Credit Rating

Home Equity

Loan Programs



Why is an appraisal required?

An appraisal is an estimate of the value of a property. An estimate of the value of the property generally refers to its fair market value. The purpose and use of appraisals include transfer of ownership, financing and credit, taxation, condemnation, insurance and many others. An appraiser is typically a province-licensed individual trained to render expert opinions concerning property values. Provinces are required to implement appraiser certification requirements. Consider working with either a Certified General or Certified Residential Appraiser. The appraiser considers three approaches to value when arriving at an opinion: sales comparison approach (formerly the market data comparison approach), cost approach and income capitalization approach. When evaluating single-family, owner-occupied properties, the sales comparison approach is most heavily weighted by an appraiser. This approach compares the subject property with other similar properties in the vicinity which have sold or are for sale. Real estate professionals also rely heavily on this approach.

Real estate agents approximate the appraisal process by conducting a Comparative Market Analysis (CMA), using the sales comparison approach to value. The accuracy of the agent's appraisal depends on the experience and skill of the agent. The CMA is not an officially recognized appraisal.

Most lenders will not lend money without an acceptable appraisal. You can be sure you are getting an expert appraisal when the appraiser is licensed or certified.

Appraisal Methods

Most appraisers use three approaches to establish the value of a property. The Sales Comparison Approach is normally considered to be the best indication of value for residential property.

Sales Comparison Approach: In this approach the appraiser finds three to four comparable properties in the neighborhood which have recently sold. Ideally, these properties are within a one-half mile radius of the subject property and have sold within the last six months. The appraiser compares the sold properties to the subject property. The factors used in the comparison include square footage, number of bedrooms and bathrooms, property age, lot size, view, and property condition.
Cost approach: This approach considers the value of the land, assumed vacant, added to the cost to reconstruct the appraised building as new on the date of value, less the accrued depreciation the building suffers in comparison with a new building.
Income capitalization approach: In this approach the potential net income of the property is capitalized to arrive at a property value. This approach is suited to income-producing properties and is usually used in conjunction with other valuation methods. The process of converting a future income stream into a present value is known as capitalization

How much does an appraisal cost?

The cost of an appraisal varies based upon the:

Type of appraisal: In depth or cursory.
Type of property: Appraisals for single-family homes and condominiums usually cost less than appraisals for multi-unit properties.
Value of property: Appraisals for higher-priced homes usually cost more than appraisals for lower-priced homes. If your home value is over $500,000, you can expect to pay more for your appraisal.
Location of property: The cost of an appraisal is affected by geographic location and availability of appraisers. In areas where appraisers are few, or the properties are hard to access, appraisal costs increase.
Use of property: Appraisals for income-producing properties, for example, usually cost more than appraisals for non-income-producing properties. Rental property appraisals include a rent survey and the property's income statement. Appraisal fees on single-family, owner-occupied homes under $500,000 in densely populated areas vary between $250 and $400. Fees for similarly priced rental properties may vary between $400 and $550.

Credit Rating

Credit Reporting Agencies

Along with the credit histories of millions of other people, your credit history is recorded in files maintained by at least one of Canada's major credit-reporting agencies: Equifax Canada and TransUnion Canada. It is possible to obtain your credit file for free. Please consult the agencies' websites in order to obtain more information. These files are called credit reports. A credit report is a "snapshot" of your credit history. It is one of the main tools lenders use to decide whether or not to give you credit. Your credit file is created when you first borrow money or apply for credit. On a regular basis, companies that lend money or issue credit cards to you, including banks, finance companies, credit unions, retailers, send specific factual information related to the financial transactions they have with you to credit reporting agencies.

Home Equity

Types of Home Equity loans

Fundamentally, there are two types of home equity loans:

Home Equity Line: When you get a home equity line, you obtain the right to draw money, whenever you want, over a certain period of time. You only pay interest on the amount you borrow. You may borrow, pay off and borrow again against the line of credit. You typically access the line with a check or credit card.
Second Mortgage (home equity loan): When you get a second mortgage, you obtain a lump sum of money. The interest rate and monthly payments are fixed.

Before deciding which type of loan you want, consider how you'll use the money. If you need funds for a single expense, such as a room addition, remodeling, etc., you'll want to strongly consider a fixed-rate, second mortgage. You receive one lump sum at the beginning of the loan term. You pay it back in equal, monthly installments.

The certainty of a fixed interest rate and equal monthly payments make the fixed-rate, second loan very attractive. Will this type of loan be less expensive compared to an adjustable rate, home equity line? There is no way to know with certainty. One would have to be able to predict interest rates with accuracy. Consider one of the reasons why adjustable rate loans were invented: to shift interest rate risk from the lender to the borrower. When market interest rates rise above the interest rate on your fixed-rate mortgage, the lender is effectively losing money on your mortgage and you're getting a bargain. Lenders wanted a way to protect themselves from this situation--thus the adjustable-rate mortgage.

If you need periodic amounts of money over time, for a child's education tuition, for example, a home equity line may be ideal. You can borrow only the amount you need, when you need it. These loans carry adjustable rates, but some banks allow you to convert a portion of your loan to a fixed-rate second. You may pay a premium for the convenience of an equity line, including a transaction fee for each draw and an annual fee if you draw or not.

Deciding in advance which type of loan is best for you helps when comparing the expense of various loans. Since the APR for a fixed-rate second is calculated differently compared to a home equity line, APR comparisons can be difficult when comparing a fixed-rate second to a home equity line. APRs of fixed-rate seconds account for points and other closing charges. APRs for home equity lines don't account for points and other closing costs. When comparing the same types of loans (apples to apples), APRs are much more meaningful.

Shopping for a Home Equity line of credit

Is a home equity line what you need?

Before you apply for a home equity line of credit (HELOC), make sure it's the type of loan you want. If you need relatively small amounts of money over time, such as for school tuition, a HELOC may be right for you. If you need a lump sum for a particular purpose, such as building a room addition, a home equity loan would probably be better.

Carefully compare plans

Carefully compare several plans. Examine terms and conditions, annual percentage rates (APR), annual and initial transaction (set up) costs, indices, margins and caps. Some lenders may not charge setup or annual fees, but may charge a higher interest rate in return.

There may be an introductory, or "teaser" rate offered. This is a temporary rate which will have little beneficial value over the life of your loan. Since most HELOCs are variable rate loans, the rate you pay is the sum of the index plus the margin. Indices are expressed as rates and include Prime and T-Bill rates. The margin is explicitly stated in your loan documents and is also expressed as a percentage. For example, if your loan were tied to the Prime rate with a 2% margin, and the Prime rate were 8%, you'd pay 10%. Historical information regarding the behavior of various indices is available on-line and at your local library. A little research will help you determine which index you'd be most comfortable with.

Your variable rate plan will identify a maximum interest rate (ceiling or cap). Your loan may not exceed the rate cap during the life of the loan under any conditions.

Consider a loan which allows amortization--repayment in installments of principal and interest sufficient to retire the debt by the end of the plan. Try to amortize your loan, otherwise, you may incur a balloon payment at the end of the plan.

Negative Amortization

Under certain circumstances, depending on your program, the monthly payments may not adjust adequately to fully account for interest rate increases. In this event, negative amortization may occur. Negative amortization is when in which your loan balance increases. If this condition is a possibility with your loan, discuss with your lender how you can avoid it.

Some lenders may permit you to convert a variable rate to a fixed rate during the life of the plan, or to convert all or a portion of your line to a fixed-term installment loan.

Agreements generally will permit the lender to freeze or reduce your credit line under certain circumstances. For example, some variable-rate plans may not allow you to get additional funds during any period the interest rate reaches the cap.

Borrow Wisely

Perhaps you discover you can borrow much more than you expected, or need. A HELOC may seem to turn your home into a new type of credit card. If you default on a credit card, you may only damage your credit. If you default on a HELOC, you could lose your home.

Loan Programs

Balloon Mortgages

With a balloon loan, at some point you'll be forced to pay off the loan, refinance the loan, or exercise a conversion option to get a new loan on or before the balloon due date. Unlike standard fixed or adjustable loans, balloon loans are not amortized. The entire loan balance is all due and payable in a relatively short time.

One of the most popular balloon programs is the 30/5, commonly referred to as a "thirty-year due in five." The interest rate is fixed and the monthly payment is sufficient to pay off the loan in thirty years, but the outstanding principal balance is due at the end of five years. Some 30/5s have a conversion option which allows you to convert to a twenty-five year, fixed rate at the time the balloon becomes due. There may be a minimal processing fee (typically $250) to convert to the new loan. The conversion rate is normally the FNMA sixty-day rate plus .5 percent. The conversion option may also be conditioned upon:

Satisfactory mortgage-payment history. If your payments were late, the conversion may be denied.
If the loan was secured by an owner-occupied dwelling, the dwelling will still need to be owner-occupied. If the house is a rental at the time of loan-conversion, the conversion may be denied, or you might be charged a higher interest rate.
Secondary financing may not be allowed. If you have a second mortgage, the conversion may be denied unless you pay off the second mortgage.
Terms vary by lender. More information can be found in the loan obligation (promissory note). This is a document the lender will require you to sign at the time of closing.

Another popular balloon loan program is the 30/7. This is similar to the 30/5 except that the balloon comes due at the end of the seventh year.

Bi-Weekly Payments

Making bi-weekly (ocurring once every two weeks) payments can shorten the life of your mortgage and reduce your interest expense over the life of the loan. Instead of making a full payment every month, you make a half payment every two weeks. Since there are fifty-two weeks in a year, you make twenty-six half payments, or thirteen full payments. As a result, you are making one extra mortgage payment per year. Making bi-weekly payments can reduce the term on a thirty-year, fixed loan to approximately twenty-two years.

There are several ways to implement a biweekly program:

Contact your lender. See if they offer a bi-weekly program.
Locate a company that helps borrowers make bi-weekly payments. The company will deduct payments from your bank account every two weeks, but will only pay your lender once per month. The disadvantage is that you loose interest on your money that you otherwise would have made. The advantage is that it is convenient and automatic. Be sure to fully investigate the company's credentials. There have been scams reported in the industry.
Do it yourself. Open a bank account and make bi-weekly deposits. Each month, pay your lender from that account. You will earn interest on the money in your account.
Make monthly pre-payments. Increase the amount you pay each month by one-twelfth (8.33%). By increasing your mortgage payment by just over 8 percent, you shorten the life of your loan and save money effectively the same as you would with a bi-weekly loan.
Ask yourself some questions before committing in writing to a bi-weekly program. Remember, any loan is potentially a bi-weekly loan. If you have the discipline to make the extra payment per month or per year, why enter into a written agreement or pay someone to help you? If you use a third party to help you, ask what their set-up and monthly servicing fees are, then determine what you're really saving.

Interest Rate Buydowns (Points)

Interest rate buydowns are used to help you qualify for a larger loan and obtain a higher priced home. Buydowns allow you to pay extra points up-front in return for a lower interest rate for the first few years. Since the additional points you pay are tax deductible, there are some tax benefits. People relocating due to employment often obtain buydowns. Employers sometimes pay the extra points as part of a relocation package.

The most common buydown program is the 2-1 buydown. With this program the interest rate is reduced 2 percent during the first year and 1 percent the second year. For example, if you obtain a 2-1 buydown on a 30-year, fixed, 8 percent mortgage, the rate is 6 percent the first year, 7 percent the second year and 8 percent thereafter.

Some companies offer a 3-2-1 buydown. This reduces your rate 3 percent the first year, 2 percent the second year and 1 percent the third year.

There are many variations of buydown programs. Some buydown programs result in interest rates changing every six months as opposed to every year.

Fixed-Rate Mortgages

Fixed-rate mortgages are very popular because the interest rate and monthly payments are constant. Fixed loans are generally amortized over ten, fifteen, twenty or thirty years.

A fixed-rate mortgage is generally preferred when the interest rate is relatively low and one intends to keep the property for more than five to seven years. When rates are relatively high, or if one intends to sell the property in fewer than five to seven years, adjustable loans are generally preferred.

The most common fixed rate mortgage is the thirty-year fixed. Borrowers who want to pay off their loan sooner may opt for a fifteen-year mortgage. If you are trying to decide between a thirty-year and a fifteen-year loan, consider the following:

Paying your loan over fifteen years can save you thousands of dollars in interest. Paying less interest results in less of a tax deduction. Determine in advance if a larger tax deduction (with a thirty-year loan) will offset the benefits derived from paying less interest (with a fifteen-year loan).
The payment on a thirty-year loan can be substantially less than the payment on a fifteen-year loan of the same amount. You could obtain a thirty-year loan and invest the difference in mutual funds, stocks, CDs, etc. If you could earn a higher, after-tax rate on your investment than the rate you pay on your mortgage, it may be advantageous to invest the difference.
The final decision you make will depend on your preferences. If your goal is to live debt free, then a fifteen year mortgage may be right for you. If you goal is to maximize your tax deductions, a thirty year loan may be best for you.

Loan programs with less than perfect credit

Are there loan programs available for borrowers with less than perfect to extremely poor credit? Absolutely. Fundamentally, all the lender wants to be assured of is that 1) one has the ability, and 2) the desire to repay the debt. The worse one's credit, the more evidence of one and two one will need to muster.

If you think you may be "credit challenged", one of the first things you'll want to know is, just how "less than perfect" is your credit? Fortunately, many bright people have dedicated their professional lives to creating methods for answering such questions. Statistical models which balance numerous credit factors provide methods for determining credit ratings. The models generate a single number a "credit score" which provides lenders with a starting point for making decisions about lending money.

How do you get your credit score? Currently there is no law requiring that consumers be given their credit scores. Lenders aren't required to give you your credit scoreā€š but some will if you ask them. The lender should, however, tell you what factors contributed to your credit score if your score was a factor in delaying or denying your loan application. Credit bureaus don't include credit scores on consumer credit reports.

Assuming you know your credit score, what does it mean? This government of Canada website explains credit score in more detail.

It would be confusing at best to present general underwriting guidelines in an attempt to interpret credit ratings and scores as they relate to individual borrowers. Your best assurance of getting the best possible loan is to shop among several lenders.


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