Mortgages are a tricky business. Nobody looks into them until they’re needed and it can take some time to fully understand the ins and outs. If you’re considering on buying a home, here’s a primer on 10 things you need to know about mortgages.
1. The minimum down payment rules have increased
As of February 2016, the minimum down payment needed to buy property has changed and is now dictated by the following:
- If the property less than $500,000, the minimum down payment is 5%
- If the property is between $500,000 and $999,999, the minimum down payment is 5% on the first $500K plus 10% on the next $500K.
- If the property is $1,000,000+, the minimum down payment is 20%.
2. High ratio mortgages need mortgage insurance
There are two types of mortgages: conventional and high-ratio. Conventional mortgages are ones where home buyers put down a down payment of 20% or more. A down payment of less than 20%, is referred to as a high-ratio mortgage because the amount borrowed accounts for more than 80% of the purchase price. High-ratio mortgages are inherently riskier and require home buyers to purchase mortgage insurance. The higher the down payment, the lower the mortgage insurance premium.
Contrary to conventional wisdom, we chose to go with a high-ratio mortgage and put down around 12% when we purchased our condo. This decision was carefully considered after we did the math. In our case, we would have needed to wait five more months to reach 20%, whereas the premium we needed to pay was approximately a month’s worth of rent.
3. The amortization period affects the amount of interest paid
The amortization period is the total length of time it takes to pay off the mortgage. For high-ratio mortgages,the maximum amortization period is 25 years. Amortization periods over 25 years are available to borrowers with down payments in excess of 20%.
A longer amortization can seem appealing as it can reduce payments, but keep in mind that more interest will be paid over the life of the mortgage. Choosing a shorter amortization period will result in higher payments but reduces the total interest paid over the life of the mortgage.
4. The duration of your interest rate is called the mortgage term
The interest rate you agree on with the mortgage lender does not necessarily extend until the mortgage balance is paid off. Lenders will specify the length of time the interest rates is in effect.
Terms typically run from as low as 6 months up to 10 years, with a 5 year term the most common. At the end of the term, borrowers can renew and renegotiate the terms of the mortgage or look for another lender.
5. Interest rates can be either fixed, variable or convertible
As the name suggests, a fixed interest rate does not fluctuate throughout length of the mortgage term. A fixed rate with consistent payments over the set number of years can provide borrowers with peace of mind.
A variable interest rate can change depending on economic conditions. As the interest rate increase or decrease over the course of the term, borrowers are required to adjust their payments accordingly. While variable interest rates are typically lower than fixed rates, there is always the possibility that rates can increase over time.
A convertible mortgage is simply a mortgage with a variable rate with which the lender provides the an option to fix the rate for the remainder of the term.
6. Mortgages are either Open or Closed
With open mortgages, home buyers have the flexibility to make additional contributions towards the mortgage on top of regular payments. This gives borrowers the opportunity to make large lump sum payments to pay down the balance quickly.
On the other hand, closed mortgages have restrictions on the prepayment terms. Borrowers can incur penalties if they opt to pay above and beyond the terms of the mortgage. In exchange for less flexibility, closed mortgages come with lower interest rates.
7. How much you can borrow depends on how well you can handle the new stress test
As of October 17, 2016, the Canadian government now requires “all insured homebuyers to qualify for mortgage insurance at an interest rate the greater of their contract mortgage rate or the Bank of Canada’s conventional five-year fixed posted rate.” In short, the new rule is a stress test the government put in place to keep household debt levels from increasing.
Rather than qualifying for a mortgage at the record lows interest rates, prospective homeowners will need to be able to sustain payments at the BoC’s current five-year rate of 4.64%. While this means you can expect a decrease in the amount you are qualified to borrow, the change protects against an increase in interest rates.
8. There are a few different ways to make payments
Borrowers can choose to make regular monthly, semi-monthly, biweekly or weekly payments to repay the mortgage. If your goal is to pay off the mortgage as quickly as possible, there are some additional options that will affect the repayment schedule.
Accelerated bi-weekly and accelerated weekly payments allow borrowers to make extra payments against the principal. These options result in slightly higher payment amounts but will save on interest and reduce the amortization period of the mortgage.
If the terms of the mortgage allow it, borrowers can also make monthly prepayments or lump sum payments directly towards the principal owing to further reduce the amortization.
9. A mortgage broker can compare mortgages for you
While banks and credit unions might be a traditional starting point for mortgage rates, consider letting a mortgage broker do all the research for you. Mortgage brokers will search different lenders for a mortgage in line with your specific set of circumstances. They will not cost anything as they are paid a finder’s fee by the lender for bringing them the business. In addition to finding the best rate, they can explain the details of the different options and help guide you through the process.
10. Negotiate your mortgage interest rate
Don’t assume mortgage lenders willingly offer the best interest rate. Never accept the first offer. Take some time to compare mortgage rates from other banks, credit unions, specialty lenders and even mortgage brokers and use the information to negotiate a better rate. With that information, lenders are more likely to match competing offers to win your business.
If you’re not convinced the extra effort is worth it, consider that saving even half a percentage point on a mortgage rate can save tens of thousands of dollars over a 25 year amortization.
The Last Word
According to TREB, the average condo in the GTA is priced at $415,643. Assuming an interest rate of 2.24% with a 25 year amortization and a minimum 5% down payment, the balance owing of $394,861 would be subject to $296,050 in interest over the life of the mortgage – if interest rates did not change. The final cost of the home could rise to $690,911.
While mortgages can seem complicated, the time spent to review the basics can go along way. Choosing the right combination of mortgage type, interest rate and payment options will maximize savings in interest and reduce the amount of time it takes to pay off the mortgage.