How exactly does a Mortgage work?

[hedgehog12]

I have a very elementary (and possibly dumb) question ,that I'm afraid to go into a bank and ask because I may be laughed out of one.

I've been hearing alot of property buying lately, can someone explain to me how exactly does a "mortgage" work?

For example, say I buy a house of $300,000, and take out a $200,000 mortgage. I understand the $200,000 is a "loan" and has to be paid back to the bank in installments. I have a few additional questions:

1) How does the bank pay the seller? Or does the bank give me the money directly (ie. the $200,000, maybe in a cheque?) and I pay the seller directly?

2) Isn't this complex to arrange?

3) Where does the Real Estate Agent come in in all this? Does he act as a representative, and give the money to the seller for me? Does he have anything to do with the mortgage?

Thanks alot!

[the-royal-mail]

Each side needs a lawyer and a RE and they coordinate all this amongst themselves and between the banks of course. It all happens on closing day. If the house sells for $200K, then the seller's bank ultimately receives payment for $200K. You then owe your lender $200K and they calculate the payments based on the terms you negotiated with them beforehand. Ask all the questions upfront and don't be afraid to shop around for the best rates the same way you would for anything else. I don't think your RE agent gets too involved in the mortgage side of things. That's something you should work out beforehand. You never personally end up with the money in your hands, unless of course you are the seller, in which case the money ultimately ends up in your bank account, after whatever you still owe has been paid back to the appropriate lenders etc. So if you still owed $75K then your lender would receive discharge of $75K and the remaining $125K ends up in your bank account. You can then use this money in the new house you buy.

Now my question for you, is can you afford it? Some of the stories I've been reading about are quite scary. People who have 10s of 1000s in debt, no rainy day money, no down payment etc. We generally in CMF recommend you aim for 20% down payment to save yourself 1000s in CMHC fees. You should also save additional cash for moving and setup, legal expenses etc in the new place. If you cannot or will not save these things BEFORE talking to any RE agents to buy, you should not buy a house. RE agents are there to sell and are usually very good at what they do. Their fees are around 4% of the selling price, half goes to each side.

Remember that RE prices in cities are super inflated right now. Be careful about what you hear, as the govt has been pumping RE through low interest rates and even certain posters in this forum. Don't allow these groups to influence your decisions. There is no rush.

[MarcFromOttawa]

I have a very elementary (and possibly dumb) question ,that I'm afraid to go into a bank and ask because I may be laughed out of one.

I've been hearing alot of property buying lately, can someone explain to me how exactly does a "mortgage" work?

For example, say I buy a house of $300,000, and take out a $200,000 mortgage. I understand the $200,000 is a "loan" and has to be paid back to the bank in installments. I have a few additional questions:

1) How does the bank pay the seller? Or does the bank give me the money directly (ie. the $200,000, maybe in a cheque?) and I pay the seller directly?

2) Isn't this complex to arrange?

3) Where does the Real Estate Agent come in in all this? Does he act as a representative, and give the money to the seller for me? Does he have anything to do with the mortgage?

Thanks alot!

#1 and #2
Your Real Estate lawyer will take care of transfering funds from the bank to the seller.

#3
A good Real Estate agent will provide you with qualified buyers, list your place on MLS, and perhaps help stage your place. They are not necessary in the transaction.

[SheaButters]

A mortgage broker, will answer a lot of your questions. You don't directly pay him anything
His job is to look around to find you the best posted rate, the lender(bank) pays him for bringing them a new client.
If you have history at a bank (had a positive account with one of the major banks) sometimes they are willing to give you a "better than posted" rate
Asking for a "pre-approval" takes a very very small hit on your credit score... anytime you ask for money, it's a hit
So although pre-approval is extremely recommended when making an offer, it can be done within a 48 hour block(or shorter).. you however wouldn't want to be rushing last minute to make an offer on your dream home

banks are so silly, they will pre-approve you for 4-5 times of your yearly wage (gaurenteed hours) so if you say "i make 40 dollars but only get 20 hours a week 40$x20(hours)x52(weeks) = 41,600 (even if you usually work more than 20 hours, thats what they do)

so they'll say, you're pre approved for 180,000 you can in turn add you downpayment lets say 70,000, and you could purchase a 250k house
but, be careful buying more than you chew, 3 times your yearly wage is more recommended so spending say 130k adding 70k, you could AFFORD a 200k house


You should look at Home Buyers RRSPs too, you can put 25k of RRSPs as your downpayment (you just ask your RRSPs lender, to take out the money for "home buyers" they send you the cheque, goes tax free on your income tax that year, and (ASSUMING YOU MAKE 30-70k) You can either pay 500 in tax, or put 1600 back into your RRSP account per year, for 15 years
RRSPs will give you a 30% return at income tax time, if you get matched by your company, then its a no-brainer!!!
so your 25k down payment, using RRSPs (between 30-70k) can turn into a 33k down payment, and you just have to pay that 7k back, either by 500 a year, or hide your income with 1600 RRSPs... its basically like a tax free 7k loan for 15 years, imo, very good!! that 7k down, will save you tons of interest on the purchase of the house!
[if you make over 70k it will really pay off!!!!!!!]

20% needed :-) best rates(which stick with you for a long time) and save 4k for CMHC fee

expect to pay an additional 4k for closing costs... (800$ lawyer fee, land certificate 400$, transfer tax, etc...)
your RE agent, will likely have a mortgage broker he recommends, a lawyer he recommends, etc... he knows exactly what is needed to get you into a house, thats how he makes the money! if he is a young honest guy, he will be willing to help you with all that stuff. if you find a vetern RE agent, he has so many clients, he doesn't want to waste his time earning a reputation with someone who is un-sure if they should buy right now... the vetern cares about money and won't see you as dollar signs, like a young guy who is fighting for business! and the young guy knows, if he does a good job now, the next time you want to buy, or have a friend interested, he knows he will get the phone call, get the busniess!!!! get the money!!!!!!!!!

[Just a Guy]

A real estate agent works on finding or selling of the house, he's the "sales guy". After you find a house, you and the Realtor write up the "offer to purchase", basically the contract setting out the terms of sale. If the offer is accepted, you pay the Realtor a deposit. This usually is used to cover all or part of the commission that the realtor gets for selling the house, but it counts as part of your purchase price, so if you buy a $100,000 house, put down a deposit of $10,000, you need to arrange another $90,000 before the sale closes... If you had any conditions on the terms of sale, like a house inspection, you work with the realtor to clear these from the offer. Once you are happy that all your terms are met, we move on to the next step and the realtor disappears for a while.

This is where we move on to banker and lawyers. Say you wanted to put down 20% and finance the remaining. You talk to your bank or mortgage broker about getting a mortgage for $80,000 (shop around and understand your options). Things you usually get a choice about are the interest rates, amortization period (how long the loan is for, generally go for shortest), payment frequency, lump sum payment amounts/frequency, and type (fixed, variable, open, closed, etc.). You'll also be offered mortgage insurance, generally a bad investment, go buy term life to cover the amount it is usually cheaper and the amount remains the same as opposed to declines (if you buy $80,000 mortgage insurance, you pay the same premiums for coverage even on your last few months where you may only cover a couple hundred dollars, if you buy $80,000 term, you get $80,000).

While you are talking to the banks about the money, your lawyer is clearing up the title, calculating the property tax adjustments (property taxes are paid 6 months from last year and six months prepaid for the next, so depending on what month you buy in you may have to pay the seller back for property taxes or you get a credit for property taxes), as well as a bunch of other things. He gets you to arrange for the bank to transfer the $90,000 into his trust account (so you give him a cheque for $10,000 and give permission for the bank to transfer the loan to your lawyer).

The bank will then want you to sign your mortgage documents, and the loan will be higher than $80,000 as they put in their legal and other fees, unless you've negotiated that they won't charge you for them. If you has a lower downpayment your CMHC fees would also be added to the mortgage. You could have your lawyer review the papers, but it would cost you his time and it basically boils down to the golden rule, and the bank has the gold. Be sure that there are no errors in what you agreed to, the forms are very standard with the major banks. One thing that may confuse you is the interest rate will look different than what you agreed to. This, usually, is because of the way interest is calculated but, in some convoluted way, it's is what they told you...legally speaking.

Near the closing day you'll meet with the lawyer too sign the transfer papers, and be presented with your legal bill, usually a couple thousand dollars to cover his time and all the "filing" fees. The lawyer will arrange for the money to be transferred to the appropriate people, as well as all the paperwork. You should get your copies of everything in the mail a few weeks later.

On the closing day, if everything goes well, you'll meet with your realtor and he will give you the keys and usually a small gift. Congratulations you are now the proud owner of a mortgage.

I may have missed a few things, and it may sound complicated, but it really is just a process, most of which you have very little control of.

I also left out all the fun stuff like the bank asking for all your financial information, losing the paperwork, land titles being backed up, having to ask for an extension on the closing date, carrying costs, etc...

Basically, whatever happens, don't worry too much, it will work out in the end. I swear making people panic is the only fun these bankers and lawyers have in life.

[hedgehog12]

Thanks! I'm still trying to digest all the information.

I have a a few more additional questions:

banks are so silly, they will pre-approve you for 4-5 times of your yearly wage (gaurenteed hours) so if you say "i make 40 dollars but only get 20 hours a week 40$x20(hours)x52(weeks) = 41,600 (even if you usually work more than 20 hours, thats what they do)

only 4-5 times what I make?? does this mean I'll never be able to get a $200,000 or higher mortgage?? I only make $30,000 per year...


2) So a 300,000 house is not really 300,000 ... wiht everything it's more like $350,000?


3) I hear if I take out my RRSPs (ie. for a down payment), I will get penalized on my RRSPs?? ... I also vaguely remember someone telling me that first-time home buyers are NOT penalized? (regardless of whether the house is old or new) ... does anyone know more about this?

[SheaButters]

Thanks! I'm still trying to digest all the information.

I have a a few more additional questions:




only 4-5 times what I make?? does this mean I'll never be able to get a $200,000 or higher mortgage?? I only make $30,000 per year...


2) So a 300,000 house is not really 300,000 ... wiht everything it's more like $350,000?


3) I hear if I take out my RRSPs (ie. for a down payment), I will get penalized on my RRSPs?? ... I also vaguely remember someone telling me that first-time home buyers are NOT penalized? (regardless of whether the house is old or new) ... does anyone know more about this?

1) my numbers aren't exact, but with a 30k a year income they will likely pre approve you for somewhere close to 150k DEPENDING ON YOUR CREDIT RATING (assuming its very good and you have no debt)... that's something that you'd have to go to the bank and check... ASKING FOR A LOAN takes a small hit on your credit rating Don't do it OFTEN!
if you had a 50k down payment, and 150k mortgage approval, you could buy a 200k house
you don't want to be extremely house poor, don't forget cable/power/taxes/insurance... once you have a house, everything starts adding up quick

2) 300k house
(lets assume 2 bidders, it sells for 308k)
+ lets say 6k for closing costs (lawyer fee, land transfer, etc..)
You're probably looking at 314k
Don't forget, you'll need furniture, lawn mower, vaccum, etc...
(less than 20% down = an additional CMF insurance of around 5k)

3) Home Buyers
http://www.cra-arc.gc.ca/tx/ndvdls/t.../menu-eng.html
says you can take up to 25k out of RRSPs, to use as a downpayment (or renos)
as long as you put it back the next 15 years (so say 1666 back per year) or you'll add that 1600 as income, and pay 500 dollars taxes
either way, better to use money now IMO :-) especially if it helps you get to 20% downpayment to avoid CMF fees of 5k
and especially, if your employer matches RRSPS :-)

*note the RRSPs have to be in there for at least 90 days
you can take it out whenever in the tax year you are going to purchase the house, and within 30 days after the purchase


**edit** no penalty with home buyers
and I wouldn't recommend going to your extreme limit of pre-approval

Gail Vaz-Oxlade (till debt do us part TV SHOW) says, should be 33% of your wage

[hedgehog12]

Thanks! I just wanna ask,

Everything in Vancouver, BC costs over $400,000 ... given my current salary and down payment of $50,000, does this mean I can never buy something in that range ?? (since I'll only be approved for a $150,000 mortgage, so 50,000+150,000 = $200,000 total)

how do people do it then ?? I've heard neighbours buying a $700,000 house and they make the same that I do and I don't think they put down more than $50,000 down payment. does this mean the bank approved them for a $500,000 mortgage??

[Just a Guy]

Things you need to understand...

Banks are in business to make money, not for you, but for themselves.

For every dollar in savings you put into the bank, they are allowed to lend out multiples of it (usually between 10-20x, it varies), so they are leveraged. Most of their "losses" are "paper losses".

If you are approved for CMHC, and default, CMHC pays the loss. No risk to the bank.

Mortgages, even at these low rates are CASH COWS for the bank. Most of your payment is interest, after a few years, they can't lose, unless there is a radical downturn.

If you default, the banks gets your house, sells your house, and probably gets another mortgage on your house, plus can probably claim a number of "paper losses" that let them keep tax dollars.

There is nothing, in their best interest, that isn't in their best favour to try their hardest to get you that loan, and we have a fairly conservative banking institution compared to places like the US.

Now, these are vast generalizations, but you must understand, they don't care about your financial well being...that's just a sales pitch. They want you to live your dreams because it's profitable to them. Most of the "advice" I've gotten over the years from the bank's "financial planners" may have made me money, but no where near as much as it would make for the bank, nor anywhere close to the amount I was able to make by learning about money.

[hedgehog12]

So if I have decent credit, I can usually get more than what is "pre-approved" on the bank's website??

I did a pre-approval using the bank website calculator and got a very low sum of around $190,000 ... all the property near here is around $400,000