One of the first steps in buying a new home is to take a realistic look at what you can afford and how you are going to pay for it. If you are like most people, you will probably have to finance your home purchase with a mortgage loan. What follows is an explanation of terms and options to understand when considering what mortgage is right for you.
What is a mortgage?
A mortgage is a loan that uses the home you buy as security. This loan is registered as a legal document against the title of your property. Here’s a quick overview of some of the most common aspects of a mortgage that you need to understand.
- Amortization period
- Maturity date
- Payment schedule
The principal is the amount of the loan, or the cash actually borrowed.
The interest is the amount the lender charges for the use of funds, or principal. Interest rates vary according to many factors, including terms and conditions of the mortgage as well as a borrower’s credit history. Mortgage payments are usually applied toward both principal and interest.
The amortization period is the actual number of years that it will take to repay the entire mortgage loan in full. This normally ranges from 15 to 25 years but can be extended in certain circumstances. A longer amortization period will result in lower payments but it will take that much longer to pay off your mortgage which in turn means you will pay more interest.
You should select the shortest period you can afford.
The term is the length of time for which a mortgage agreement exists between you and your lender. Typically, terms range between six months and ten years. A longer term means you will keep the interest rate agreed upon for that longer length of time. Rates vary with the term and the difference in payments and interest costs can be calculated by your mortgage professional. Once your term is up you are able to reevaluate your financial situation and consider new term and amortization periods.
The maturity date marks the end of the term, when you can either repay the balance of the principal or renegotiate the mortgage at interest rates in effect at that time. If you should choose to repay the balance or renegotiate the mortgage before this date, penalties may be charged.
Payment schedule is the frequency at which you will make your mortgage payments. These can occur monthly, semi-monthly (twice a month), biweekly (every other week), or weekly. Generally, more frequent payments can result in lower interest costs over the life of your mortgage.
Some Mortgage Options:
- Open vs. Closed
- Fixed, Variable or Adjustable Interest
Mortgage Options let you tailor the mortgage to fit your personal needs and circumstances. Open or closed mortgages, pre-payment options, fixed or variable rates or portable mortgages are just a few of the most commonly available options.
Open vs. Closed:
Open, describes the option to prepay without penalty allowing a borrower to make large lump sum payments or pay off the entire mortgage without incurring extra fees. This option generally comes with higher interest rates and shorter terms. This is a good option if you plan on selling your home soon, or need a short period of time to weigh your options before locking into a closed mortgage.
Closed,may set a limit on the amount or frequency at which lump sum payments are allowed. Should you choose to pay off your mortgage before the end of term you will most likely be charged a penalty. As such they are not a good option if you plan on moving in the near future. They do however involve fixed payments allowing a homeowner to adjust to a new budget that now includes regular mortgage payments. Also, terms are normally set for longer periods allowing for greater certainty when planning for the future.
Fixed vs. Variable vs. Adjustable:
Fixed,describes an interest rate which will not change over the term of the mortgage. This is a good option when interest rates are low and are expected to rise in the near future. It also gives a first time homeowner time to adjust to any change in budget that making mortgage payments may have caused.
Variable, means that the interest rate being charged is changing based on the interest rate set by the Bank of Canada. This rate fluctuates based on market conditions. Your payments will, with few exceptions, continue to stay the same however the amount you are paying will be distributed to the interest and principal in different amounts. If interest rates rise you will be paying off less of the original borrowed sum as more of your payment goes to interest. The opposite being true should interest rates drop. If you have a fair bit of flexibility in your budget this may be a good option as variable rates over the life of your mortgage often result in lower interest charged.
Adjustable, as with the variable option above, interest rates will change with market conditions however any change in interest rate will result in an increase or decrease in payment. This option should be considered with great care as an increase in rates could results in payments outside you budgetary limits.
Your mortgage professional can help you decide which option is best for you by talking to you about current market conditions and expectationson future rate changes, as well as the risk you are willing to assume within your personal budget.
Many lenders offer products which will allow you to carry your current mortgage to a new home should you decide to move. The options vary by lender so please consult your mortgage broker if this is something you may be planning in the near future.
Regardless of the type of loan (fixed/variable, term, amortization) most lenders will have guidelines that will allow you to pre-pay a portion or percentage of your mortgage in advance of the end of the term. Such conditions often include anoption to double up a payment or pay an extra 10-20% each year on the amount of principle borrowed. These conditions should be considered with care should you anticipate any ability to make larger mortgage payments in the future. Pre-payments can make a drastic difference to the interest incurred over the life of the mortgage as they are applied only to the principle amount and not divided between principle and interest as your regular monthly payments will be.