For newcomers to Canada, understanding how mortgages work can make the homebuying process easier to plan. A mortgage is a loan used to help buy a home, with the property acting as security for the lender. Borrowers repay the loan through regular payments that usually include both principal and interest.
Mortgage basics
The principal is the amount borrowed to buy the home. Interest is the cost of borrowing that money.
Mortgage payments are usually based on:
- The amount borrowed;
- The interest rate;
- The amortization period.
The amortization period is the total time it would take to fully repay the mortgage at the current interest rate and payment amount. A longer amortization period may lower monthly payments, but it can increase the total interest paid over the life of the mortgage.
Mortgage term vs. amortization period
A mortgage term is the length of time the borrower agrees to a specific interest rate, payment amount, and mortgage conditions with the lender.
Mortgage terms commonly range from 1 to 10 years. At the end of the term, the borrower may be able to renew or change the mortgage.
The amortization period is different. It refers to the total repayment timeline for the full mortgage, not just the current contract period.
Fixed-rate and variable-rate mortgages
One major decision is whether to choose a fixed or variable interest rate.
With a fixed-rate mortgage, the interest rate stays the same throughout the mortgage term. This gives payment predictability and protection if interest rates rise during the term. The trade-off is that the borrower does not benefit from rate decreases during that same term.
With a variable-rate mortgage, the interest rate may change during the mortgage term based on changes to the lender’s base rate.
Possible effects of a variable rate include:
- Borrowing costs may decrease if interest rates fall;
- Borrowing costs may increase if interest rates rise;
- The payment amount may change automatically depending on the mortgage terms;
- A higher payment may be required to maintain the amortization period if rates rise.
Open and closed mortgages
Borrowers may also need to choose between an open and closed mortgage.
An open mortgage allows more flexibility. The borrower can make extra payments, pay off the mortgage in full, or increase payment amounts without prepayment charges. This may suit someone who expects to repay the mortgage before the end of the term. Open mortgages often come with higher interest rates and fewer term options.
A closed mortgage usually offers lower interest rates than an open mortgage with a similar term. However, there are usually limits on how much extra can be paid without prepayment charges. Some closed mortgages allow limited lump-sum payments or increased regular payments, depending on the lender’s terms.
Features to consider if moving
Some mortgage features may matter if the borrower expects to move or sell the home.
A portable mortgage may allow the borrower to request a transfer of the existing mortgage, including the interest rate and terms, to another property. The borrower still needs to requalify with the same lender.
An assumable mortgage may allow a buyer to take over the seller’s existing mortgage, subject to lender approval and conditions.
Choosing a mortgage
The right mortgage depends on the borrower’s financial situation, long-term plans, and comfort with changing payments or interest rates.
Newcomers may want to compare features such as:
- Payment flexibility;
- Ability to make lump-sum payments;
- Interest rate type;
- Prepayment limits or charges;
- Portability if moving;
- Total borrowing cost over time.
Mortgage terms, rates, payment flexibility, and penalties can affect long-term costs. Newcomers should understand the difference between the term and amortization period, compare fixed and variable rates, and check how much flexibility they need before choosing a mortgage.
Source article: www.cicnews.com
