Understanding Mortgages


Overview

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 of the money required to finance the purchase of the home. A mortgage allows individuals to buy property without paying the full value all at once. The person borrowing the money is called the mortgagor; the lendee is called the mortgagee.

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 mortgages available, each offering different terms by which the mortgage must be repaid.

Repayment

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.

Mortgage Insurance

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.

First Time Home Buyers

Canada Mortgage and Housing Corporation (CMHC), Genworth Financial and AIG United Guaranty offer assistance to first-time home buyers who do not have a lot of disposable funds for a down payment. Ask your mortgage professional for more details.

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Terms and Rates

What Is the Term?

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, two to five years being the most common. 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

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

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. In recent years, mortgage lenders and insurers have offered consumers longer amortization periods of 30, 35 and 40 years.

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.

Rates

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.

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MortgageTypes

OpenMortgages

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.

Closed Mortgages

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.

Convertible Mortgages

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.

Reverse Mortgages

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.

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Closing Terms and Costs

Final Negotiations

When you and the seller come to an agreement on the price to be paid for the house, you must provide a deposit. A deposit is an advance payment of part of your down payment and is paid at the time of signing the Agreement of Purchase of Sale.

The Agreement of Sale is a legal document the buyer and seller approve detailing the price & terms of the transaction.

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 semi-annually 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.

Consider Insurance Protection

Talk to your mortgage professional about insurance protection against your mortgage in case of death, accident or illness. There are many insurance options to choose from.

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Paying Off Your Mortgage Sooner

Shorten Your Mortgage

There are many benefits to shortening your mortgage, and thereby paying less for the cost of borrowing the money. You can free up money for other things in your life - the education of your children, money for your retirement or an emergency fund.

Make More Payments

Increase the frequency of your payments. Ask your mortgage professional to show you how you'll save by paying bi-weekly or weekly instead of monthly. Paying more frequently can save you hundreds of dollars in annual interest costs.

Max out Your Down Payment

Make the biggest down payment you can afford. This will substantially reduce the length of time to it takes you to repay the mortgage. If interest rates decrease when it is time to renew your mortgage, consider keeping your payments the same and applying more money to the principal.

Make Pre-Payments or Anniversary Payments

Most mortgages will allow you to make payments up to 20% of the entire mortgage once a year. This money is applied directly to the principal, saving you money in annual interest costs. Consider using your tax refund or annual bonus for this type of payment.

Make lump sum payments whenever your financial circumstances permit.

Double your payments whenever possible.

Shorten the Amortization

Choose a shorter length of time to repay your loan. Ask your mortgage professional to show you how selecting a 20 year amortization period instead of a 25 year amortization period will affect your payments and interest costs. Consider choosing 15 years to repay if possible. Your mortgage payments will be higher but you'll pay substantially less interest over the course of the loan.

If interest rates have dropped when you renegotiate your next term, keep your mortgage payments the same. More money will go directly to paying down the principal.

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Types of Homes

Condominium

A form of ownership in which the homeowner purchases and owns a unit of housing and shares financial responsibility for common areas. (In British Columbia, these are also called "stratus".)

Detached/Freehold

A property where you own both the property and the land on which it is built.

Townhouse

An attached home that is not a condominium.

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Finalizing Your Mortgage

You will be required to provide the following list of information to your mortgage professional to finalize the mortgage:

  • Employment letter to confirm income and time with employer
  • Verification of your down payment
  • List of assets
  • List of liabilities
  • Contact information for your lawyer
  • Copy of the Purchase Agreement
  • Copy of the MLS listing
  • Contract and building plans if your home is being built

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What to Ask Your Mortgage Professional

  • What is your role in helping me buy a house?
  • What products do you offer?
  • Why are you recommending this particular mortgage?
  • What is your relationship between you and the lender?
  • How are you compensated?
  • How long have you been in business?
  • How long will it take to process my application?
  • What documents do I need to provide?

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