Scene: Beau just signed papers to buy a house and now he’s visiting his bank manager, Steve, to arrange a mortgage for this house. Beau is pre-approved for a $700,000 mortgage.
Beau: Hey Steve! I got the house for exactly $700k – awesome. So let’s do this mortgage thing!
Steve: Great news Beau, so the first thing we should talk about is your down payment.
Beau: Of course, I want to do 5% – so $35,000
Steve: Oh, haven’t you heard? Since April, anything over $500,000 has to be minimum 10%. So you can do 5% on the first $500,000, which is $25,000 and then 10% on the remaining $200,000, which is $20,000. I’ll need at least $45,000 from you.
Beau: Ok, I must have missed that new rule, but I can do $45,000. Ok, so I give you the $45,000 and then I have a mortgage for $655,000 and pay you interest for lending me the money, right?
Beau: Hmmm, I think you’re mixing up dates AND countries there Steve…anyway, I hear you, it’s not as simple as giving me a loan and paying interest. What’s next then?
Steve: Well, you may be aware of the Canada Mortgage and Housing Company (CMHC). They are a company made up by the government to make it harder for anyone but really rich people to afford a home. They charge you “mortgage insurance” on anything less than a 20% down payment. If you don’t have $140,000 in cash for a down payment on this new house of yours, you are considered risky by the CMHC and you have to pay them to protect the banks.
Beau: Ok, wait, isn’t the whole concept of a mortgage that if I miss the payments, the bank gets my house? And by accepting the terms of my mortgage, isn’t the bank agreeing that my house is worth at least $700,000?
Steve: Yes, all true things.
Beau: So why do I have to pay extra insurance when, if I default, the bank gets a $700,000 asset? Shouldn’t the banks speak up and say that they don’t need insurance?
Steve: Oh, I got this one. Because banks hate you, Beau. I don’t know if you realize where you are right now, but this isn’t a drum circle. We are not friends who just shared a chalupa from Taco Bell. This is a BANK. Our first priority is to protect ourselves from risk, our second priority is to make PILES AND PILES OF MONEY, and our third priority is to make you feel like a small bug, that we can squash any time you don’t follow our restrictive rules. WE ARE WATCHING YOU!
Beau: Wow, ok, I get it Steve. How do you make your eyes go all red and glowy like that? Moving on then…how much is this mortgage insurance?
Steve: Since you’re doing the minimum down payment, it is $24,000.
Beau: $24,000! That’s more than half of my down payment!
Steve: Beau, you are a huge risk. People like you that only have $45,000 in cash to spend on a house are embarrassing to Canadians everywhere. I just spent $45,000 on a new watch. Get with the times. Anyway, the CMHC lets you roll that into your mortgage so what do you care? Your mortgage amount would be $679,000.
Beau: I see now you really meant what you said about making me feel like a small bug. Oh man, I don’t want to pay $45,000 and then have a mortgage that is only $21,000 less than the purchase price. I guess I could ask all my relatives for money, sell all of my assets, liquidate my retirement fund, and borrow $25,000 from my RRSPs under the Home Buyer’s Plan…
Steve: YES! YESSS! That’s what you should do! Do all of that! HAHAHAHAHAH! Now you’re talking like a true Canadian! Trade your financial freedom for ONE asset that is not guaranteed to appreciate! IT’S THE ONLY WAY!
Beau: Fine. I don’t know why you have to be so creepy about it, but fine. I’ll get you your $140,000. Wow, I think this might be the worst day of my life.
Steve: That’s what I like to hear! In 25 years, when you own this house, you will thank me.
Beau: 25 years?
Steve: Yes, based on your current income, we have to amortize the mortgage over 25 years. At a time in your life when you have trouble putting together a 5-year life plan, I’m going to have to ask you to commit to paying the bank every month for the next 25 years.
Beau: Sure, I guess I have no choice. So I give you $140,000 then I have a $560,000 mortgage. I pay this off over 25 years. I pay you monthly interest on the remaining balance until it’s gone. By my calculations, my payments should get lower and lower every month, the lower my mortgage balance gets. This will be good for me, because every month, I can slowly increase my savings and rebuild my retirement fund, repay my RRSP loan and all of my relatives.
Steve: Beau, I don’t know where you get this stuff, but it’s hilarious, and you’re way off. We take your $560,000 and the interest rate – let’s use 3% – and we plug it into a complicated amortization formula that spits out a flat monthly amount that you will pay every month for 25 years. In that monthly amount, the formula makes sure that we get a lot of interest upfront and that your repayment of your $560,000 is very slow at the beginning. Your monthly payment amount is $2,650 but only $1,250 of that is repaying your mortgage, and the remaining $1,400 is interest. If we did what you’re suggesting, we would get $25,000 less in interest over the life of the mortgage. And that’s not in our “best interest”, if you know what I mean.
Beau: Steve, exactly how much interest am I paying you over 25 years?
Beau: What? Hold up. First I paid $140,000 to save CMHC insurance of $24,000 and reduce my mortgage amount to $560,000. Now you’re telling me that after all of that, I’m going to end up paying you almost half of my mortgage amount in interest? So the total cost of my $700,000 house is actually $935,000? I think I’m going to be sick.
Steve: Now you’re getting it. But I forgot a few more things. Things you need to pay before you get the house and you can’t roll these things into your mortgage, like the CMHC insurance.
Beau: What now, Steve? Do I have to insure the mortgage insurance? Or maybe there’s a Steve’s Vacation fee? I give up.
Steve: Land transfer tax.
Beau: Land transfer tax?
Steve: Yes, Land Transfer Tax?
Beau: Ok, would you care to tell me about that?
Steve: Of course. If you thought the concept of mortgage insurance was ridiculous, then you’re really going to laugh at land transfer tax. It’s really just another property tax. So instead of increasing property taxes to balance the budget, the governments came up with a flat tax that is only charged when a property is transferred from one person to another. Your provincial and municipal land transfer taxes are a total of $20,000. Sure, they could spread this out over a few years, but they decided to ask for it all upfront, to really, really stick it to anyone who is bold enough to buy a house from someone else.
Beau: I really hate you right now Steve.
Steve: Oh but since this is your first house, you get a rebate of $6,000! This is great news, Beau. But then there are lawyer fees and title insurance and you probably want a home inspection so that’s around $3,000.
Beau: Ok, so the total upfront cash I need to buy this house is $157,000? (140,000 + 20,000 – 6,000 + 3,000)
Steve: Finally – you get it.
Beau: Ok, I’ll need to think about this…well…at least it’s a better option than renting for the rest of my life…
OR IS IT????
TO BE CONTINUED…