Buying a home is the most important decision in the lives of most people and in most cases a mortgage on the property is part of the process. A mortgage has a number of fundamental legal and financial elements that are not well understood by many consumers. So what is a mortgage?
Parties to the Mortgage
First of all there are two parties to a mortgage. The lender (generally a financial institution) is called a mortgagee and the borrower (generally a consumer who is buying a home) is called a mortgagor. The lender provides a loan to the borrower and receives a mortgage as security for the loan.
A Mortgage is not a loan
Second, within Canada the mortgage is not a loan but it is an interest in land created by contract as security for a loan made by a lender to the borrower. The mortgage, therefore is not a debt but it is evidence of a debt and almost all mortgage agreements contain a promise to repay a debt. More importantly, it is a transfer of a legal and equitable interest in land on the condition that the interest in land will be returned when the terms of the mortgage contract are performed. If the borrower repays the loan or performs some other obligation under the contract, the transfer becomes void or the lender must transfer the interest back to the borrower. In almost all cases the obligation in the mortgage is the repayment of borrowed money.
Provincial Differences and the Equity of Redemption
Third, Canada has three levels of government (federal, provincial and municipal). Property rights in the province are the responsibility of each province and they can vary by province. Within British Columbia, for example, under the Torrens system of land title registration, all mortgages are registered as charges against the title. The lender receives the right to have the legal title of the property conveyed to it in the event of default, subject to the equity of redemption. For example, if the owner of a property worth $500,000 grants a $200,000 mortgage, the borrower’s equity of redemption is worth $300,000 at the time. Because a borrower retains an equitable interest in the land after granting a legal mortgage, the borrower is free to mortgage this equitable interest by granting a second or subsequent mortgage. These subsequent mortgages are called equitable mortgages because they are mortgages of the borrower’s equity of redemption.
Legal and Equitable Mortgages
In BC, therefore, the first registered mortgage will be like a legal mortgage but the title will continue to show the borrower as the registered owner. Any subsequently registered mortgage will be an equitable mortgage charging the borrower’s equity of redemption. Borrowers often find it difficult to arrange for subsequent mortgages because each one reduces the gap between the market value of the property and the total amount secured against the land. For this reason second and subsequent mortgages are generally for smaller amounts and they bear higher interest rates.
Foreclosure and the Personal Covenant
As already discussed, the lender receives the security of the land through the mortgage given by the borrower as security for the loan given by the lender to the borrower. Most mortgage contracts also provide the lender with an additional types of security called the personal covenant. The personal covenant is a personal contractual promise to repay the loan. In the event of default, the lender can sue to the borrower on the personal covenant, foreclose against the land or do both. It is very important for a borrower to read and understand all of the terms and conditions in a mortgage contract so that they fully understand their rights and responsibilities of the contract. For example, in some circumstances the lender can sue the borrower on the personal covenant even though the borrower sold the property to someone else who assumed the mortgage.
Bankruptcy and the mortgage
Bankruptcy in Canada has exemptions and exclusions. Bankruptcy helps rid you of most of your debts but not all. Bankruptcy nondischargeable debts include child and alimony support payments, student loans less than 7 years old, a fine or penalty imposed by the court, debt arising from fraud, and secured loans such as a car loan and loans secured against mortgages. Bankruptcy proceedings will also adversely affect your credit rating or six years after the discharge which in turn will make is harder to obtain credit such as loan against mortgages later.
Pre-qualification and Pre-approval
Before a lender is willing to grant a loan to a borrower and receive a mortgage as security for a loan, there is a process that a borrower can use to become pre-qualified and then pre-approved for the loan. Pre-qualification by a lender means that the lender is providing you with an estimate of what you could borrow. This often occurs via a discussion with a representative of the lender and it does not mean that the lender is prepared to give you a loan. By going a step further and getting pre-approved means that a lender is generally prepared to give you a loan after reviewing your financial information. Here, again, however, this does not guarantee that you will be granted a loan. With many lenders the pre-approval has made a commitment to loan the money to you subject to some conditions such as a property valuation. The home that you are planning to buy also has a role in the process. After you get an accepted offer on a home, most lenders will do an appraisal on the home (either in house or by having an appraiser visit the home). They do this in order to assess the lending value (a long-term estimate of market value for lending purposes) of the home before they unconditionally commit to lending you the money. So, if you buy a high risk home and/or pay too much for the home relative to what the lender determines its appraised value is, you may not get the loan that you anticipate. As a minimum, consumers should get pre-approved before seriously looking to buy a home.
Getting pre-approved means sitting down with a mortgage specialist or mortgage broker to discuss your needs and financial situation. You will fill out an application that provides details of your employment, income, debts, down payment, etc. and you will give permission for them to obtain a credit report. As well, you will be told what documentation you will have to provide upon conditional approval. Most often these requirements take the form of providing a photo ID, a record of employment (such as a T-4 slip), a letter from your employer providing length of employment and current salary (two years of personal income tax returns and financial statements if self-employed), confirmation of your down payment, details of assets such as vehicles and investments and details of liabilities. You may also be asked for the name, address and contact information of your lawyer / notary with whom you will be transferring the title of the property. By getting pre-approved you are under no obligation to buy a home and accept the loan but you will be in a stronger and more advantageous position to proceed with your house hunting process.