Buying a Home North of the Border? How Canadian Mortgages Differ From U.S.

Many Americans or Canadians that have spent the past number of years in the U.S. assume that navigating the mortgage landscape in Canada will be the same as what they have experienced in the U.S. We are next door neighbours, after all!

There are some similarities such as Canadian lenders will use your credit history, your earned income, and your existing debts to base their decision on how much debt to offer you. There are also a number of differences, with the key being:

• Amortisation periods

• Mortgage terms

• Mortgage prepayments

• Mortgage debt-service ratios and stress-test

• Interest deductibility

Amortisation and Mortgage Terms

In the U.S. it is common to have a mortgage amortisation for 30 years, whereas in Canada a 25 year term is the most common and a 30 year amortisation is generally not available to all borrowers.

A mortgage term is a period of time within the amortisation period that your interest rate structure is guaranteed for. Terms are offered between 6 months up to 10 years, but the most common in Canada is a 5 year term. You can choose a fixed rate term where your interest rate will remain even through the length of your chosen term, or a variable rate term where the interest rate is set against the lender’s prime rate, for example prime -0.5%.

At the end of a Canadian mortgage term, you have the options of:

1. Paying off the balance without any penalty, or

2. Renewing the mortgage with the same lender, or

3. Renegotiating with a new lender.

Mortgage Prepayments

In Canada, usually the most competitive interest rates for a fixed or a variable rate mortgage is with what’s called a closed term. A closed term means that there are limitations to how much extra money you can pay onto your mortgage in a year above your regular payment schedule (called prepayments). If you make more prepayments on a closed mortgage than you are entitled to, there are penalties charged by your lender. To complicate things even further, each lender has their own conditions around what they allow in the way of prepayments. A typical allowable prepayment on a 5-year fixed term mortgage would be somewhere between 10-20%, depending on the lender.

Mortgage debt-service ratios and the mortgage stress-test

American mortgage lenders look at your debt-to-income (DTI) ratio to determine mortgage eligibility. Canadian lenders are more stringent with two tests called gross debt service ratio (GDSR) and total debt service ratio (TDSR) and the new mortgage stress-test. The GDSR looks at pre-tax income used to pay for all housing costs and the TDSR looks at all your personal debts and your ability to service these in addition to the new mortgage. Most mortgage providers are looking for a maximum GDSR of 32% and a maximum TDSR of 40%.

Additionally, all borrowers in Canada face an interest rate stress-test to qualify for a mortgage. The reason for the stress test is to ensure that a borrower can still qualify for their mortgage if interest rates increase in the future. Currently, the stress test is a calculation of your ability to service your debt based on the higher of the lender’s interest rate offered to you plus 2%, or 5.25%. For example, if a lender makes you an offer of a 5-year fixed term at 3.65%, you would need to prove your household can handle the required payments for a mortgage of 5.65% (higher than 5.25%). Additionally, at the end of a mortgage term you may have to qualify through another stress-test. The Government of Canada has a stress-test tool at this link.

Interest deductibility

Unfortunately, unlike in the U.S., the interest payments on your principal residence in Canada are not tax deductible as they can be for some in the U.S. This is because Canadians enjoy something called the principal residence exemption, meaning when you sell your primary residence in the future, it is a tax-free transaction. In the U.S., each individual has only a $250,000 real estate exemption, and anything beyond this is a capital gain on sale (subject to certain exceptions).

Getting yourself mortgage ready

If you have started house shopping but are not yet living here or newly arrived, it is ideal to get your down payment ready in Canadian dollars in a Canadian bank account as soon as possible. Ideally, look to have your down payment ready in the Canadian account 90 days prior to making a down payment.

As well, you will need to have Permanent Resident (PR) status to purchase a home in Canada. Current regulations prohibit non-PR status individuals from purchasing a home throughout 2023-2024 (subject to change).

Depending on how long you have been living in Canada and creating credit history here, it is more likely that the lender will want to look at both your Canadian and U.S. credit reports.

Consider working with a mortgage broker or lending institution that has experience with US/Canada lending. They will ensure you have all of your ducks in a row and lessen the stress in what is already a stressful situation.

First-time home buyers

For Canadian Permanent Residents there are a number of incentives and rebates to help buy your first home. Some of these schemes are based on your province (eg. Ontario’s land transfer tax refund) or even city specific (eg.Toronto’s first-time purchaser rebate) so make sure to do your research to see what applies to your geographic location. The most commonly used program would be the Federally introduced First-time Home Buyer’s Plan (HBP) which allows you (and your spouse) to borrow up to $35,000 from your RRSP(s), tax-free towards the down payment of your primary residence. Check out the Government of Canada Homeowners page for further details.

To be eligible as a first-time home buyer for most of these schemes, you and your spouse must not have lived in a home that you owned in the four-year period prior to and including the year of purchasing your new home.

As of the 1st of April 2023, the Canadian federal government has introduced the new First Home Savings Account (FHSA) to help Canadians save for their first home purchase. Like a TFSA, they are likely to be viewed as a foreign trust for U.S. persons and have onerous filing requirements. Speak with your cross border accountant before opening a FHSA to save for your first home down payment.

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