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All About Mortgages

This section of the web site explains mortgage terminology and how a mortgage works. A mortgage is, in simple terms, a loan that you take to buy a home. The loan is secured by the property value and your ability to repay the loan. The amount borrowed is called principal, and the cost of borrowing the money is called interest. The borrower is the mortgagor, and the lender is the mortgagee.

Different types of mortgages
Your Down Payment
Choosing an Amortization Period
Deciding on a Term
Open versus closed
Short versus long
The effects of interest rates on the term
Payment Options
Monthly versus bi-weekly versus accelerated bi-weekly
Prepayment privileges

Different Types of Mortgages

Conventional Mortgages:
Under a conventional mortgage, a lender will normally provide up to 75% of the appraised value or purchase price of a property, whichever is less. You must be able to provide at least 25% of the financing on your own.

Example:

Purchase Price: $ 200,000.
Conventional Mortgage: $ 150,000.
Required Down Payment: $ 50,000

High Ratio or Insured Mortgage:
A high ratio mortgage finances a higher percentage - up to 90% - of the appraised value or purchase price of the property, whichever is less. This type of mortgage must, by law, be insured against non-payment by either the Canada Mortgage and Housing Corporation (CMHC) or the Mortgage Insurance Company of Canada (MICC). Mortgage insurance protects the lender against loss if the borrower fails to meet the repayment terms.
The application fee (approximately $75) and insurance premium (approximately 0.5% to 2.5% of the loan) are paid by the borrower. The higher the ratio of mortgage to down payment, the higher the cost of insurance. Mortgage insurance may be subject to provincial sales tax.

Example:

Purchase Price: $ 200,000
Down Payment Available: $ 20,000.
Assuming insurance premium of 2.5%

Amount of Mortgage: $ 180,000.
Assuming Mortgage Rate of 8%

Total Interest would equal 8%
plus 2.5% equaling 10.5%

Your Down Payment

A minimum cash down payment from your own resources is required because mortgage lenders won't advance the entire purchase price of a property. Your minimum down payment would normally be 10%, however, a recent government program has lowered the minimum to 5% for qualified first time buyers. Another temporary program allows first time buyers to use funds from their RRSP for their down payment. Ask your Coldwell Banker Sarazen Real Estate sales associate for details of these and other government programs.

It's to your advantage to aim for a down payment of 25% or more, so you'll qualify for a conventional mortgage and avoid paying the mortgage insurance premium. The larger your down payment, the easier it will be to arrange a mortgage and carry it comfortably. The smaller your loan, the lower your interest expense will be, and the more equity you will have in your home. Equity is equal to the value of home minus the amount of your mortgage.

Choosing an Amortization Period

Once you're settled on the type of mortgage that fits your financial circumstance, you are ready to start considering the various options available. Amortization refers to the number of years it will take to repay the loan in full - most commonly 25 years. Longer amortization periods result in lower payments, but increase the total amount of interest paid. If you can handle a shorter amortization period, you'll achieve tremendous savings on the interest cost of your mortgage and live mortgage free sooner!

Example: If you have a $100,000 mortgage with an 8% interest

Amortization Period Monthly Payments Total of Payments Total Interest Paid Interest Savings
25 Years $ 763.21 $ 228,963 $ 128,966 -----
20 Years $ 828.36 $ 198,806 $ 98,805 $ 30,161
15 Years $ 948.15 $ 170,667 $ 70,668 $ 58,298
10 Years $ 1,206.41 $ 144,769 $ 44,769 $ 84,197

Assuming constant interest rate for entire amortization period.

Each mortgage payment consists of interest plus repayment of part of the principal. In the early years of a mortgage, a higher portion of your payment is used to pay interest. By the time you reach the last years of your mortgage, almost all of your payment will be applied against the principal.

Deciding on a Term

The length of time for which the interest rate is fixed is called the term. Most mortgages have terms of six months to five years.

Open versus closed term
An open mortgage is one which allows payment of the principal, in part or in full, at any time without penalty. Open mortgages tend to be for a short term - usually six months or one year. Since open mortgages offer greater flexibility than closed mortgages, they usually have a higher interest rate.

A closed mortgage requires you to maintain a specific payment schedule. A penalty usually applies if you repay the loan in full before the end of the term.

A convertible mortgage allows you to renew your mortgage at any time without penalty for a longer term, closed mortgage.

Short verus long term
When interest rates are either high or falling, there is a tendency to choose a shorter term mortgage. This strategy pays off if you can renew at a lower rate six months or one year later.

You may want to consider a longer term mortgage if interest rates are rising, if you have limited income or if you want to keep your mortgage payments the same for a few years.

The effects of interest rates on the term
As a rule, you'll find interest rates rise with the length of the term. The lowest interest rates are usually associated with six-month and one-year mortgages. Higher interest rates mean higher mortgage payments.

Example: If you have a $100,000 mortgage and 25 amortization

Interest Rate Monthly Payment Total Amount Total Repaid Interest paid
6% $ 639.81 $ 191,943 $ 91,943
7% $ 700.42 $ 210,126 $ 110,126
8% $ 763.21 $ 228,963 $ 128,963
9% $ 827.98 $ 248,394 $ 148,194

Assumes constant rate for the entire 25 years. Payment consists of principal and interest.

When you apply for a certain mortgage, you'll receive an interest rate that is usually guaranteed for up to 90 days or until the day before closing, whichever comes first. The interest rate on your mortgage will be the lesser of the rate at application or on the day before closing. If rates increase, you are protected. If rates decrease, you should receive the lower rate.

Payment Options

The three most common payment frequencies are monthly, bi-weekly and weekly. Increasing the frequency of your payments can allow you to pay off your mortgage sooner and reduce the total amount of interest paid.

You should select a payment frequency based on what is convenient for you. You may want to match your payments to your pay periods. If your goal is to pay off your mortgage quickly, consider accelerated weekly or bi-weekly payment plans. You'll make the equivalent of 13 monthly payments each year, rather than 12, and realize significant interest savings. Other options are to choose a shorter amortization period or take advantage of prepayment privileges.

Example: If you have a $100,000 mortgage, 8% interest rate, 25 year amortization

Payment
Frequeny
Payment
Total
Interest
Paid
Interest
Saving
Mortgage
Free
Monthly $ 763.21 $ 128,966 ----- 25 Years
Bi-Weekly $ 351.29 $ 127,720 $ 1,246 24 yr. 10 mon.
Accelerated Bi-Weekly $ 381.61 $ 98,483 $ 30,483 20 years

Savings assume interest rate of 8% for entire 25 years

Prepayment Privileges

Prepayment privileges are voluntary payments in addition to your regular mortgage payments. The money is applied directly against the principal owing, so you'll pay off your mortgage more quickly. You'll also significantly reduce the total amount of interest you would otherwise have paid.

Some examples of possible options available:
1) You can increase your regular principal and interest mortgage payment by as much as 100%.
2) You can pay up to 15% of the original principal balance in a lump-sum once annually or on the anniversary date.