The ABCs of buying a house
Part II: The offer to purchase and the mortgage
In Part I of my article I discussed the different players involved in a house purchase. In this part, I will discuss the Offer to Purchase and the mortgage process.
Once you have found the house you want to make your home, you must make a formal offer to purchase. If you have a real estate agent assisting you, they will draw up the offer. If you are purchasing through a private sale, you will need to hire a lawyer to prepare the offer for you.
What is the Offer to Purchase?
The Offer to Purchase (OTP) is the legal document presented to the vendors (the people selling the house) with your formal offer on the house. The OTP outlines the purchase price you are offering to pay, the appliances you are asking to be included in the purchase, the possession date, the date the offer expires and any other conditions you are requesting. Three of the more common conditions requested are:
- that the offer is subject to the purchasers obtaining adequate mortgage financing;
- that the offer be subject to an adequate home inspection report;
- that the vendors provide the survey certificate or zoning memorandum, if available.
Once the vendors receive the OTP, they can accept it, reject it, or make a counter-offer. If a counter-offer is made, the purchasers will have to decide whether or not to accept it, reject it or make their own counter-offer.
Once all parties accept the OTP, copies of the signed OTP must be provided to the lawyers for the purchaser and vendor and to the financial institution providing the purchaser with a mortgage.
Before the OTP can be final, any conditions placed on the offer must first be met. For example, if the three more common conditions are placed on an offer, all three must first be met and removed before the OTP can be final and binding.
Most homebuyers will try and obtain a mortgage pre-approval before they begin their search for the perfect house. However, a pre-approval does not always mean that the financial institution will give you a mortgage. A pre-approval simply means that based on your financial situation, you are pre-approved for a certain loan amount. Once you have found the house you wish to purchase, you must submit the OTP to the financial institution for their final approval. I will discuss this in more detail later on in this article, under Mortgages.
Once the financial institution provides their final approval, the financing condition has been satisfied and can be removed from the OTP.
If the OTP is subject to an adequate home inspection report, the purchasers must hire a home inspector to conduct the inspection. Once a report is produced, the purchasers will need to decide if they still wish to proceed with the purchase or back out. They can also try and renegotiate the price of the house if the report turns up problems. However, it will be up to both parties to decide if they want to renegotiate or not.
The survey certificate and zoning memorandum are documents required by most financial institutions for obtaining a mortgage with them. If the vendors have these documents, they tend to give them to the purchasers as a courtesy. However, if the vendors do not have these documents, it is the purchasers’ responsibility to meet the requirements of their financial institution.
Once all the conditions have been met, the OTP is now final. Should either party wish to back out of the contract, they will have to face the legal consequences.
The cost of buying a house
The purchase price is normally split into three parts – the deposit, the down payment and the mortgage.
Once you make an offer on a house, if it is accepted, you as the purchaser will need to give the vendors a deposit. This can range anywhere from $500 to $1000, $5,000 to $10,000 or more. The amount of the actual deposit required will depend on the two parties involved. The deposit is used to secure the purchase until the possession date. This deposit is non-refundable should the Purchaser decide to withdraw from the deal. The only way to get your deposit back is if you placed a condition on the purchase and that condition was not met.
For example, if you placed a condition on your offer that said it was “subject to mortgage financing” but you are unable to secure sufficient mortgage financing then you can get out of the contract and you are entitled to receive your deposit back. However, if you want to back out of the deal because you found a better house or if you can’t find someone to sublet your current apartment, those are not acceptable reasons to get out of the contract with your deposit. However, the purchaser can still choose to break the contract but they would lose their deposit. Furthermore, if the purchaser decides to break the contract, the vendor has the option of suing the purchaser for breach of contract.
Down payment and mortgage
The amount of the down payment made on the purchase will depend on the purchasers. However, the amount of your down payment will determine what kind of mortgage you will require.
A conventional mortgage is a mortgage loan that does not exceed 80% of the lending value of the property. The lending value is typically the lesser of the property’s purchase price and market value. If you place a down payment that is at least 20% of the purchase price, then you are obtaining a conventional mortgage.
If you contribute less than 20% of the home price as a down payment – and as little as 5% – you will need a high-ratio mortgage. This type of mortgage usually requires mortgage loan insurance, which is available from Canada’s national housing agency called the Canada Mortgage and Housing Corporation (CMHC) or a private company. CMHC will charge a fee to the lender for providing this insurance. In turn, the lender will typically add the mortgage insurance premium to your mortgage or ask you to pay it in full upon closing.
The mortgage insurance premium is based on a percentage of the home’s purchase price that is financed by a mortgage. If you’d like to see the calculation chart used by CMHC you can visit: www.cmhc.gc.ca.
What are the benefits of mortgage loan insurance? It helps protect financial institutions against mortgage defaults and it provides purchasers with a minimum 5% down payment with the ability to purchase homes at interest rates that are comparable to those buying with a down payment of 20%. Without CMHC’s involvement, many financial institutions may not be so willing to provide mortgages to individuals who have less than a 20% down payment.
Once you have made an offer on a house, you need to submit the OTP to the financial institution for final approval. If you are obtaining a high ratio mortgage, the OTP must also be approved by CMHC. CMHC may ask that an appraisal of the house be conducted to ensure that the purchase price does not exceed the fair market value (FMV) of the property; in other words, that it is not too high. It is at this stage that problems can occur.
For example, if you made an offer on a house for $200,000 and planned on making a 5% down payment ($10,000) you will require a mortgage of $190,000. If CMHC asks for an appraisal and the appraisal report states that the FMV of the house is only $180,000 then it will only approve a mortgage based on a $180,000 value. In other words, a normal 5% down payment on $180,000 is $9,000 with a mortgage of $171,000. If the house is being sold for $200,000, and you are only eligible to get a mortgage for $171,000, your down payment increases from $9,000 to $29,000. In most cases, this will result in the rejection of the mortgage application because the purchasers will not have the money to pay the additional down payment.
In this same example, if the purchasers were planning to make a 20% down payment of $40,000, there would be no CMHC requirements involved. Thus, when there are bidding wars involved in the sale of a house, be careful not to get too carried away with your bids. At the end of the day, you might outbid your opponents but still lose the house because CMHC states that house’s FMV is less than your bid. This is another reason why it is always prudent to place a financing condition in the Offer to Purchase.
The content of this article is not intended as legal advice and is for information purposes only. Should you require legal advice on a specific issue relating to the contents of this article, please seek the services of a legal professional.
Alona C. Mercado is a lawyer practicing in Winnipeg with the law firm of MONK GOODWIN LLP. She was called to the Manitoba Bar in 1999 and the Ontario Bar in 2003. Her preferred areas of practice include wills and estates, committees, real estate and immigration law. Alona can be reached at (204) 956-1060 ext. 233 or firstname.lastname@example.org.