Mortgage terms Part 1 – What Does That Mean?

General Bobby Magee 13 Feb

What does it mean?
 

Mortgage lenders and brokers often use terms that mean something different in mortgage lending than in other endeavours.  

 
Terms like interest, leverage, term and many others have multiple meanings depending on the context.  Compiled here for your information is a list of terms that clients often need defined in the context of the property transaction.

Interest – One of the most misunderstood term in mortgage lending.  Interest is usually thought of as the ‘cost of borrowing’.  It is not that simple, interest is also the description of other participating shares.  A husband and wife may have Joint Interest With Right of Survivor-ship on title to a property. And I won’t even begin to describe the multifarious ways the mortgage interest is calculated! (Maybe in a future blog I will try to untangle this.)

Leverage – What is financial leverage?
Financial leverage refers to the use of debt to acquire additional assets. Financial leverage is also known as trading on equity. Below are two examples to illustrate the use of financial leverage, or simply leverage.

John uses $400,000 of his cash to purchase 40 acres of land with a total cost of $400,000. John is not using financial leverage.

Sue uses $400,000 of her cash and borrows $800,000 to purchase 120 acres of land having a total cost of $1,200,000. Sue is using financial leverage. Sue is controlling $1,200,000 worth of land using only $400,000 of her own money.

If the properties owned by John and Sue increase in value by 25% and are then sold, John will have a $100,000 gain on his $400,000 investment, a 25% return. Sue’s land will sell for $1,500,000 and will result in a gain of $300,000. Sue’s $300,000 gain on her $400,000 investment results in Sue having a 75% return. When assets increase in value leverage works well.

When assets decline in value the use of leverage works against you. Let’s assume that the properties owned by John and Sue decrease in value by 10% from their cost and are then sold. John will have a loss of $40,000 on his $400,000 investment—a loss of 10% on John’s investment. Sue will have a loss of $120,000 ($1,200,000 X 10%) on her $400,000 investment. This is a loss of 30% ($120,000 divided by $400,000) on Sue’s investment.

 
Equity – Or skin in the game
Equity is most commonly used to refer to the amount of investment a borrower has in a particular investment.  As in – if a borrower is seeking to finance 80% of a particular investment the remaining 20% is usually referred to as the borrower’s equity.  The following equation is a simple definition of this type of equity.

             Equity = Assets – Liabilities

Yet, because of the variety of types of assets that exist, this simple definition can have somewhat different meanings when referring to different kinds of assets. The following are more specific definitions for the various forms of equity:

– A stock or any other security representing an ownership interest. This may be in a private company (not publicly traded), in which case it is called private equity.

– On a company’s balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Also referred to as shareholders’ equity.

– In the context of margin trading, the value of securities in a margin account minus what has been borrowed from the brokerage.

– In the context of real estate, the difference between the current fair market value of the property and the amount the owner still owes on the mortgage. It is the amount that the owner would receive after selling a property and paying off the mortgage. Also referred to as “real property value.”

– In terms of investment strategies, equity (shares) is one of the principal asset classes. The other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor’s portfolio.

– When a business goes bankrupt and has to liquidate, the amount of money remaining (if any) after the business repays its creditors. This is most often called “ownership equity” but is also referred to as risk capital or “liable capital.”

Equity’s meaning depends very much on the context. In finance in general, you can think of equity as one’s ownership in any asset after all debts associated with that asset are paid off. For example, a house with no outstanding debt is considered entirely the owner’s equity because he or she can readily sell the item for cash, with no debt standing between the owner and the sale. Stocks are equity because they represent ownership in a company, though ownership of shares in a publicly traded company generally does not come with accompanying liabilities.

Yet, in spite of what seems like substantial differences, these variants of equity all share the common thread that equity is the value of an asset after deducting the value of liabilities. One could determine the equity of a property by determining its market value and deducting liabilities (factoring in any sales commission, early payment penalties, and outstanding property taxes) .

Closing Costs – 
Closing costs are mortgage fees associated with loan generation, escrow payments, title insurance and other third-party fees, and some may shared by both the buyer and the seller. Title insurance protects both the buyer and seller from potential defects in the property’s title and pays attorneys and lawyers to fix any problems before the transaction is complete.
 
Escrow 
A third-party account that safely holds money and documents until the entire purchase of property is complete.
 
It is precisely because financial terms have different meanings that you need to talk to your mortgage professional, they work for you (called Fiduciary Duty) and will help you understand which meaning is being used in your property transaction,  Call your Dominion Lending Centre professional to help you find clarity on your property transaction. It will probably be free and will save you money.
 
I will be adding to this list in future blogs, please check back!
 
Bobby Magee
Mortgage Planner
250-538-7024
bobbymortgages@gmail.com
www.bobbymagee.ca
 
“We have a mortgage for that”

Making The Shoe Fit The Foot.

General Bobby Magee 6 Feb

In every mortgage I have brokered there is a moment when my client says to me in one way or another, “Why does the bank need that?” and, in every case the answer has either been ‘Risk Management’ or ‘Regulation’

And strangely it is the first one that has great effect on the rate.  In other words, if the answer is ‘Regulation’ you will find one mortgage quite similar to other mortgages, all other criteria being equal.  But when the answer is ‘Risk Management’ then you can directly connect the amount of risk management documentation required to the amount the mortgage rate is set to.  

 
An ‘A’ lender’s risk management requirements are often seen as onerous, but it is this very risk mitigation documentation that allows an A lender to offer a better rate than some alternate lenders you may have heard advertised.  The easier it is to get a mortgage, the higher the rate is pretty much an axiom.
 
This is where a borrower really needs a mortgage professional.  It is in the sometimes convoluted risk management policies where the ‘perfect fit’ mortgage can be found.  Borrowers who are self employed, going through a separation, down sizing, up sizing, incorporated, income property, estate planning, recreation, 2nd home etc…… lenders and borrowers have specific needs for their ‘best mortgage’. When a borrower discusses their mortgage needs with a mortgage professional it does not take long to distill the required features of the borrower’s ideal mortgage.  It is knowing what lender and what compromises will best meet the borrower’s needs that the value of the mortgage professional becomes readily apparent.
 
By having a good working knowledge of the mortgage products offered by each lender and their individual risk management requirements, a Mortgage Professional can zero in on the lender(s) most likely to have a product that best meets matches the borrower’s ideal mortgage.  The added bonus is that the professional also knows the unique process by which a mortgage is submitted for at each lender as well as the followup process leading to the closing of the mortgage.  That is why mortgage brokers can provide their services to the borrower for free.  The lenders appreciate the efficiency of only having mortgages submitted to them that have already been vetted to match one of their specific mortgage products and show that appreciation by compensating the broker. 
 
A mortgage professional may also provide referrals and recommendations for many of the other services a borrower needs.  From home and default insurance to legal and financial advisers, a mortgage professional will have dealt with many of them and will have developed opinions on which might have the most experience with the borrower’s mortgage profile. No cost, no obligation.  Why wouldn’t you deal with a mortgage professional?
 
Bobby Magee 
Mortgage Planner
Vancouver, Chilliwack Salt Spring Island

 

DLC/Drake Entrust Mortgage Services

 

 
Introductions to people like you are the backbone of my business.  Please let your friends, family and coworkers know I am available to help them with their mortgage needs​. I appreciate your support, and your referrals will too!