Perspectives: What you need to know when buying a home

Stephen Meurice: Getting into the housing market these days can be daunting to say the least. There’s rising prices, limited supply. And oh yeah, the highest interest rates we’ve seen in a couple decades. But even putting all that aside, the world of real estate and mortgages can be full of intimidating jargon. Especially for first-time buyers. Amortization, stress tests, default insurance, mortgage protection insurance, fixed-rate, variable-rate, trigger rate, the four Cs. It can be a lot. And buying a home is certainly something you don’t want to do unprepared.

Tracy Gomes: It's the largest financial purchase you're probably going to make in your life. Don't do it on your own. Get some input, research, advice.

SM: That's our guest today, Tracy Gomes. She’s the Senior Vice President of Real Estate Secured Lending at Scotiabank. She’s here to answer all the questions you may have had about mortgages and real estate but were too afraid to ask. Not only will she define all those terms I rifled off earlier, but she’ll also cover things like how to pick between a fixed and variable interest rate mortgage, tips on how to pay off your home faster, how to begin to save for a down payment and how much that down payment might need to be - and much more.  Get ready for real estate 101.

I’m Stephen Meurice and this is Perspectives.

Tracy, thanks so much for joining us. Really appreciate you coming in.

TG: Thank you, Stephen.

SM: So today we have you here for a beginner’s guide to real estate, but before we start, you’ve been in this role for about six months or so as I understand it. It’s been a pretty tumultuous time in the real estate market. What's the big question or the big concern that you hear from people who are looking to buy a home, looking to get into the market?

TG: Yeah, it has been a tumultuous time. I would say there are two things that I hear a lot that are on consumer minds. One is housing affordability, access to housing, especially in big urban centres. House price appreciation has made it almost unattainable for certain first-time homebuyers to get into the market. The second one is interest rates. Interest rates were skyrocketing last year. They've been very high, but hopefully the outlook of interest rates coming down anywhere from, you know, 1 to 2% over the next several years will provide some relief. But those are the top two things.

SM: So, we'll get into a lot of those details, particularly around things like variable rate mortgages and the impact that has had on people over the course of the last couple of years as interest rates have been going up. But let’s get into our topic today, which is a sort of real estate or home buying 101 lesson. What is the first thing someone should be thinking about if they’re looking to get into the real estate market, if they’re looking to buy a house for the first time?

TG: Yeah, the number one thing is how much can you afford? That's what customers want to know, especially before you call up a real estate agent and you're going to go out shopping for a home. You need to be comfortable with what you can afford to carry as a mortgage. That also includes how much do you have saved for a down payment? So, you know, you're buying $1,000,000 home and let's say you want to put 20% down payment, then you're looking at an $800,000 mortgage. I would say do some homework upfront. Any lender will offer, like you can go to a Scotiabank branch advisor or one of our home financing specialists to do a pre-approval. We also have a pre-approval actually digitally on eHOME, which is our digital platform, where a customer can get a pre-approval within five or ten minutes and get actually a confirmation letter that they can use before they start with a real estate agent. So, they have a bit of confirmation that they would be approved should they proceed. But really, it's about can they afford to make that mortgage payment and all other costs associated with buying a home before they go ahead and start to look for a home.

SM: So basically, doing the research. So, you want to look at your own market, what the average house price is, as you say, like in Toronto, it's a million bucks, a little bit more than that, maybe. It’ll vary a bit across the country. How much money you have for a down payment and then I guess figure out — so you've got that $800,000 mortgage, what does that look like from a payment perspective?

TG: Yeah and would you qualify? Just based on your other debt obligations that you may have at the time.

SM: Right. So, can you talk about the qualifying part? What do you need to do? What do you need to have, I guess, in terms of assets or income to qualify for a mortgage?

TG: Every lender's looking for your capacity or ability to pay. Your credit history. The value of the home, the collateral. And your capital, or how much savings you have. We actually call that the four Cs.

SM: Okay, So the four Cs are capital, capacity, collateral and credit.

TG: Yeah, those are the four Cs of credit that a lender is always looking at when they're processing an application. But really, like, the lender will be asking you for, you know, what income do you have? What sources of income do you have? What are your debt obligations? So, do you have credit card bills on a monthly basis? Do you have a loan? Maybe you have a car loan already or some student loans. Do you have any other debt obligations on a monthly basis that would offset your ability to have enough to pay that mortgage payment? What savings have you accumulated that you can use for your down payment? So would be asking a little bit about your assets that you have, whether you own a car or whether you have investments saved up. Maybe you already have a home. And then your credit history. And those will be all factors that get considered in whether you qualify for a mortgage.

SM: Okay. And again, on that sort of example that we're talking about of the million-dollar home, $800,000 mortgage. $200,000 down payment, is that standard what you'd be looking at? Can you buy a home with less than a 20% down payment?

TG: In Canada, you do require to put a minimum of 5% down payment. But if you don't have the up to 20% down payment, then we call that a high ratio mortgage. New first-time buyers or someone who has less than 20% down payment can buy a home and get a mortgage, but they have to purchase something called default insurance. And that's a high ratio mortgage. But there is a minimum of 5% in Canada that's mandatory.

SM: Does that have an impact on the interest rate? Like how big the loan is on the home?

TG: Yeah, no, the interest rate isn't determined by the amount of the down payment, but there is an insurance premium that gets calculated. It's anywhere from 2.8% to 4%, depending on how much of a down payment you put. And that insurance premium gets calculated on the mortgage amount that you want. And gets added to your mortgage.

SM: Okay. So, there's an additional amount on top of your mortgage payment. There's this insurance component on there as well.

TG: Right. One thing I'll add there is that it's not something that the client has to go and separately apply for. When they're applying for their mortgage, and you determine that you don't have sufficient down payment and you are going to be in a high ratio mortgage, the lender will apply for that insurance as part of the mortgage application on the client's behalf.

SM: Right.

TG: I'll add one other type of insurance, though, that is worth talking about is mortgage protection insurance. So, mortgage protection insurance actually is an insurance that you can purchase for a premium and you can purchase it at any time. You can add it at any time, your mortgage doesn't have to be when you're for setting up your mortgage, it can be at any time. That protects you from financial hardship. So, there's actually four types. Life, critical illness, disability or job loss. And they're kind of pretty self-explanatory, but they protect you in the situation that you might find yourself: some illness, you're not working. How do you make your mortgage payment? Right? If you have purchased this insurance, then the insurance covers your mortgage payments during the time at which you can't pay or in the awful event of passing away, then it covers your full balance. And so, these are things that you should talk to your advisor about to add as a really great component to protect yourself on this very big purchase.

SM: So that would be to protect yourself in the event probably, well, except in the case of death, from like a shorter-term event in your life that might prevent you from being able to make mortgage payments? Versus default insurance, which is really you can't afford this house anymore.

TG: Right. So, default insurance is mandatory if you don't have the 20% down payment. But default insurance is protecting the lender. So should you not pay, the insurer is going to pay the lender for the amount that you couldn't pay. And so that's default insurance. It doesn't really protect the client, but it's mandatory if the client doesn't have the down payment. The difference with mortgage protection insurance is that it's insurance for the client.

SM: Right. And what those really big down payments that people are being required to make now because the value of homes has become so high. You know, you hear a lot about the bank of mom and dad or whatever. Do you see that a lot? People are essentially getting gifted or loaned money by family in order to make the down payment.

TG: Yeah, I mean, in this environment, like, I'm totally saving up some money for my kids. [laughs] I think that's a reality these days with how high of a down payment you're required to make at an early age. You probably haven't had time in a working life to have accumulated that. So, we see lots of people getting gifts from parents. They have to, in fact, be gifts and not be loans. But yeah, that is a part of the equation in today's reality, with interest rates being high and house prices being the way they are.

SM: Is it possible to buy a home without a down payment at all?

TG: No, you absolutely need…

SM: Oh, you said it was 5%.

TG: Yeah, right. Minimum of 5%. Now, I would say for first-time homebuyers, there are some options and that should be part of the research plan before you decide to buy a home is what's available to first-time homebuyers from a government perspective. Because there is a home buyers plan which allows a first-time homebuyer to take a portion of their RRSP that they've been saving to use towards the down payment. And as well, the government introduced the First Home Savings Account [FHSA], which most of the lenders launched last year in 2023, and that also allows consumers to save money tax free that they could then use for a first-time purchase. So, some things that help when you're considering, how do you accumulate that down payment.

SM: Okay. We’ve you've heard of something called a stress test when it comes to getting a mortgage, can you explain what that is?

TG: Yes. The stress test is something that OFSI [Office of the Superintendent of Financial Institutions] introduced.

SM: OFSI is?

TG: The regulator for the banking system. And it really is to ensure that when the lenders are qualifying a customer for the mortgage that they can afford at the current interest rates, we're adding a buffer to ensure that if rates go up that they would still be able to handle the increase in payments with rates rising. Now, this took place in 2017 when rates were actually much lower and the stress test is 2% on top of your mortgage rate, which is the qualifying rate or 5.25%. So whichever is higher, that's what determines the amount of mortgage you could qualify for making those payments. And so, when you think about when this was introduced more than five years ago, the rates at the time might have been less than 2% even. We would have added the stress test to make sure that the amount that they're getting, they could afford to pay in today's interest rate environment. Which, you know what, has proved out really well to ensure customers weren't overextended at the time because rates were so low and they could qualify for much more than they would have had rates been high.

SM: Right. So probably people were thinking this was…

TG: Crazy. Exactly

SM: Excessively conservative and so on at the time. But it turned out to be kind of wise.

TG: It turned out to actually protect consumers. Yeah.

SM: Just to go back to that sort of research part of it – when somebody is planning on buying a house, obviously the big thing is the actual cost of the house. But there are other costs associated with buying a house that I guess people should be thinking about.

TG: Yeah. For sure there's lots of additional costs that you should be doing your research on to make sure you're fully aware of and you're not caught off guard at the last minute. There's land transfer taxes and fees that come with the purchase. You've got appraisal costs when you're doing your mortgage, you've got property taxes. That might be something new for you if it's the first time you're buying a home. The utilities associated with running the home.

SM: So, moving costs, legal fees – so that's the stuff associated with the actual purchase of the home. Land transfer taxes in some places. And then the costs that you have to think about as a homeowner that maybe you weren't thinking about before, if your utilities were included in your rent or whatever you have to think about all that stuff.

TG: Yeah. Or you need to buy new furniture or window coverings that you didn't anticipate, that always adds additional costs. Or we were talking about default insurance, right? If you don't have the full down payment, you got to factor in that that will be an additional cost.

SM: So, and as a lender, are you kind of calculating all that, at least like the ongoing cost that the person can afford, not just their mortgage payment, but they're not going underwater because suddenly, you know, they have all those other things that they have to pay on an ongoing basis.

TG: Whoever is doing your mortgage, so your advisor, should help you to have line of sight into all the different costs and help you figure out what those costs are ahead of going into the application.

SM: Okay – one other thing that there would be costs associated with, is that I guess most people buying a home or selling a home they would use a real estate agent. Can you explain that process a little bit? And how do real estate agents get paid? Who’s paying them?

TG: Yeah, real estate agents will get paid a commission of the sale price of the home. It generally tends to be 5 to 6% of the value of the home as a commission and split between the buying and the selling agent. The seller of the home is usually the one that pays the commission. And then it gets split up.

SM: But that's coming out of the seller's cut.

TG: It is.

SM: The buyer's not paying for that.

TG: Yes.

SM: Right. So, let's say you're not buying your first home. You're selling a home. You have to relocate or you want a bigger or smaller house or whatever. Is there like an order in which you should do that? Do you sell the house and then look for a new one or decide where you want to live and then put your house on the market? Maybe it depends on where you live?

TG: Yeah, it depends on honestly, your own personal circumstance. I would say like if you had the luxury and timing to sell your house first, the advantage is you know how much you're getting for the home. So, what can you afford to buy in a new home? Especially if you're upsizing. You have the down payment from the sale proceeds that you can use. But then the downside could be if you don't find the house that you want, you may be stuck having to exit the home that you just sold and finding like a rental or some temporary accommodations, which isn't ideal. If you're buying your home first, you obviously can take your time, find the home you want, the neighbourhood that you want to be in, negotiate the price, do all of that. But you're putting down the down payment and you're hoping that you can sell your home in time to not carry two mortgages, should the timing not work out.

SM: Right.

TG: Generally, in the real estate market, it takes about like four months. The home buying or selling process. It would be dependent on what's happening, the dynamics in the market.

SM: In any given market.

TG: Yeah. How quickly, how quickly are things selling? What's your own level of risk appetite that you have? You know, if you're not going to sleep at night because you're worrying about this, then maybe take the option that gives you minimal stress. But either one can work. They both have their own offsetting pros and cons.

SM: Okay, let's delve into actual mortgages, which is your specialty, clearly you know about all of this stuff.

TG: [laughs]

SM: But mortgages is what you do for a living. So basically, a mortgage is just a loan that you get from a bank or a lender in order to buy the house. They pay the seller. You owe them the money.

TG: Exactly. You've got it. You can do my job.

SM: [laughs] For many people, this is probably, it might be the biggest financial transaction they'll do in their lives. We’re talking about hundreds and hundreds of thousands of dollars. What's the first step when you're looking for a mortgage?

TG: Yeah, I think I'll come back to the very first question you asked me, which is like, make sure you can afford your mortgage. Obviously, once you get to that point and you're pre-approved, you know what you will be granted should you buy a home, I think it's just deciding on how the mortgage is set up for you so that it works. Most people think of monthly payments for mortgage, but you can actually go to a weekly or a biweekly, which is an accelerated payment structure. The way that the calendar works, if you pay bi-weekly, you actually get in one extra mortgage payment in the year so you can pay down that mortgage a little faster. Won't be quite the amortization that you planned. You'll actually get it down faster. So, I always encourage people to look at that because we have clients best interests in mind in terms of making sure that they achieve their financial goals that they want in their life. So, the sooner they can get their mortgage off so they can be retiring earlier or, you know, living the lifestyle that they want. That's where connecting with an advisor or a mortgage specialist to really just understand, ‘When will I be mortgage free? Are there other options for paying down my mortgage quicker should I have the ability to?’ Those are questions you want to be asking upfront rather than just being concerned with getting an adequate amount to get into your house.

SM: Okay. So, this is probably the big one for most people. Interest rates obviously a huge issue. We talked about it a little bit. Bank of Canada has raised rates tremendously over the last couple of years as they try and bring inflation down, which has been another problem. And the interest rate on a huge loan like a mortgage is obviously a very important factor in the decision that you make. Can you explain the different types of mortgages in terms of the interest rates, so fixed, variable — are there others?

TG: Yeah, generally it's the fixed and variable. So on fixed, you select the rate. For a one year, let's say not quoting today's rates, but let's say it's 6%. Then your mortgage is calculated at that amount. And then that mortgage term will come up for renewal. And then you can select a new term at that point. With a variable rate, and this is actually something that Scotiabank has unique in our variable rate program, is that our flex variable rate mortgage, the rate adjusts and the payment adjusts as the Bank of Canada or the lending rate changes. So, you may sign up for a variable rate mortgage for five years and as the rates change – so last year is a great example. Rates went up. So anybody who was in a variable rate mortgage last year would have seen their payments go up by the amount that the rates went up. So obviously a big shock. In most cases when we look at our variable rate customers last year, some cases they went up to 50% payment increase and had to weather that payment shock. But if you look forward on the outlook for the next couple of years, rates are coming down. So variable rates are actually a really good option right now to consider. Taking a variable rate now, hedging the fact that, you know, rates will come down in your payments will go down. On today's rates, let's say it's a $400,000 mortgage, I'm not going to go with the $800,000 on a purchase, but let's say it's a renewal on the $400,000 balance. If rates come down 1%, which we believe they will in the next 18 months, that would be approximately $2,700 savings per year in interest by taking a variable rate today versus locking in for a five-year fixed.

SM: Okay.

TG: So again, it's a question that you should be asking your advisor. They can calculate it out for you and then you can make your choice based on your level of risk tolerance that you feel and how comfortable you feel with, you know, would you like the stability of a fixed payment that's never going to move and that's how you will sleep well at night versus you're comfortable taking that risk and you know, rates will come down and so you'll go into a variable.

SM: I want to maybe get into a couple of definitions because it'll help maybe explain things. So, the term of a mortgage would be like the length of the contract that you're signing with the bank. So, it might be a one-year fixed or a five-year variable. So, it's just it's the amount of time that you're locking in with –

TG: For that rate.

SM: – with that particular lender at that particular rate.

TG: Yes.

SM: The amortization. Why don't you explain that? Because that's a little bit different.

TG: Yeah. And I'll add one thing there on the term. So, when you come up for renewal on the term, so let's say you’re a Scotiabank client, when your mortgage comes up for renewal with Scotia and you are going to renew it and select a new term, you actually don't have to requalify for your mortgage. You're basically just choosing the term that you're comfortable with and the payments. Which is a little different than if you're switching your mortgage to another bank, you're actually like re-qualifying all over as if, you know, some of the things that we talked about. Yeah. So, amortization is different. Amortization is the length of time it will take you to pay down your mortgage in full. Completely. So, most people start with like 25 or a 30-year amortization. And then depending on how quickly you pay your payments, that can be a much shorter amortization over time. And so one of those is instead of paying a monthly payment and paying a bi weekly, you sneak in one extra payment every year and you'll see how it does actually shorten your amortization considerably. And there are other ways that you can also speed up and accelerate.

SM: Right. So, the amortization is based on the terms of the mortgage that you've selected. If then you just make the regular payments according to that, it would take you this long to pay it. To pay off the house.

TG: Yeah. What happens is when you're first getting your mortgage, we calculate based on 25 year or 30 am [amortization] what your payment would be, and that sort of determines how large of a mortgage you can afford.

SM: Right. And you were talking about the difference between Scotiabank and maybe some other lenders. That Scotiabank’s approach to the variable-rate is that payments fluctuate with the interest rate. The alternative to that is if you just keep making the same payments but interest rates are going up, then it’s just going to take you a lot longer to buy the house. It just stretches out the amortization – is that right?

TG: Yeah. So those variable mortgages that are at the other banks, what will happen is the payments stays fixed, so you know, last year rates went up, your payment didn't change. You're feeling comfortable. But what you're not realizing is that you're paying more then of that payment towards interest because the interest rate gets applied, your payment just doesn't adjust. So, what happens is in some cases, the way that rates actually spiked considerably last year, some customers, the entire payment was going to interest. And so, you know, if you're not paying down your principal balance, that definitely doesn't shorten your amortization, in some cases actually extends the amortization. So, you would hear probably, I'm sure you heard some terms in the media like negative amortization. Some banks have trigger rates. So, you know, once you hit that situation where your amortization is actually infinite, it actually forces you to come in and increase the payment. So, it was a new phenomena for the banks last year because we hadn't seen interest rates spike as much as they had. And so that was a lot of, and still is, a lot of the discussion today that the regulators are wanting to ensure that the banks are working with clients to make sure they're not leaving them more vulnerable than we need to. Yeah, but Scotiabank does not have that sort of variable-rate mortgage. Ours is an adjustable-rate mortgage which adjusts.

SM: So, when the interest rate changes and you have one of those adjustable-rate mortgages, your payment comes down. But the proportion of your payment that is going towards interest versus the principal remains the same.

TG: Yes.

SM: Right – okay maybe just very quickly, because I’m sure this is a common question for first-time buyers. Can you just give us a recap of variable vs fixed-rate mortgages?

TG: Yeah. So, one of the most common questions people ask me is should I go with a variable-rate or should I go with the fixed? And what is the difference? So, on a fixed-rate, you know what the rate will be and you select the term. So, if you choose a three-year mortgage term, you know that rate and your payments stay the same. Your interest is fixed for that three-year term until it comes up for renewal. With the variable-rate, it's different. You know, your interest rate today, it's a flex variable-rate for five years. But as the Bank of Canada and the lending rate changes so will the interest rate on your mortgage. And so, your payments will adjust specifically in the Scotiabank mortgage, which we have an adjustable-rate mortgage. That is the big difference with the outlook for rates the way they are over the next couple of years, we expect rates to come down. So, when you're considering a mortgage term, I always tell people to like work the math out and if you're comfortable with not having complete assurance over the next five years and you think rates will come down, you will benefit from lower rate payments as you choose a variable-rate mortgage at Scotia. But that is a personal choice and you don't have to make that choice yourself. Reach out to one of our advisors or mortgage specialists. If you're doing a renewal, it's a branch advisor. They can help walk you through what the payments would look like and what you should be considering before you make that decision.

SM: And what kind of things should people be looking for if they want, as you mentioned, they want to try and pay off their mortgage a little bit more quickly. I assume there's all kinds of different terms within each type of mortgage as to how much you can prepay. Are there penalties for prepaying? Are you allowed a certain amount of prepaying? What questions should people be asking about prepayment?

TG: Most lenders – this is sort of an industry thing – you can generally prepay 15% lump sum per year without any penalties. In some cases, it's 20% or 10%, but generally 15% that you can make additional contributions. Which is a lot when we're talking about an $800,000 mortgage or less. You can go from a monthly to biweekly. That definitely speeds up paying down your mortgage faster. A lot of banks will also have where you can do an annual extra payment and as well, you can match your payments. So, if your payment today is $3,000 a month, you can actually do two payments for the same amount if you're in a position to do so. I wish I could. [laughs]

SM: If you happen to have $3,000 sitting around that you don't know what to do with.

TG: I know. Maybe not as viable today. And I would also say to clients consider as well talking to your accountant. If you have an extra dollar of savings, you should be looking at like, ‘Should I pay to my RRSP? Should I put it down on my mortgage? Where should I put that extra dollar that I've saved? And what's going to be beneficial to me overall considering my entire financial goals and plan?’

SM: Right. So could be paying down credit card debt, which has higher interest.

TG: Yep. Exactly.

SM: Yeah. Any other questions people should be asking that we haven't talked about that they should be asking when they're going to look for a mortgage?

TG: I would say Scotiabank has what we call Mortgage+, it's a new program. Find out if there's any bundle opportunities, the Mortgage+, how it works is, Stephen, you're coming for the first time to Scotiabank. I would love to service all your financial business with us. And so, if you're willing to move your banking to Scotiabank in particular, the Mortgage+ is open a day-to-day bank account where your mortgage payment would come out of and open an additional product, could be a savings account, could be overdraft protection, could be a credit card or one of our Scene payment loyalty programs. You’d get a discount on your mortgage rate. And so that's part of the bundling. We launched it last September. And when we have your full business, guess what? We can advise you better, too. We can actually work with you to look at your financial goals short and long term and give you the best service. So that would be something I would definitely recommend.

SM: Okay. You've been in this business while. Is there something that people should know that maybe they don't about the whole process of buying a house, getting a mortgage that you'd like people to know about?

TG: I think, like you said, it's the largest financial purchase you're probably going to make in your life, buying a home. Having a mortgage, it's a long time to pay it off, so it stays with you for quite many stages while you're going through different life stages. I would say reach out to an advisor. We have 4,000 financial advisors across Canada at a local branch near you. Don't do it on your own. Get some input, research, advice. Our mortgage specialists also can help. So, I would say do that research because your unique situation might warrant something that's customized for you.

SM: Tracy, thank you so much for coming.

TG: Thank you, Stephen. This is wonderful.

SM: I've been speaking with Tracy Gomes, Senior Vice President of Real Estate Secured Lending at Scotiabank.