Mortgage Basics

A mortgage is a loan secured by the property you are purchasing. The borrower is referred to as the mortgagor and the lender is known as the mortgagee.

A down payment, which is the initial amount you put towards your purchase price, can be as little as 5%. Your mortgage amount will be the difference between the purchase price less the down payment. Your down payment can come from the following sources:

1) Personal savings and investments

2) RRSPs

3) A gift from a family member

4) A loan (some restrictions apply)

Mortgage payments include, the principal, interest, and the fee charged for borrowing the money (e.g. mortgage loan insurance). If you have a high ratio mortgage, which is a down payment of less than 20% towards the purchase price, you will be required to insure the mortgage through Canada Mortgage and Housing Corporation (CMHC), Genworth Financial or Canada Guaranty. Mortgage loan insurance (aka Mortgage Default Insurance) varies between 0.5% and 7% depending on your down payment amount and your qualifying position. Most commonly your insurance cost is 2.75%.

Pre-Approval

A pre-approval is not necessary, however, it is an important indicator to the amount you can borrow from a lender. This will assist you to find properties within your price range. Pre-approvals also guarantee a rate for upwards of 120 days. This is especially important if rates are expected to increase in the short term.

Options

There are many options that can provide you with significant savings depending on your ownership goals.  Rate should not be your only driving concern.  By not limiting yourself to just the lowest rate, we can consider finding a plan that could give you more flexibility and provide savings on penalty fees, interest, or additional costs down the road.  In many cases, these savings can give you the same or better return on your investment than if you chose to go with the lowest posted rate.  Read more about your term and repayment options below:

Term Options

There are generally two types of terms, short terms and long terms. Short terms are usually considers two years or less while long terms are over three years. Term duration usually runs between six months to ten years, with two to five years being the most popular. In most cases, the shorter the term, the lower the interest rate due to the lower risk to the lender. A person may choose a short-term mortgage if they are expecting the interests rates to be lower at the time of renewal; where as a person may go with a long-term option for stability and comfort.

At the end of your term you will need to either pay your remaining balance or renegotiate the mortgage. Renegotiating can be with the same lender or by going through your mortgage professional to optimize your mortgage position.

The amortization of a mortgage can range in years, the average being between 15 to 25 years, but can go up to 25 for high ratio mortgages, or up to 35 years for a conventional mortgage depending on the lender. By extending the amortization, payments can be lowered, which usually assists applicants to get a higher mortgage amount by effectively lowering their debt ratios.

Repayment Options

In today’s market, there are a number of products available to support you and your level of comfort in repaying your mortgage. Fixed rates offer predictability and consistency, which are great for budgeting and life planning. You’ll know how much each of your payments are and what the total outstanding balance will be. Variable rates provide more flexibility and allows for fluctuations in cash flow, which can be very rewarding if interest rates drop over the term. When you are deciding whether variable or fixed is best for you, take into consideration the economic outlook, but don’t weigh everything on that. Blend in your understanding of your current financial commitments with your personal and professional objectives to see what fits with your lifestyle.

Lump sum payments can usually be applied to your mortgage, but the limit may vary greatly over the type of product you select. A typical closed mortgage will allow you a 10-20% lump sum payment each year without penalty, but will charge a penalty if the loan is fully paid before the term closes. This penalty differs again, but is usually the greater of three months’ of interest or an interest rate differential.

An open mortgage saves you the penalty charges should you be able to pay out your mortgage before your term is complete. It is also an ideal option if you are in a position where you can make a number of large payments. Open mortgages have higher interest rates due to their flexibility, but by having the flexibility to make lump sum payments, you will save on the overall interest paid.

A convertible rate mortgage option allows the borrower to change the type of mortgage during the term. It usually has lower rates than the open mortgage and allows you to lock into a fixed rate.

Home owners who have built up equity in their homes and are equity rich, but cash poor, have the option of refinancing or in retirement considering a reverse mortgage for living expenses.  The outstanding balance must be paid at the end of term, or in the case of death of the borrower, the property can be sold to clear the loan.