*Please note that School of Scheff is not legal advice and should not be taken as such. School of Scheff provides general legal information which is specific to the Province of Alberta. Should you reside outside the Province of Alberta, please contact a lawyer in your jurisdiction with any legal queries as the laws across the Canadian provinces vary widely.*
A Primer on Mortgages & the Foreclosure Process
If you’re contemplating purchasing a house, you’ve likely come to the conclusion that you’re going to need a mortgage. We all likely understand the concept of a mortgage, but when we truly think about it – do we actually understand what rights we’ve granted the bank or what our obligations are as a borrower? If we become unable to pay our mortgage, most of us understand that the bank is going to foreclose on our house – but what does that actually mean and what does that process look like? If you’ve wondered all of these things, then you’ve come to the right place. We’re going to do a deep dive on mortgages and foreclosures, so buckle up!
There are two main types of mortgages: 1) collateral mortgages and 2) conventional mortgages. We are going to focus on the conventional mortgage, which is the more common of the two types.
Conventional mortgages are a single loan, the mortgage, which is registered against the title to the home as security for the loan.
There are also many different kinds of mortgage products out there within a conventional mortgage and not all mortgages are created equally. There are mortgages that are available to you through the “Big 5” (RBC, BMO, CIBC, Scotiabank, & TD) or “1st Tier” banks and then there is a network of other banks that are not your typical brick and mortar “Big 5” but are sometimes referred to as “2nd Tier” banks. It’s not to say that the mortgages granted by these banks are any less good; but the banks can be more difficult to deal with and get in touch with as a client (for instance, typically, only brokers can access these banks and you can’t walk into a branch if you have questions). They can also have more onerous requirements for approval or be more difficult for your lawyer to work with. At the end of the day, for most people, the interest rate is often what determines which bank that individuals select.
Insured vs Uninsured
Within conventional mortgages, there are insured and uninsured mortgages. This refers to the amount you put down for a down payment which corresponds to whether the mortgage is “insured”. Anything less than 20% down will be insured by either Canada Mortgage Housing Corporation, Genworth Insurance, or Canada Guaranty. The insurance premium is factored into your mortgage and can surprise you if you weren’t expecting it. The fees are a percentage based on the amount of your mortgage but are usually between $5,000-$10,000.
This insurance protects the bank in the event of a foreclosure situation where they have sold the home and the sale proceeds are not enough to cover what is owed.
In these situations, the bank can make a claim to the insurer and be paid the deficiency. Then, the insurer will come to you for the amount they had to pay to the bank.
Mortgages and interest rates can be a bit of a mystery. There are 4 main types:
- Closed Mortgage with a Fixed Interest Rate
- Closed Mortgage with a Variable Interest Rate
- Open Mortgage with a Fixed Interest Rate
- Open Mortgage with a Variable Interest Rate
Closed Mortgage vs. Open Mortgage
What is the difference between a closed mortgage and an open mortgage? This refers to your ability to make payments on the principal balance of the mortgage outside the ordinary payment schedule. One thing that you’ll notice between these two types is that open mortgages tend to have higher interest rates than closed mortgages. This is because one consideration banks have when deciding what to set their interest rates at, is how much money they are able to make on a particular mortgage product. Much of the profit made by a bank on a loan comes from the interest that they collect.
With a closed mortgage, the bank restricts your ability to pay down the principal balance of the mortgage by restricting how much you can increase your payments and how much you’re able to prepay at one time.
Closed mortgages generally carry prepayment penalties should you decide to renew your mortgage or change financial institutions earlier than your term expires. With a closed mortgage, the bank has a pre-determined amount of interest that it is counting on collecting from you over the term of the mortgage and therefore, it is not keen on letting you pay the principal down early and interfering with that interest.
Conversely, with an open mortgage, the bank does not place constraints on your ability to pay down the principal balance of the mortgage. Generally, you can pay as much as you want, as often as you want without penalty. In an open mortgage, the bank has considered in their calculations that they may not make as much money in interest, either because you will pay the principal down more quickly or that you will end the term early, thus reducing the interest payable and the profit made. The higher interest rate on the open mortgage compensates for this.
Fixed Interest Rate vs Variable Interest Rate
What is the difference between a fixed interest rate and a variable interest rate? These two are bit more self explanatory – a fixed rate is an interest rate that is set out at the beginning of the mortgage term and does not change throughout the mortgage term. It will not fluctuate as the prime lending rate rises or falls and can offer much needed certainty. A variable rate is one that is usually tied to the prime lending rate and fluctuates as the prime lending rate changes. Variable rates are generally lower than fixed rates because they carry more risk. In a year such as this one, the prime lending rate has changed rapidly and thus the risk may not have paid off; however, during COVID when the rates were low, those with variable rates were reaping the rewards. A variable rate mortgage generally carries with it the ability to “lock-in” to a fixed rate, but this does not mean you lock into your current variable rate, it means that you can “lock-in” to whatever the current fixed rate is at the time you “lock-in”.
Mortgage Term vs. Mortgage Amortization
The last major component of a mortgage is the mortgage term and over what period of time the mortgage is amortized for. Some people use these two terms interchangeably, but they are very different. Mortgage amortization refers to the number of years that your mortgage is meant to be paid back over. This can be 15 years, 20 years, 25 years, and in some cases 30 years. Generally, the longer the amortization period, the lower the mortgage payment. Conversely, the mortgage term is how long the current interest rate that you have is locked in for with your current lender.
You can get terms anywhere from 1 year to 10 years and the interest rates adjust according to the length of the term. The longer the term, the higher the interest rate.
If you are a first-time home buyer then you most likely will be looking at a 25 year amortization over a 5 year term. At the end of that term, you will either renew with the current lender or shop around and find a new lender. At the end of a five-year term, you would then be looking at a 20 year amortization over another 5 year (give or take) term. Each time you renew or re-finance, you are subject to the current market rates.
Standard Terms and Foreclosure
Every financial institution has a set of standard terms and conditions that apply to every mortgage product that they offer. They are usually 30-60 pages long and serve as fantastic bedtime reading material.
What do the standard terms and conditions say? They contain very important terms and if you are ever signing mortgage documents with me, this is the Coles notes version that I provide my clients (should they decide they don’t want to review them in detail):
- The bank has agreed to lend you money and you have agreed to pay that money back over time with interest.
- You have also agreed to do a number of things to protect the banks asset, your home, and yes, you can think of it as the bank’s house until it’s fully paid off.
- The bank is interested in ensuring that should they need to foreclose on your home and sell it that they will get as much money as they can. In order to do that, you have agreed to keep the house insured; pay the utilities; pay the property taxes (and condominium fees, if applicable); keep the home in a reasonable state of repair; and not let builder’s liens get registered against the title to the home and if you do, you’ll take all reasonable steps to have it discharged.
- The other very important part of the standard terms is the default section which contains all of the nasty things that the bank can do in order to ensure that they recoup the money that they’ve lent you or to ensure that their asset is protected.
- The bank is allowed to take any of those steps, or none of those steps, at any time if the mortgage is in default. One of those remedies is to foreclose on the home. Another is that the bank can bring you to Court in order to fix a lesser default (such as your failure to insure the home). If the bank has to do either of these things, you get the added bonus of paying for all of their legal fees.
- The mortgage can be in default for a few reasons, one of which is if you fail to make the mortgage payments when due, but other acts of default are failing to do any of the things that you agreed to do such as pay the taxes, utilities etc. etc.
You missed a mortgage payment – now what?
Every bank is different in how they pursue their foreclosures. Most do not want to jump straight to instructing their lawyers to commence an action as that starts to run up costs and after the first missed payment, most individuals will respond to a letter from the bank or they will catch up without prompting.
After two missed payments, the bank is likely to send you a letter. Don’t ignore your bank. Ignoring the problem isn’t going to make it go away and most mortgages contain a “skip-a-payment” option or some banks are able to work with you to come up with a plan.
They are much happier to get a response from you, then to have you ignore the problem. After a third missed payment, the bank is likely to instruct their lawyer to issue you a formal demand outlining the arrears owed in order to bring the mortgage back into good standing. The letter will contain a deadline for payment and if payment is not received, the bank is most likely going to instruct their lawyer to start a lawsuit and formally begin the foreclosure process.
From here, you would be served with the statement of claim and have 20 days to file a defence or a demand for notice. If no defence is filed, the bank can note you in default and obtain a valuation of your house to determine the price at which they’re going to list it at. These documents are filed with the Court and the lender will usually apply for a Redemption Order.
At this stage, all is not lost! If there is still term left on your mortgage, generally you will be granted 6 months to bring the arrears current. During this time the bank can take no action to sell your home. In rare circumstances, the Court may shorten the redemption period to less than 6 months but there has to be a compelling reason (such as the borrower being deceased).
If you are able to bring the arrears current within the 6 months, that ends the foreclosure process. If not, at the expiry of the 6 months, the process to sell the home will begin and the home will be listed. At this stage, all is not lost either! So long as there is term left on your mortgage and the home has not been sold to a bona fide third party, you can still pay the arrears, bring the mortgage current, and stop the foreclosure process.
While this isn’t everything you could possibly need to know about mortgages or the foreclosure process, it should give you an idea of what to research further and if you ever find yourself in a foreclosure situation, hopefully it provides you a bit of comfort knowing that you have options.