6. New hypothecary loan
In residential real estate, the obtaining of a new mortgage loan by the buyer is a payment method that has a significant impact on the completion of the transaction. The funds obtained in this way generally constitute the largest portion of the purchase price. Since it is rare that the buyer has enough money to make a cash purchase, his promise to purchase must include a commitment to take the necessary steps to obtain a loan to complete his capital contribution.
Conventional and insured loan
To obtain a mortgage loan, the buyer must meet certain eligibility criteria and provide the lending institution with various documents attesting to his employment situation, his income and the stability thereof, his assets and his debts. The prospective buyer’s status as a salaried or self-employed person is also taken into account.
In Canada, a buyer cannot take out a loan secured by immovable hypothec for 100% of the market value of the property. The buyer must make a down payment. The down payment is the amount of cash paid up front at the time of purchase of a property (the mortgage covers the rest). In Canada, the minimum down payment is 5% for properties up to $500,000, but some lenders may require more. When the purchase price is above $500,000, the minimum down payment is 5% of the first $500,000 and 10% of the remaining portion.1
A loan is considered conventional when the purchase is made with a down payment of at least 20% of the market value of the property. This is not necessarily the purchase price, but the market value estimated by the lending institution. If the institution estimates the market value to be less than the price paid, then it may ask the buyer for a larger down payment or require the buyer to purchase insurance if the down payment ratio is insufficient. Depending on the institution, the maximum amortization period for a conventional loan is 25 years.
When the down payment for the purchase is less than 20%, the mortgage loan is considered an insured loan because the Bank Act requires the financial institution to protect its debt with insurance. The cost of this insurance, which is borne by the borrower, may be a one-time premium payable in a lump sum or it may be added to the amount of the mortgage loan.
In Manitoba, Ontario and Québec, mortgage loan insurance premiums are subject to provincial sales tax.
The amount of the premium varies according to several factors, such as the percentage of the down payment to the market value of the property (the loan-to-value ratio), the source of the down payment, the property involved and the type of insurance. The higher the loan-to-value ratio, the higher the premium. Whether the borrower is salaried or self-employed can also be a factor. The amortization period for an insured loan cannot exceed 25 years and mortgage insurance is only offered by a few specialized insurers.
A conventional loan can also be insured at the request of the lender, for example, in exchange for a more advantageous interest rate or a longer amortization period.
Finally, it should be noted that the source of the down payment is relevant in determining whether the loan is conventional or insured. The borrower must normally use his own financial resources to provide the down payment. However, a gift from a relative, a loan or even an incentive granted by the lender could be taken into consideration in the case of certain properties and depending on the borrower.
1 GOVERNMENT OF CANADA. 5.2.2 Downpayment, accessed online February 6, 2023 at https://www.canada.ca/en/financial-consumer-agency/services/financial-toolkit/mortgages/mortgages-2/3.html
The loan
Since there is a fair amount of uncertainty in obtaining a new mortgage loan, the process must be well defined by outlining the parameters of the loan, specifying a time frame and specifying what will happen if the loan cannot be obtained. The commitment of both the buyer and the seller is in a sense temporarily suspended until a loan is obtained.
Clause 6.1 of the Promise to purchase form sets out this condition.
The broker must indicate the amount of the hypothecary loan and a current annual interest rate that may be charged by the lender. This rate should not be the best rate available on the market, but rather the rate that the buyer does not wish to exceed. Since this is a mortgage, the interest will be calculated semi-annually and not in advance, as set out in Canadian regulations. The broker must also indicate the maximum term of the amortization plan as well as the minimum maturity of the loan. In the case of a new loan, the rank of the mortgage does not have to be indicated since it is not essential to the agreement between the seller and the buyer. The same is true for the amount of the payments. They do not need to be indicated as they are likely to vary depending on the agreement between the buyer and the financial institution. However, not having to specify monthly payments does not exempt the broker from discussing with the buyer the maximum amount he is prepared to pay per month. Remember that this is different in the case of an assumption of an existing mortgage, in which case the rank of the mortgage and monthly payments must be specified.
The amount of the loan to be taken out is specific and must correspond to what is indicated in clause 5.3. The amount of the mortgage insurance premium to be paid by the buyer in the case of an insured loan should not be included in the amount entered here.
The interest rate entered is a maximum, so that if the lender were to grant the loan at a rate higher than the rate entered and not the current rate, the condition would not be considered fulfilled and the buyer would no longer be required to purchase. The broker should not enter a random rate that is either very low or very high. A rate that is too low could result in the buyer not getting the loan, as such a rate is not available, and a rate that is too high would leave too much margin and could put the buyer in a situation where he would not have the ability to pay. The rate listed must be consistent with the market, i.e., the current posted rate for that type of loan. In practice, the broker should list a rate slightly higher than the current five-year rate to ensure that the payment amount is the maximum the buyer is prepared or qualified to pay.
In the space provided for the interest rate, the words “which shall not exceed the current rate” must not be used. In the event of refusal by a financial institution, the seller could force the buyer, under clause 6.3, to obtain a new loan at a significantly unfavourable rate. The broker must enter a realistic rate and calculate the result so that the buyer is well aware of the monthly payments and the cost of the loan. If necessary, the monthly payment amount can be specified in clause 12.1.
The parameters describing the loan also allow the buyer some flexibility to negotiate with the lender for a shorter term or longer maturity, which are factors that the buyer can easily take advantage of given the diversity of mortgage products available from lenders and the competition in this market.
Despite this room for negotiation between the buyer and the lending institution, the amortization period and term specified must take into account the institution’s qualification requirements and whether or not the loan is insured. Thus, while it is desirable to specify a minimum term, such as one year, to allow the buyer the flexibility to negotiate a longer term with the lender, it is important to ensure at the outset that the buyer will meet the requirements for a longer term, such as five years, as is the case when the loan is required to be insured. This is why it is important for the buyer to obtain a pre-approval from the financial institution.
► DUTIES AND OBLIGATIONS OF THE BROKER
Reminder
The immovable presented to the buyer which becomes the subject of a promise to purchase must meet the buyer’s needs and criteria. The financing scenario used must be consistent with these parameters and not be used to force the buyer’s hand.
Undertaking
The mortgage lender’s undertaking must be for an amount equal to or greater than the amount set out in clause 6.1. For example, the buyer may wish to borrow more than is needed to purchase the property because he wants to do some renovation work. However, the financial institution’s undertaking must not be less than the amount indicated, since this would trigger the promise to purchase cancellation mechanism set out in clause 6.3.
The broker must follow up on the mortgage application. If the deadline is approaching and confirmation has not been received, a follow-up should be made with the lending institution or the mortgage broker acting for the buyer. If necessary, the broker should obtain time extensions by using the Amendments form.
For more information:
Mortgage approval: The required document
Promise to purchase and financing of an immovable: The importance of the section relating to new hypothecary loan
Clarifications about financing and inspection deadlines
On the promise to purchase forms: how to provide for the financing of renovations or taxes
Absence of undertaking
If the seller receives no proof of undertaking confirming that the buyer has obtained his loan, the seller may, within five days of the expiration of the period stated for in 6.2, notify the buyer in writing that he requires the buyer to reapply for a loan from a mortgage lender designated by the seller, granting the buyer a new period of time in which to obtain the required undertaking, or render the promise to purchase null and void. If the seller does not act within the five-day period, the promise to purchase automatically becomes null and void.
If the buyer receives a notice of refusal, he must forward it to the seller. The broker must ensure that the refusal is forwarded and that the seller acknowledges receipt. In the event of a refusal, the seller again has five days to decide whether to refer the buyer to another lender. This period is calculated from the date of receipt of the notice and not from the end of the period provided in 6.2. The broker must be vigilant, because depending on the situation, the calculation may be different.
If necessary, the broker must recommend to the seller to prepare his written notice using clauses AV4.1 and AV 4.2 of recommended form Notice and follow-up on fulfilment of conditions – Immovable.
This form is simple to use and has the advantage of providing a signature space for the seller to give notice and for the buyer to acknowledge receipt. It is not the broker’s responsibility to send the notice; it is the seller’s responsibility. However, the broker must remind the seller of the importance of respecting the deadline and the precautions to be taken before he enters into any other undertaking with another buyer, if applicable. The broker can also assist the seller in this process and forward the document for him and obtain an acknowledgement of receipt thereof. Although this engages the broker’s responsibility, it may be the best way to ensure that everything is done properly.
Following the expiration of a deadline not met by one or the other party to the transaction which has the effect of rendering the promise to purchase null and void, the broker should always recommend that his client confirm his intention in writing to the other party. Such a notice avoids any ambiguity as to whether the promise has indeed become null and void. It is very common for the lender’s commitment to be received by the buyer on the last day or the second-to-last day of the period set out in 6.2 of the promise to purchase. The buyer must then act very quickly to inform the seller. The seller, on the other hand, must avoid rushing to send his notice of cancellation on the same day as the deadline expires in order to immediately accept another promise to purchase, especially if he has been informed that the lender’s commitment has been obtained and that it will be sent to him shortly.
Due to circumstances, the seller could find himself receiving confirmation of the lender’s undertaking at the last minute, after having just accepted another promise to purchase. In addition to the potential legal problems that could arise from this situation, the seller could be required to pay remuneration twice. In the context of multiple promises to purchase, the broker should advise the seller to wait until the end of the five-day period provided for in 6.3 before accepting a second promise to purchase. If the seller wishes to accept another promise to purchase while the time limits for providing the undertaking have not expired, then the seller must make the acceptance conditional upon the cancellation of the previous promise to purchase, using clause 2.4 of Annex R – Residential immovable.
