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Textbook Notes
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Canada
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Ryerson University
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Finance
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FIN 502
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Joan Lobo
(33)

Chapter 13

Description

CFIN502- Chapter 13- Buying a Home and Mortgage Financing
MORTGAGE FINANCING
Mortgage financing- traditional way of borrowing money to purchase a home
Home mortgage- real estate loan with equal monthly payments
o Payments may increase or decrease according to changes in interest rates
Mortgage- the transfer of interest in property to a creditor as security for payment of a debt
with a right o redemption by the borrower upon repayment of the debt
o Title of ownership actually conveyed up to the bank—you have right to reclaim
clear title to home upon full repayment of debt
o Equity of redemption- right to reclaim title from the lender
o Two parties to a mortgage—mortgager and mortgagee
Mortgager- person who gives the security to obtain the loan—homeowner
Receives funds and maintains possession of property
Mortgagee- lender who receives the title to the property until the debt is
fully repaid
o First mortgage- mortgage where the conveyance of title is involved
Second mortgage-conveys the right to a further equity of redemption which can again be
mortgaged
o Third mortgage- further equity of redemption is mortgaged
o Right to reclaim title of home upon full repayment of loan retained by the mortgager
This right is an asset that has value of itself and may be used as security for
anther loan
o Act of second mortgage consists of using the equity of redemption as security or
collateral for a loan
o Red hot real estate boom—not common to hear borrowers with fourth and fifth
mortgages on their properties
Basic concepts and terminology
o Principal- amount of money that is being borrowed
o Interest- price paid by the borrower to the lender for the use of the lenders money
o Amortization- gradual retirement of a debt by means of partial payments of the
principal at regular intervals
o Amortization period- time period required to retire completely a debt through
scheduled repayments of principal
o Blended payments- periodic repayments are constant and each payment includes
interest and repayment of part of the principal
o Term- actual length of time for which the money is loaned at a particular rate of
interest
Most common terms for home mortgages are 6 months, 1-5 years
o Maturity date- final date in the term of the mortgage is called maturity date
o Conventional mortgage- describe a first mortgage granted by an institutional lender,
where amount of loan does not exceed 75% of the appraised lending value of the
property
o High ratio mortgage- mortgage that exceeds 75% of lending value and must be
insured, via a national housing act loan or a private insurer
Insurance is paid by the borrower in favor of the lender to protect against
default
o Default- failure to meet the obligations imposed by the debt
o Foreclosure- remedial court action taken by a mortgagee, when default occurs on a
mortgage, to cause forfeiture of the equity of redemption of the mortgager
o Power of sale- right of a mortgagee, to force sale of the property should default occur
Mortgager financing mathematics
o 5 important elements in a mortgage
Principal, term, rate of interest and the compounding frequency, period of
payment, amortization period
o Canadian home mortgage rates
Started as annual rate with semi-annual compounding—normally repaid by
monthly payments
Compounding period (six months) is different from the repayment period
(1 month)
1 CFIN502- Chapter 13- Buying a Home and Mortgage Financing
1/2 2
(1+m) = [1+k/2]
o How to calculate the monthly mortgage payment
o How to calculate the outstanding principal at any future point in time
Outstanding principal or outstanding balance of the loan is equal to the
present value of the remaining stream of mortgage payments—discounted
at the equivalent monthly compounding rate
o Change in mortgage rate
Rate of interest is guaranteed and fixed only for the term of the mortgage
End of term—mortgage must be renewed or refinanced at the rate of
interest that applies at the time
HOW MUCH HOME CAN YOU AFFORD
Minimum down payment and other rules
o Financial institution may not lead more than 95% of the appraised value of the
property for a residential mortgage loan
Borrower must provide a down payment of at least 5%
o If the down payment is 5-20%-- mortgage is high risk and the financial institution
must require the borrower to qualify for mortgage insurance
o Premiums are higher for a smaller down payments and higher for a self-employed
borrowers with no independent verification of their income
o Maximum permitted amortization period for an insured loan drops to 2 years—limit
on refinancing a loan falls to 80% of the loan down from 85%
o Maximum GDS is fixed at 39%
o Max TDS is fixed at 44%
o Loans on home with a purchases price of $1 million cannot be insured
Using debt ratios to calculate how much you can afford
o How much home one can afford depends on how much mortgage financing one can
obtain
o GDS rule—your monthly mortgage payment plus property taxes must be less than a
certain percentage of your monthly gross income
Saving up for a down payment
1. Estimate the amount of mortgage you can get—based on your expected gross
income, current GDS ratio or TDS ratio, and current mortgage rate
2. Amount of mortgage is approximately equal to 75% of the value of the house—
you can find the amount of housing you can theoretically afford
3. Minimum down payment is equal to 25% of the value of the house obtained
above
4. Set up deadline for acquiring this minimum down payment
Balance the budget
o Comes down to choice of goals—may have to give up some other goals temporarily
o Bankers tell us that they are more likely to find well-off families getting into debt
troubles—they couldn’t cut their luxury spending than they are to find modest
income families who took on too much
o On average, cost of renting rises over time
o Mortgage amount is fixed—it is

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