Canadian banks more cautious with mortgages

It's not unusual for homebuyers to be shocked by the amount of debt lenders will let them take on, but the U.S. sub-prime mortgage crisis is making banks on both sides of the border a little more cautious.

With the Ontario economy slowing and financial market fallout continuing over the meltdown that has pushed mortgage rates higher in Canada, banks are making sure people know what they are getting into.

"We are being more cautious," says Joan Dal Bianco, a mortgage expert and vice-president of real estate secured lending at TD Canada Trust. "We have a discussion about how much you can really afford."

She notes house hunters here don't face the same dangerous choices that got so many Americans in over their heads.

Unscrupulous U.S. lenders were pre-approving borrowers for mortgages at initial "teaser rates" as low as 1 per cent – often not warning that payments could rise by a third or more when the cheap rates expired. Scores have walked away from their homes and mortgage companies have gone bust.

"We qualify buyers at the posted mortgage rates," says Dal Bianco. "All the banks are doing that."

Posted rates from Canadian banks are now in the 7 per cent range for closed mortgage terms from one to 10 years, although it's easy to get a percentage point or more off by negotiating.

The rule of thumb in Canada is that mortgage payments shouldn't exceed 33 per cent of a family's gross income.

That's not to say buying a house won't land you deep in debt, even as mortgage rates are expected to slide in the coming weeks – leaving variable rate mortgages popular because the interest rates fall with the prime rate.

The trick is to be fully aware of how far in debt you'll be, and be comfortable that your finances can cope, given the twists and turns that may come as economic growth slows, with possible consequences for job security and income levels.

Economists at the Royal Bank of Canada recently warned that Ontario will "teeter on the brink of recession" this year as growth in the economy falls below 1 per cent.

The amount a homeowner will end up paying in principal and interest on a mortgage over the years can be double the amount borrowed, says Greg Johnston, senior consultant at mortgage broker Your Mortgage Connection.

That means a $300,000 mortgage today can take $600,000 out of your pocket once long-term interests costs are factored in.

"New people coming into the market are somewhat aware of that," Johnston notes, calling mortgages "a necessary evil."

"You're the one making the payments, you've got to be able to sleep at night."

Homebuyers have to make a trade-off between how much the mortgage will cost in the long run and keeping a good cash flow today.

More buyers are opting for the financial flexibility provided by the new 40-year mortgages, which hit the market last year – even though paying back a mortgage over 40 years is double the cost of a 25-year amortization period.

There are other reasons, too. Higher house prices are forcing people to spread out the mortgage payments longer so they can maintain a lifestyle they enjoy, instead of being house-poor.

"A lot of young people, they want it all," says Dal Bianco. "They want to have vacations, a nice car and a house."

And Toronto's new city-council-imposed land transfer tax, which added $3,469 to the cost of an average $374,449 home, seems to be encouraging some people to bypass the old "starter home" and get a place that will accommodate a growing family, avoiding the cost of future moves.

Johnston recalls one client who recently sold a condo for $160,000 and bought a house for $450,000, opting for a 40-year amortization period on the mortgage to keep the payments comfortable.

Because of the higher interest costs of a 40-year mortgage, experts recommend making it a temporary plan.

To make clients aware of how much their costs of borrowing will be, Johnston shows them amortization schedules that detail how much of their regular payment goes to paying down the principal (the initial cost of the home) and how much goes to interest.

In the first five years of a mortgage, 75 per cent of the payments go to interest and just 25 per cent to the principal.