Our “Mortgage Basics” Section is designed to help lift the fog surrounding the mortgage process and guide you in making a financial decision that is right for you.
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What is a Mortgage?
Few people can come up with the entire amount of money required to pay for the cost of a home. A mortgage is a loan secured against real estate. A mortgage allows individuals to buy property without paying the full price all at once.
When negotiating the amount of your mortgage, you should be aware that you will most likely be required to provide a down payment which is the money you put towards the purchase price of your home. The amount of your mortgage is determined by the purchase price of the home less the amount of your down payment. As with all loans, a mortgage must be repaid by the borrower with interest. There are different types of repayment methods which make up the different kinds of mortgages available.
Like all loans, regular payments made over time go towards paying down the mortgage. These payments are made up of two parts – one part goes towards paying the principal (the amount of money borrowed) and other part goes towards paying the interest (the fee charged for borrowing the money.)
The more money you can put down, the less you will have to borrow, and the less interest you will have to pay over the length of the mortgage.
If you have a down payment equivalent to 20% or more of the purchase price, you will have what is called a conventional mortgage.
If your down payment is less than 20% of the purchase price, you will have what is called a high ratio mortgage. A high ratio mortgage must be insured to protect the lender. This insurance is called mortgage default insurance. It protects the lender in case the borrower isn’t able to repay the loan.
More often referred to as a pre-approval, a pre-qualification is where you complete a mortgage application with a Mortgage Professional. By analyzing your income and debt obligations, a mortgage professional will be able to give you a maximum mortgage amount. By know this maximum mortgage amount, it will avoid you from looking at homes that may be out of your price range.
A closed mortgage is a commitment with a pre-determined interest rate, over a pre-determined period of time. A buyer who uses a closed mortgage will likely have to pay the lender a penalty if the loan is fully paid before the end of the closed term.
With a closed mortgage, the interest rate will not change over the length of the term and the length of the term will not change. Payment amounts are predictable and the principal amount owing at the end of the term is predictable.
Closed mortgages generally have lower interest rates than open mortgages. Most closed mortgages will allow the homeowner to make a payment up to 20% of the entire mortgage once a year without penalty. This payment goes directly toward paying down the principal of the amount owing.
NOTE: There are some really low interest rate mortgage products on the market that are FULLY Closed. These type of products are NOT flexible and will NOT let you get out of the mortgage unless you sell your property. No Porting your mortgage to another Property. No Refinancing. No Prepayments. No Blending and Extending. No Blending and Increasing. FULLY Closed!
If you want to make large payments on your mortgage or pay off the entire mortgage without penalty, then an open mortgage is for you. An open mortgage offers maximum flexibility. These homeowners are willing to accept some fluctuation in the interest rate for the flexibility of paying off the entire mortgage before the term is complete.
It is important to keep in mind that most regular mortgages will allow homeowners to make lump sum payments of up to 20% of the entire mortgage once a year without penalty. These are often called privilege payments. That payment goes directly towards paying down the principal of the amount borrowed. You may therefore not need an open mortgage, with higher interest rates, to make additional payments.
NOTE: Most OPEN mortgages today take the form of Home Equity Line of Credits. These Home Equity Line of Credit products can really hinder you at renewal time; as they are registered as Collateral Charge Mortgages. Most lenders will not simply “Switch” your mortgage to them. You’ll have to discharge your current mortgage and then re-register the mortgage with the new financial institution. This means new legal fees. Click here for more info
A convertible mortgage is an agreement made at the beginning of a term that allows homeowners to change the type of mortgage they hold during its term.If a homeowner wants to start with an open mortgage and then lock into a closed mortgage, a convertible mortgage is the right choice. It offers lower rates than an open mortgage, and has the option of switching to a closed term.If stated at the onset of the mortgage, it may also allow a homeowner to change from a Variable to a Fixed Rate mortgage.
This type of mortgage allows older consumers to convert their home equity into monthly cash payment(s), generally for living expenses. A homeowner’s equity is gradually drawn down by a series of monthly payments from the lender to the homeowner – the borrower. At the end of the loan period, or upon the death of the borrower, the loan balance is due, which is usually settled by the heirs who sell the property to meet the outstanding obligation.
NOTE: This mortgage product is NOT for everyone. Make sure you speak with a Mortgage Professional before getting into one of these mortgages. There are other options.
The term of a mortgage is the length of time a lender will loan mortgage funds to a borrower. This duration can be from six months to ten years. Generally, the shorter the duration of a mortgage term, the lower the interest rate, and the less it costs to borrow the money. At the end of each term, you will either pay off the balance owing or renegotiate the mortgage for another term until the entire mortgage is paid back.
Short term agreements or mortgage contracts are usually for two years or less. Short term mortgages offer a lower cost of borrowing (interest rate) than a longer term. People who believe that interest rates are currently higher than they will be in the future generally choose a short term mortgage. They anticipate that interest rates will be lower at the time of renewal.
Long term agreements are generally for three years or more. Long term mortgages cost a bit more than short term mortgages, so the interest rate will be higher. A higher interest rate appeals to borrowers who value the stability and predictability of fixed expenses over a set period of time. A stable mortgage payment is easier to budget and offers peace of mind.
It can take a long time to completely pay off your mortgage – usually from 15 to 25 years. The process of fully paying off your loan by installments of principal and interest over a definite period of time is called Amortization.
There are many ways of repaying your mortgage. Some people find comfort in a pre-determined fixed rate – it helps them budget and plan for other things in their life. Some people desire more flexibility in their repayment – their circumstances might include fluctuations in their cash flow, and they may want to make larger payments whenever possible. Different kinds of mortgages appeal to the different types of borrowers. Your mortgage professional can help you decide what is best for you.
An interest rate is the amount of interest charged on a monthly loan payment, expressed as a percentage. It is based either on the rate the Bank of Canada charges to lend money to money lenders or on bond yields. Interest rates are generally lower if you borrow money for a short period of time and higher if you borrow the money for a longer period of time.
Fixed Rate Mortgage
When you agree to a fixed rate mortgage, your interest rate will never change throughout the term of your mortgage. There are no surprises as you’ll always know exactly how much your payments will be and how much of your mortgage will be paid off at the end of your term.
Variable Rate Mortgage
When you agree to a fluctuating interest rate for the length of the term, then you have a variable rate mortgage. Interest rates fluctuate with the bank’s prime lending rate, and may vary from month to month. When interest rates change, your payment amount remains the same, however the amount that is applied to the principal will change. For example, if interest rates drop, more or your mortgage payment is applied to the principal balance owing. The variable rate mortgage is a good option for homeowners who believe that interest rates are currently high and will drop.
NOTE: There are some people that will only pay the minimum amount they can with a Variable Rate Mortgage. In this case the payments may fluctuate from month to month, as the Prime Lending Rate changes.
Closing Terms and Costs
When the buyer and the seller come to an agreement on the price to be paid for the house, and Agreement of Sale (or Offer to Purchase) is completed. It is a legal document that details the price and terms of the transaction that must be approved and signed by both the Purchaser and Seller.
When making an offer, the Purchase must provide a deposit. The amount of the deposit varies depending on Purchase Price. This deposit can also form part of your down payment amount that a lender requires. If the offer is not accepted, your deposit will be returned to you (another benefit of dealing with a Realtor or Lawyer).
When negotiating the cost of the house you want to purchase, it is important to keep in mind that you will also be required to pay property tax. Property tax is paid on privately owned property and is usually paid in installments or monthly. The amount is based on local tax rates and assessed property value.
Other than the deposit and down payment, you should keep in mind that you will likely also be paying for a home inspection – an examination of the structure and mechanical systems to determine a home’s safety and makes the potential homebuyer aware of any repairs that may be needed.
Other Closing Costs
Appraisal Fee: The process of assessing the value of a home, usually to determine a selling price. An appraisal is not always necessary.
Land or Property Transfer Tax: A tax paid on property that changes hands. First time buyers may be eligible for a rebate in certain provinces.
Legal Fees: The cost paid to have a lawyer finalize the property transfer between the seller and the purchaser.
Mortgage Loan Insurance:Mortgage loan insurance enables home buyers to purchase a home with as little as 5% down payment. The amount of the insurance premium depends on the amount borrowed from the lender. This amount is usually added to the mortgage total and paid down through the years. However, the GST/HST on this premium must be paid at closing time.
Title Insurance: Title Insurance provides the purchaser with coverage against title risks inherent in real estate transactions (including title fraud) for as long as you own your home.You may also have to pay for Lender Title Insurance. This will vary depending on the Lender.