By definition, real estate professionals are on the front-line of the home-buying process with their clients: They are called upon to explain the process, to find them the right home, and then – alongside the involved lawyers – to help shepherd them through the actual legal home-buying process.
These roles are generally governed by the written contract between the agent and his or her client. However, real estate agents may also be an informal source of information and guidance to their clients on related topics as well.
Advising on Mortgages
As one common example, a client may depend on his or her agent to assist with finding the right mortgage. This is an important role, because the client’s commitment to the right (or wrong) mortgage is one that can last for years and years and can have a serious impact on his or her finances – and by extension on their ability to meet their other obligations and to maintain a suitable quality of life.
For most buyers, the mortgage takes up a huge portion of their financial “landscape”.
This is why it’s important for agents to truly understand the complexities of mortgages, and to have a good grasp of the factors and nuances that they may be asked about by clients. (And sometimes the worst scenario is to have a client who doesn’t even know the right questions to ask).
Basic Things to Consider
Whether it’s for a new purchase or re-financing – and whether the home is new, old, residential, recreational, investment, retail, commercial, or industrial – there are various issues that home-buying clients need to reflect on when deciding between financial institutions and private lenders.
What are some of the key factors that your clients should be looking for?
- The type of mortgage (closed, fully open, or partially open);
- The interest rate (i.e. fixed or variable);
- The term of the mortgage; and
- The mortgage’s amortization period (which is the time it would take you to pay off your mortgage based on a certain payment amount for a certain number of years).
As a quick aside, it should be noted that the distinction between the mortgage’s term and its amortization period can be difficult for consumers to grasp.
Simply put: the mortgage term is the period of time that a borrower is committed to a specific lender, under the particular provisions of the mortgage that have been agreed to (which document sets out the agreed interest rate and terms for that period). Customarily, the term of a typical residential mortgage is somewhere between one and five years.
In contrast, the mortgage amortization period is the lengthier period of time it will take the borrower to pay off the mortgage entirely, calculated using the entire amount borrowed, applying a fixed interest rate, and allowing for only the minimum required payments. For example, a 25-year amortization means that if the borrower pays the mortgage-stipulated payment amount on account of principal and interest, is governed by a 25-year fixed interest rate, and makes no extra payments, then he or she will have paid off the mortgage at the end of 25 years.
(Note that to be eligible for Canadian Mortgage and Housing Corporation (CMHC) insurance, the mortgage amortization period must not exceed the current maximum of 25 years. If no CMHC mortgage insurance is required, then the amortization might be as long as 40 years).
One of the other factors to consider when informally advising clients on their mortgage-shopping relates to penalties, is that the borrower will very likely be subjected to a penalty for paying off the mortgage earlier than at the end of the original term (unless the mortgage is fully open). In other words, the borrower will need to ask this simple question: “How much will it cost me to pay off the mortgage before the maturity date?”
The standard penalty is usually based on the greater of:
- A sum equivalent to three (3) months’ interest on the balance being paid out before maturity, or
- The “interest rate differential”.
The interest rate differential is calculated on the difference between the interest rate the borrower is paying for their existing mortgage and the then current rate being charged for this type of mortgage product at the time he or she wishes to make either a partial pre-payment or else discharge the mortgage completely.
Ideally, the mortgage will include a provision for some pre-payment that does not incur a penalty; this type of mortgage clause allows the borrower to pre-pay a certain percentage of the original principal owed of the mortgage annually. The mortgage may also be assumable or portable, which gives the borrower the most flexibility.
Finally, another key consideration relates to the nature of the terms and conditions that may be offered by the lender upon mortgage renewal, or when re-negotiating during the current term (for example, if after some period of living in the home the borrower needs to increase the principal amount borrowed).
This should involve the borrower re-evaluating his or her needs and capacities, including:
- The ease or difficulty with which existing mortgage payments have been made, in the context of the borrower’s overall household budget and other financial obligations;
- Whether the borrower has other, higher-interest debts to ideally consolidate into the mortgage agreement;
- Whether the borrower would prefer to change the payment amount or frequency on any new/renewed mortgage; and
- Whether the borrower would like the flexibility of added pre-payments as an option.
Upon renewal or renegotiation, the borrower should also ask the lender whether he or she, as an existing client, qualifies for any special or discounted rates.
And remember: Mortgage renewal is only an option; the borrower is not obliged to stick with the same lender after the initial mortgage term ends. You can always shop around for a better rate or a better term with a different lender.
Mortgage-shopping has its complexities. If you are a real estate professional who is being asked for information and advice from a home-buying client, BEWARE!
Needless to say it’s important that the client gets the proper information – ideally from an independent professional advisor – because the decision to commit to a mortgage is a financially profound and long-lasting one.
So if your clients are relying on you – even just informally – to help them make this decision, just make sure you completely understand the advice you are giving.