Mortgages in 10 lessons

You’re almost ready to realize your dream and buy your first home, but the very thought of a mortgage gives you hives? You don’t understand anything when it comes to down payments, interest, insurance, amortization and mortgage terms? Don’t worry! These simple points will help demystify mortgage loans and equip you to choose a mortgage that’s right for you.

1. The down payment

In order to buy a home, you will have to pay a portion of the cost from your pocket. This amount – known as the down payment or cash down – normal equals at least 5% of the selling price. This means that to buy a $300,000 condominium, for example, you should expect to spend at least $15,000 as a down payment.

Where are you going to find that kind of money? The best idea of course is to save it up before you buy. But you can also take out a bank loan to serve as a down payment, or use the Home Buyers’ Plan (HBP). The HBP allows you to take up to $25,000 out of your RRSP to use as a down payment. You can learn more about the criteria and how it works from the Canada Revenue Agency.

2. Borrowing capacity

Even if you have a substantial down payment, that doesn’t mean that you can take on a big mortgage. Just to be sure, you’ll want to meet with a mortgage broker. Together you can calculate your borrowing capacity, taking into account a number of factors: your salary, your other sources of income, your existing debts, the costs associated with your current home, etc.

3. Mortgage pre-approval

Work with your mortgage broker to get a mortgage pre-approval from a financial institution before you even start looking for a home. Why? First, you will have a clear idea of your buying capacity. Also, a pre-approval will give you more negotiating power with sellers. In most cases, a mortgage pre-approval is free and not binding.

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4. The amortization period

The most common amortization period is 25 years, which is also the maximum mortgage period allowed by Canadian law, as of 2012. The days of 30, 40 or 50 year mortgages are gone. You can choose, however, to pay back your mortgage loan in 20, 15, 10 or even 5 years. The amortization period will of course affect the amount of your monthly payments: the longer it is, the less you pay. Or at least, that’s how it seems.

The truth is, the longer the amortization period, the more you will be paying in interest. You can end up paying twice the amount you borrowed, or even more! If you can manage it, choose to reimburse your mortgage in the shortest time possible. You can save tens of thousands of dollars in interest payments.

5. Interest

All mortgage loans involve interest payments. When you choose a mortgage plan, you can choose between fixed-rate interest and variable-rate interest.

Fixed-rate interest is determined according to the current rate at the time of signing and cannot be changed during the term of the loan. This type of interest offers the security of regular payments and allows you to budget accordingly, without any surprises. On the other hand, the rates may be higher than variable-rate interest, and you will not benefit from any dip in interest rates in the market during the period of your term.

Variable-rate interest is, as you might expect, variable! In other words, the rate will fluctuate according to the changes in the market, which will increase or decrease your monthly payments. At the end of the day, a variable interest rate is often advantageous, because it allows you to benefit from all the reductions. But it is also more risky, as the market fluctuations remain unpredictable. You must be in a good enough position to assume the outcome.

6. The term

The term refers to a set period of time – often between 2 and 5 years – during which you are committed to reimbursing your mortgage according to the conditions that have been established: the amount and frequency of payments and the interest rate. At the end of the term, you can renegotiate your mortgage with your financial institution.

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7. Payment frequency

There are several options of payment frequency : monthly, semi-monthly, bi-weekly or weekly. Whichever option you choose, you will reimburse the same amount over a one-year period unless you opt for an accelerated plan.

In order to speed up the reimbursement of your mortgage loan, you may choose to pay through an accelerated plan on a bi-weekly or weekly basis. What’s the difference? The accelerated payment is based on the number of weeks in the year (52 weeks, therefore 26 bi-weekly payments or 52 weekly payments), whereas regular payments are based on the number of months (12 months, therefore 24 payments twice a month).

Accelerated payment enables you to reimburse the equivalent of an extra month every year, eventually reducing the amortization period of your mortgage.

8. Prepayment

When you sign your mortgage, it is important to ask if you will be able to pay off your debt in advance if the opportunity arises, that is, to increase your monthly payments or to reimburse the capital you borrowed before the end of the mortgage term.

Generally, a mortgage is either “closed” or “open.” In the case of an open mortgage, you are free to pay back your mortgage early without any penalty, but the interest fees are generally higher for this type of arrangement. On the other hand, a closed mortgage offers lower interest rates but will impose certain restrictions and limit your freedom to reimburse at your convenience.

9. Mortgage default insurance

There are certain insurance policies associated with a mortgage loan that you should take into consideration when setting your budget.

If your down payment is less than 20% of the sale price, you will likely be required to take out mortgage default insurance, in order to cover any potential repayment difficulties. The amount of this insurance may vary between 0.5 and 3% of the sale price. It can be paid in yearly instalments or be included in your monthly mortgage payments.

10. Life and invalidity mortgage insurance

Mortgages sometimes include life insurance that covers the remainder of the loan on your house if you die. This insurance is not always necessary, but may be useful if you have dependents or if you purchase with a spouse or a friend who shares the mortgage payments.

Invalidity insurance may also be recommended: it will protect you in the case of accident, injury or serious illness. Be sure to read the fine print though – this kind of insurance often comes with an interminable list of conditions.

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This brings us to the conclusion of our introduction to mortgages. Of course this has been an overview and many details could be further developed. This is why, in the buying process, it is important to be accompanied by a competent mortgage advisor. Purchasing a property is one of the most important investments of your life. It is essential that you understand all the details of your mortgage. Do not hesitate to ask questions of the appropriate experts.