Ok so this article is a bit dry but it does provide you with some of the basic lingo that you will hear when you are speaking to a mortgage specialist. Once again, it is highly recommended that you speak to a mortgage specialist before you start looking for a home. By doing this, you will know how much you can realistically afford and feel more confident when writing an offer.
Your down-payment: Most institutions will require a minimum down-payment of 5%-10%. Generally, you should try to make the down-payment as large as you can safely afford. The higher the down-payment, the smaller the loan and the less you will pay on your monthly payments. Having a smaller loan usually results in a more preferable interest rate as the risk of default is reduced. Having a 20% or larger down-payment will also allow you to save on mortgage default insurance premium. The larger the down-payment, the greater your bargaining power in terms of interest rate and monthly payments. FYI starting February 2016, the CMHC will require a minimum downpayment of 10% on the portion of any mortgage over $500,000. The 5% rule remains the same for the portion up to $500,000.
Types of mortgages available: There are two basic types of mortgages. Conventional mortgages allow you to borrow up to 80% of the purchase price or appraised value, whichever is less. A high-ratio mortgage is any type of mortgage that involves a loan greater than 80%. This type of mortgage requires the borrower (you) to pay a mortgage default insurance premium. It’s important to keep in mind that this insurance is for the benefit of the lending institution in the event that you default. A lending institution will usually favour a conventional mortgage with a higher down-payment which results in a more favourable interest rate and lower cost of borrowing for you.
Amortization period: This is the overall lifetime of the loan and is typically over a 20-25 year period. The shorter the amortization period, the less interest you will accrue over the life of the loan. A longer loan will mean smaller monthly payments but more of your payment will go towards interest.
Term of the mortgage: A mortgage term allows the contract to be re-negotiated at pre-determined intervals (anywhere from 6 months to 5 years or more). The end of the term means you will need to repay the loan or refinance it. The term length you choose really depends on what you think interest rates will do over the course of the term. If you think rates will go up, then locking-in at a low rate would be wise. If you think rates will go down, you might prefer the flexibility of a shorter term which will allow you to re-negotiate a lower rate in the future.
Fixed Vs Variable: Another factor to consider is whether you want a fixed or variable term. Fixed term means that the interest rate will remain the same throughout the term of the loan regardless of what the market interest rate does. A variable rate will fluctuate based off of the prime-lending rate of the lending institution. This means that your payment will change based off of what interest rates are doing. This is a personal choice and should be based off of your risk tolerance and your level of financial flexibility. If you think interest rates will drop, a variable term may be more suitable. If you think rates will rise, you might benefit from a fixed term mortgage.
Monthly payment: So what can you actually afford to pay for your mortgage? The rule of thumb (also known as the Gross Debt Service Ratio) is no more than 30% of your gross monthly income. Most of us carry some other forms of debt. After all, how else could you afford an ATV, motorboat and that new car you bought this year? A more thorough way to find out how much you can afford is to calculate the Total Debt Service Ratio. Below are the basics for calculating your GDSR & TDSR
Innovations in Mortgages: In general, the shorter the amortization period of the loan, the less interest you will pay on the loan. This is a clear benefit but the unfortunate side-effect is that your regular payments will be higher. There are many innovative ways that banks are offering to reduce the time needed to pay-off loans. These include increased mortgage payments, lump sum principle payments, increased payment frequency, and accelerated payments. Ask your mortgage specialist for details.
Increased Mortgage Payments: Allow you to increase the amount of a payment or make additional principal prepayments. This option allows you to pay off your mortgage faster resulting in less interest. Each lender will have their own rules on this option so you will need to do your homework and see if this is a possibility.
Increased Payment Frequency: By increasing the payment frequency, you reduce the length of the loan and save on the amount of interest. Common options are bi-weekly or weekly.
Accelerated Payments: This takes increased payment frequency one step further. Essentially, your monthly payment is cut in half and one-half of the monthly payment is paid every two weeks. The result is that you make an extra mortgage payment every year and reduce the time needed to pay the loan. Weekly options are also available from some institutions so shop around.
You did it! If you are reading this, you have made it through the hardest article on this site. It's all down-hill from here!