4 Common Mortgage Questions, 4 Good Answers

Category: First Time Buyer, Real Estate Agent,

We answer common questions on mortgage underwriting, stress tests, tax deductions, and variable, floating, and adjustable interest rates.

We love answering mortgage related questions! In fact, it’s a big reason we get out of bed in the morning. We’ve heard all sorts of questions over the years, but we thought we’d pick a few common ones people are asking right now and address them here today. If you have a question we didn’t include, please don’t hesitate to contact us

What is Mortgage Underwriting? 

A mortgage underwriter is someone in a lending institution assessing the risk of lending money to a particular individual or group. In the case of mortgage underwriting, an underwriter would consider the borrower’s ability to repay the loan based on income, credit history, down payment, the property being purchased or mortgaged, and more. The underwriter has final say on whether a file is approved or passed on (declined).

When a Mortgage Broker uses the term “underwriting,” we mean that we are setting up a file to be submitted to a lender for approval. Brokers tend to hire “underwriters” on their team who can process mortgage applications but are not real underwriters of a lending institution. These processors do a good job of preparing applications for underwriting and the term “preparing the application” can also be thought of as “underwriting” an application. 

So while Brokers use the term underwriting as a catch-all for application processing and application decision-making, the actual term is only for decision making.

What is a Mortgage Stress Test? Why Will My Results Change? 

A mortgage stress test is a formula used to determine how much money can be lent to a particular borrower with minimal risk of default. In Canada all those who are applying for mortgages to purchase or refinance homes are subject to this test. Those looking to switch to a new lender are also required to take the test. 

The stress test factors in such things as your annual income and monthly expenses, but also considers interest rates. The goal is to determine that an increase in interest rates is unlikely to render you unable to meet your monthly payments. 

Potential borrowers are stress tested using the greater of the following two numbers: 

·      5.25%, which is the Bank of Canada’s mortgage qualifying rate (MQR)

·      Your contract rate + 2%

This means that if you are able to secure a loan at a rate below 3.25%, you will use a rate of 5.25% when taking the test. If the rate of your loan climbs above 3.25%, then adding 2% will put you above 5.25%, ultimately reducing the size of loan you will be able to qualify for. While the stress test does lead to disappointment when people fail to qualify for the mortgage needed to purchase a desired home, it does provide a good safeguard, preventing people from overextending themselves.

What’s the Difference Between Variable, Floating, and Adjustable Interest Rates? 

First things first: a floating interest rate is an adjustable interest rate, they’re simply two names for the same thing. A variable interest rate is something else. Let’s explain.

A variable interest rate means that your monthly interest payment will change with the market rate. However your overall monthly payment will remain the same for the length of the term. When interest rates increase, you’ll simply be applying a smaller amount of your monthly payment to principal; this means you’ll be paying off your mortgage more slowly. Of course the opposite holds true when interest rates decrease, allowing you to chip away at your principal more quickly. The benefit of the variable interest rate is in its predictability; you won’t have to guess what you’ll owe each month. What isn’t predictable with a variable rate is your amortization schedule. You may add years to the life of your mortgage. 

An adjustable (or floating) rate means that an interest rate change will result in a fluctuation to your monthly payment. On the plus side, you know exactly how much principal you’ll pay off each month, allowing you to determine your ‘mortgage-free date’ with certainty. On the downside, a sudden rate-hike announcement by the Bank of Canada can leave you with less disposable income and have you scrambling to adjust your monthly budget accordingly. 

If I had to choose, I would almost certainly choose a variable rate over an adjustable rate every time. The main downside of the variable rate is that a borrower may pay their mortgage off more slowly if rates increase. However, all mortgages allow borrowers to increase their payments so that their mortgage can act as an adjustable rate mortgage, providing for keeping amortization the same, or pay off the mortgage even faster. 

Are Mortgage Loans Tax Deductible in Canada? 

Yes, but only if the loan is used for investment purposes. Interest paid on a mortgage for your primary residence is not tax deductible in most cases, but there is a strategy that can have a similar effect. 

The Smith Manoeuvre

In one instance, a borrower may make mortgage payments, and the amount of the principal paid can be immediately re-borrowed and used on an income producing investment. Under this arrangement, the total amount of the mortgage owed doesn’t change, but the portion attributed to the home decreases, as the amount owing to the investment increases. Because investment loans qualify for a certain amount of tax benefit on interest paid, the interest is tax deductible. Of course this plan carries with it the inherent risk that the investment may decrease in value, but it has helped many Canadians increase their net worth. 

Taking out a Home Equity Line of Credit or Additional Mortgage 

The proceeds of money mortgaged from a home that is then used for a non-registered investment is tax deductible. If you refinance your home and increase the mortgage (or add a HELOC) and then invest that money, the interest on the increase is now tax deductible against your investment income and/or employment income, depending on the situation.

Helping people understand, evaluate, and secure mortgages is what we do. For most people, a home is someone’s largest investment, so it’s only natural to seek information when making mortgage decisions. No question is too big or too small, so contact Pinsky Mortgages today.  

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