Mortgages: you really need to know at least this much.
Updated: Nov 11, 2019
Unless you’re the co-founder of some cool tech start-up, if you get a bank loan, it usually means you will be granting the bank some sort of "security". While this is all pretty standard stuff for most of us, it’s often not very understandable stuff. So if you’re a typical real estate buyer using a typical lender (and of course using a typical real estate lawyer), you’ll be dealing with loans virtually every time you do a deal – so you better know at least this much:
1. Open and Closed:
This has nothing to do with crazy bank hours. Did you know that the bank really doesn’t want money back? Not unless they are guaranteed to make a good return off of you first.
An "open" mortgage is a mortgage that can be paid out before its maturity date (end of the term) without notice, bonus or penalty payment. But banks don’t like that so it usually comes with a higher interest rate.
A "closed" mortgage is one that is locked in for the term: to get out of it and pay it out early requires the payment of a penalty. This is where it gets scary: investigate this!
Some penalties are equivalent to three months of interest – substantial, but not crazy. But some also state that it could be the greater of that amount or something called the ‘interest rate differential’. It’s a bit complex- and many bank commitment letters spend pages showing how to calculate that amount – but generally it means the amount the bank would lose if they put the principal amount back into the market at interest rates then applicable. I’ve seen these as high as $20,000.00.
Don’t miss the importance of this. If you plan to hold the property for the length of the term then it doesn’t matter. But if you have even a remote chance of selling before the term expires, then consider an open mortgage even if rates are higher.
2. High ratio:
If you can’t put at least 20% equity into the property being purchased then you will need a high ratio mortgage. Two nasty things flow from this:
First, you’ll be charged a fee for the cost of the required insurance that covers the lending bank. That’s right, you pay the premium for someone else’s insurance coverage. What a deal! And it will be significant (usually between 2-5% of the loan amount)
Second, you will personally be liable for the loan. The bank’s remedies are not (unlike conventional loans) limited to the land (i.e. foreclosure). They can come after the borrower for the difference if the foreclosure sale doesn’t net enough to fully payout the loan.
So while your potential return on investment is significantly higher the less cash you inject into the deal, the potential costs and risks are higher too.
3. Linus’ blanket:
A mortgage is just the 'security blanket' that banks need to feel good about giving you a loan. I can’t tell you how many times I’ve been told by clients that they don’t have a mortgage on their property – yet they do. Why? They have a line of credit loan and mistakenly believe a mortgage is a different type of loan. It’s not. It’s security for a loan. A mortgage can secure a traditional loan that contemplates principal and interest payments over a specific term at a specific rate. (i.e. what most people think of when they think of a ‘mortgage’). But a mortgage can secure any type of loan – including a line of credit or a HELOC.
Evidence for a loan is a loan agreement or a promissory note. Security for a loan can be several things:
A Mortgage registered against title to Real Property
A General Security Agreement registered against Personal Property
Guarantees given by individuals or corporations to back the loan
And other fun stuff like hypothecation of shares.
4. Property Taxes:
A bank will usually want to get their security blanket – I mean mortgage – registered on title as a first position financial charge. That means that nobody else has a higher priority than they do. If you sell that place they get first dibs on the money. But those nasty politicians have complicated things a bit. Even without a registration on title, the government has a supra-priority interest to the extent there are any outstanding taxes. So do you think the bank cares? You bet they do! Nobody is going to step ahead of them!
So your mortgage requires you to pay property taxes when due. You have basically three options:
Pay Once: you can pay June 30th (usually) for that year’s property taxes;
Pay Monthly: most municipalities have a monthly payment plan where your bank account is automatically debited each month;
Pay monthly through your mortgage: in that case, a tax component is added to your mortgage principal and interest payment. The Bank collects it for a year. For example, they will collect a monthly amount July 2018 through June 2019 so they have enough in your special tax account with them to fully pay the 2019 property taxes.
If you know this much, you can impress most bank representatives. And they may even give you a loan! If you want to learn more, or you’re having a hard time falling asleep some night, pull out that old report your lawyer gave you and read through your copy of your mortgage – you’ll find even more amazing tidbits I’m sure.
This is not meant to be, and should not be construed as, legal advice for your specific situation. You should contact one of our lawyers here at Richards + Company for further information and to discuss your particular facts and situation.
Darren L. Richards practices real estate and corporate/commercial law with Richards + Company in Edmonton, Alberta; he is rated as one of the ‘three best real estate lawyers’ in Edmonton.