foreclosure. If the borrowers take advantage of this opportunity, it stops any foreclosure proceedings and puts the borrower in the same position as if no default had occurred. This is called redeeming the mortgage, or redemption.

Judicial Sale

When a lender sells a home after foreclosure, it can keep any proceeds from a foreclosure sale that exceed what is required to pay off the debt and cover costs. This surplus represents the borrower's equity in the property. Borrowers who do not wish to lose the equity in their property may object to the foreclosure and request the court to grant an order for judicial sale.

An objection and request for judicial sale must be made before a final order for foreclosure has been granted. A judicial sale is a court-ordered sale of the property. These sales are sometimes called sheriff's sales because they are often conducted by the sheriff. The proceeds from a judicial sale will be applied to pay off the debt, property taxes, legal costs, and the costs of the sale. Any money left over is paid to the borrower.

Discharging the Mortgage

When the mortgage has been paid in full, the borrower has the right to have the mortgage discharged. Discharge of the mortgage means that the registration of the mortgage is removed from the Certificate of Title. The lender has no further claim against the property. When the mortgage has been fully paid off, the homeowner may want to consult a lawyer to make sure that all matters about the discharge of the mortgage are completed.

Vendor Financing – Agreements for Sale

A vendor financing arrangement requires careful drafting of the agreement for sale and other documents to ensure that the legal interests of both parties are adequately protected.

Sometimes it is possible to buy property and have the seller (vendor) finance the purchase. To do this, the parties will usually have a lawyer draw up an agreement for sale in which the seller keeps title to the property until the buyer has paid the seller the full purchase price. The agreement outlines terms such as the purchase price, possession of the property, down payment, interest, and payments. Once signed, the buyer can register the agreement as an interest against the property.

Breach of Agreement for Sale

If the buyer breaches any term of the agreement for sale, for example, by failing to make a payment, the seller can cancel the agreement for sale. However, the cancellation of an agreement must be done through the courts and it can take several months before the matter can be resolved. The court can refuse to order cancellation where it appears that the buyer will likely be able to pay the full purchase price. If the court orders cancellation of the agreement, the buyer could lose the money already paid to the seller. Once an agreement is cancelled, the buyer has no claim to the property.

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