What is bridge financing and how does it work?
There may come a time when you want to sell your current house and buy a new one, however you are having trouble getting the closing dates to align. Or, for convenience, you would like to move into your new house first before having to move out of your current house. This may make the move easier and allow you to complete any renovations, if needed, before moving all your belongings in.
The challenge with closing on your new house first is that you may need the funds from your existing house for the down payment on the new house. If your current house sells after the closing date of the new house then you need a way to access the equity from your current house early to use for the down payment.
This is where bridge financing can assist. Bridge financing allows you to use some of the equity in your current property towards the down payment on the new property.
It’s important to note that bridge financing requires you to have a firm agreement on your purchase and your sale. A firm agreement is where are conditions have been waived on the house you are buying and for the house you are selling.
If your current house has not sold yet then bridge financing is not possible. In that case other options would need to be explored such as refinancing your current house, to access some of the funds needed for the down payment on the new house, which would then be paid out once your current house sells.
Budgeting your monthly cashflow is important when exploring bridge financing as you will have your current mortgage payment, the new house’s mortgage payment and the bridge loan payment.
A few cautions with bridge financing are:
-Some lenders do not have a bridge financing option so its important to let your mortgage professional know you may require a bridge loan early in the process so they are sure to seek lenders that offer them.
-You may not have enough equity in your house for the bridge loan you desire. In this case you will have to come up with the shortfall of funds yourself on closing.
-Bridge loans are at a higher rate then your mortgage and some lenders will charge a set up fee.
-Bridge loans are typically restricted to a maximum of 90 days.
Choosing the right mortgage payment option for you:
When setting up your mortgage, part of the process is choosing your mortgage payment preference.
There are 6 main payment options. Here are some details on each one.
Monthly: This is a popular option perhaps due to the simplicity of it for keeping track/budgeting. Also, many first time buyers are used to paying rent monthly. Your monthly payment is simply your annual mortgage payment total divided by 12. (ie $12,000 annual divided by twelve is $1000)
Bi-weekly: This is another popular option and many enjoy it because it aligns with people’s bi-weekly payroll cycle. There is a common misconception that bi-weekly will help pay the mortgage off faster however the bi weekly accelerated option is what reduces your amortization. Bi weekly is your annual total mortgage payments divided by 26. (ie $12,000 annual divided by 26 is $461.53)
Bi weekly accelerated: This is a good option for those who want to pay their mortgage off faster and are not as cash flow sensitive. It has the convenience of bi-weekly payments to match one’s payroll cycle, if paid bi weekly, however there is a larger payment. (ie $12,000 annual total divided by 24 is $500, but taken 26 times)
Weekly: This helps reduce the size of each payment and is one option for those paid weekly. Or for a couple sharing the payments and each one would pay alternate weeks.
(ie $12,000 total divided by 52 is $230.77)
Weekly accelerated: This helps reduce the amortization of the mortgage. ($12,000 divided by 48 is $250 but taken 52 times)
Semi-monthly: This allows you to have two payments taken on the same days each month, such as the 1st and the 16th. Each payment is one half of your monthly payment amount. This option does not assist in reducing your amortization. (ie $12,000 annual divided by 24 is $500 and taken 24 times)
If you would like to review what payment option is best for you, I invite you to contact me anytime.
Pros and cons of collateral mortgages
In the last few years collateral mortgages have gained quite a bit of negative reputation. This is been heightened by television shows such as CBC’s Marketplace and newspapers such as the Toronto Star discussing the downsides to these products and the lenders offering them.
One major challenge is that lenders who are offering these products are not disclosing the downsides to the consumer.
Collateral mortgages can come with more flexibility with regards to the products that can be secured against a property as well as the type of repayment. These products typically have a maximum borrowing limit and within that limit there can be multiple lending products such as a mortgage, lines of credit, credit cards and so on. When consolidating debt into this type of mortgage one can save on interest over personal debt interest rates. Also, with many of these products you are able to borrow back what you have paid off similar to that of a line of credit or credit card. Note, some banks/lenders register all their mortgages as collateral mortgages even if it is just a standard mortgage like a five year fixed rate mortgage without all the multiple products within it or ability to borrow back what you have paid down.
During your term with the lender, for example during a five year fixed term, if you were to return to the lender to refinance, the collateral charge will allow you to do so with savings on the legal cost towards refinancing.
Collateral mortgage is however have been making negative news due to some of the challenges one can face with this type of mortgage. When a standard conventional mortgage is that renewal one can simply switch their mortgage to another lender with no cost or penalties. This is because the mortgage is transferable. A collateral mortgage however is nontransferable and with that cannot be simply switched to another lender for a more competitive interest-rate at renewal. In this situation to move lenders it would trigger a refinance which would come with appraisal and legal costs for the client. It can cost a client upwards of $1200-$1500 to move lenders at renewal.
Under the new lending guidelines one can only refinance up to 80% of the value of their property as well which could create challenges when wanting to switch lenders and not having enough equity in your property yet. In this case it may not be possible to switch lenders until your mortgage is paid down further.
Furthermore, if you have multiple products within the collateral mortgage such as a credit card or line of credit, they would all have to be closed if switching lenders at renewal.
When the current lender has the upper hand in this situation, they may not be as proactive with low rate offers, or matching other offers at renewal as they know leaving them comes with extra work and costs. The collateral mortgage can be a strong retention device for the lender.
Another challenge with a collateral mortgage is that the lien registered against the property does not decline like a conventional mortgage which at the end of the amortization will be at zero. The lien with the collateral mortgage typically will stay at the amount it was originally registered for for the life of the mortgage.
The negative news with collateral mortgage is is mostly centralized on how banks and lenders are not informing their clients of these downsides when offering the products or informing them that all of their mortgages are collateral mortgages when a client is applying.
As I offered both conventional and collateral mortgages, I can review your specific needs and find the best mortgage solution for you.
What are all these insurances?
When purchasing a property, the different types of insurance that you may be offered, can be a little confusing.
The three main insurances that may come up are mortgage default insurance, life and disability insurance and home insurance. Here is some information on these.
Many refer to mortgage default insurance as CMHC insurance. CMHC stands for the Canadian Mortgage and Housing Corporation and is one of the three main mortgage insurers in Canada. Genworth and Canada Guaranty are the two other main insurers. Different lenders will turn to different insurers depending on the insurer program needed and other factors.
By law, anyone who purchases a home and obtains a mortgage over 80% of the value of the home, must have mortgage default insurance. This insurance protects the lender in case of default. It allows lenders to be able to lend higher loan to value mortgages to clients while reducing the risk of doing so. Lenders can lend up to 95% of the value of the home. Once you achieve 20% down you no longer need this insurance. The cost of this insurance is the client’s responsibility and the premium is 4% of the mortgage amount, when putting 5% down. Therefore on a $300,000 mortgage, the premium would be $12,000. If you have 10% down the premium is 3.10% of the mortgage amount and with 15% down its 2.8% of the mortgage amount. Tax is also charged on this premium. The premium can be added to your mortgage however the tax is paid on closing. The value of this insurance to the consumer is that it allows you to purchase a home without having 20% the purchase price saved. The premiums increased earlier this year.
Life and disability insurance is typically offered by your bank, mortgage professional or lawyer. It assists with coverage in the event of death or disability. Some disability coverage will cover the mortgage payment as well as the property taxes. This coverage is optional but important.
Home insurance is there to protect your home. Many lenders require that you have fire insurance as a minimum and will have the lawyer verify this is in place before advancing the mortgage. For this insurance you can look to your bank or other insurance companies.
What is an Interest Rate Differential (IRD) and how is it calculated?
A mortgage is a contract between you and the lender. The contract has terms, conditions, obligations, rights and so on.
When you take a mortgage you are agreeing to follow the terms of the mortgage until the maturity date, or the expiry date, of the contract. Sometimes the unexpected can happen and one needs to break their mortgage contract prior to the expiry date.
Many lenders will allow you to break the contact if you pay a penalty. For a fixed rate mortgage, this penalty is often the higher of three months of interest or an Interest Rate Differential (IRD).
When calculating the IRD, the calculation can be more lender focused, a larger penalty, or more client focused, a lesser penalty.
Let’s look at a few ways that IRD is calculated.
Posted rate calculation: This is a more lender focused calculation and is generally used with banks and some credit unions. Think, big banks – big penalties.
This calculation typically uses the Bank of Canada posted rate.
Here is an example:
Two years ago you got a five year fixed rate mortgage. The Bank of Canada 5 year posted rate at this time was 4.49%.
You now need to break you mortgage and there are three years left.
The current posted rate for a three year term is 3.64%.
If you subtract the current three year posted rate from the original five year posted rate you get 0.85%
With three years left in the term, you would times 0.85% by three giving you 2.55%. Therefore the penalty is 2.55% of your mortgage balance.
On a $350,000 mortgage, this would be a penalty of $8925. This is a very large penalty.
Published rate calculation: This is a more client focused penalty calculation and uses published rates. This is generally used by monoline lenders and most credit unions. See my video called Banks and credit unions versus monoline lenders to learn more about these lenders. For this penalty think, smaller lender – smaller penalty.
Here is an example:
Your rate is 2.79% and the current published rate is 2.69%. You have three years left in your contract.
For this you subtract the published rate from your rate which in this case gives you 0.1% and times that by the three years left giving you 0.3%.
On a $350,000 mortgage this would be a penalty of $1050. Now if the IRD penalty is lower then 3 month of interest, some lenders may charge the higher of the two.
As you can see the penalty with a published rate calculation is much more favourable then the calculation with a posted rate calculation.
You can be a first time buyer more then once:
As many of you know there are some great perks to being a first time buyer with the Home Buyer’s Plan (HBP), for example, borrowing up to $25,000 from your RSP without penalty.
Many however you may not know that you can be considered a first time buyer multiple times.
To be considered a first time buyer again under the Home Buyers’ Plan you (in addition to the standard requirements):
-at any period during the timeline beginning January 1 of the fourth year before the year of the withdrawal and ending 31 days before the date of the withdrawal, you or your common law spouse must not have owned a home that you occupied alone or together while you were spouses or common-law partners
With that, if an acceptable amount of time has pasted since you have owned a home, you may be eligible to use the HBP again.
You must also have repaid any balance outstanding from your last Home Buyers’ Plan withdrawal, if applicable.
This plan can also be used for purchasing a home for a relative with a disability. Otherwise, the home must be an owner occupied home no later then one year after the purchase.
You have up to fifteen years to pay back the entire amount of the RSP funds used for the Home Buyers’ Plan and the full amount can be paid back at anytime.