Mortgages 101: Learn the basics of getting a mortgage
Section A: Types of Mortgages
It should be noted that the “types of mortgages” should not be confused with the large variety of different “mortgage products or solutions” available . Mortgage products or solutions target a client’s particular needs, and may contain any one of the “mortgage types” but will also vary according to interest rate, the terms of the contract, including repayment and the benefits and privileges available to the client, as well as how a client is qualified.
1. Conventional Mortgage
- This mortgage is for an amount which does not exceed 75% of either the appraised value of the property or the purchase price, whichever is lower. Your down payment is a minimum 25% of the purchase price
2. High-ratio Mortgage
- With this type of mortgage, you contribute less than 25% of the cost of the home as a down payment and as little as 5%. A high-ratio mortgage requires mortgage loan insurance. CMHC and GE Capital offer mortgage loan insurance for a premium of between 0.5% and 3.25% of the mortgage amount. This premium can be added to your mortgage payments or paid in full on closing
3. Open Mortgage
- An open mortgage allows the borrower to repay all or part of the principal amount at any time without notice or penalties. The interest rate on this type of mortgage is generally higher than closed mortgages. This type of mortgage is usually used for short term financing of 6 months to 1 year
4. Closed Mortgage
- A closed mortgage do not allow the borrower to make any prepayment or early prepayment unless the property is sold, in which case the borrower will have to pay a penalty to discharge the mortgage. The interest rate on a closed mortgage is generally much better than on open mortgages
5. Fixed Rate Mortgage
- The rate of this mortgage is normally fixed or permanent for the duration of the mortgage term regardless of changes in the market interest rate. On average, terms are from 1 to 10 years in length; with longer terms typically carrying a higher fixed interest rate.
6. Variable Rate Mortgage (VRM) / Adjustable Rate Mortgage (ARM)
- These loan types are based on a variable interest rate that can change during the term of the mortgage. The rate of interest for VRM / ARM is based on a function of the Prime rate, for example, prime rate minus 0.50%. As a result, the repayments of interest can vary over the term of the loan
7. Split or Step or Multiple-rate Mortgage
- This mortgage product allows you to negotiate a portion of the total mortgage loan at one rate and term, and another portion at a different rate and term. In this way you can split your mortgage into two, three or more terms. For example, the loan can be portion to have a fixed rate, variable rate or even with a credit line term
8. Convertible Mortgage
- A convertible mortgage allows you to change the term of the mortgage, for example, from a short term to a long term or from a variable rate to a fixed rate mortgage.
9. Second Mortgage
- This usually has a higher interest rate and shorter amortization than a first mortgage. The mortgage payment can incorporate both repayment of principal and interest or interest only. Secondary financing is often used to make renovations to a home or debt consolidation, or a way to access equity in the property without having to break the current mortgage term, thereby having to pay a penalty
10. Private Mortgage
- The private mortgage industry is an important source of return on investment for the private investor. Private mortgages are created by private lenders and these loans are usually over a short period (between 6 months to 2 years). Private mortgages also allow the investor to earn substantially higher yields on an investment than banking institutions, while offering the security of real property as collateral on your investment
Section B: Interest Rate on the Mortgage
- Interest is the cost of borrowing money and is paid to the lender. Mortgage interest rates are affected by the prevailing market interest rates and can either be a fixed or variable rate.
- A fixed rate is protected so that it will not rise for the term of the mortgage.
- A variable rate will fluctuate depending on the prevailing market rates. The rate is set each month by the lender, based on the bank’s prime rate. Your monthly payment is the same each month for the term of the loan, however, the percentage of each payment that goes toward the interest, and principal will change with changes to the prime rate.
- A variable rate can be a good choice if rates are high and fall after you initially set up your mortgage. Most variavle rate mortgages are also convertible, allowing the borrower to convert the mortgage into a fix rate mortgage for the remaining balance of the term.
- Furthermore, some lenders offer a protected or capped variable rate. This means your interest rate will not rise beyond a predetermined limit. However, you usually pay a premium for this protection.
Section C: Term of the Mortgage
- The term of a mortgage refers to the period in which you are bound by agreed upon conditions and an agreed upon interest rate
- A term usually lasts anywhere from 6 months to 10 years. At the end of the term, you the borrower, can either pay off the mortgage or renew it. The longer the term the higher the interest rate, therefore, during periods of rising interest rates, it is suggested that you choose a longer term, where as, if rates are falling, you may want to select a shorter term
Section D: Amortization & Payments
1. Amortization
- Amortization is the period of time over which the principal loan is to be paid. Most mortgages are amortized no less than 5 years to a maximum of 25 years. The longer the amortization the lower your scheduled mortgage payments, but the more interest you will have to pay
- A mortgage loan is repaid in regular payments either monthly, biweekly or weekly. The more frequent the payment the greater the amount that will be paid to the principal loan, thereby lowering the interest cost
3. Mortgage Payments
Mortgage payments are comprised of the principal (the amount borrowed) and the interest (the cost to you of borrowing money).
Your goal should be to minimize the amount of interest paid. This can be a accomplished in the following ways:
- Decrease the initial mortgage amount by increasing the down payment
- Increase the frequency of your mortgage payment from monthly to bi-weekly
- Decrease the mortgage amortization period
- Utilize the lump sum payment option offered by the lender
- Increase the monthly payment
Section E: Mortgage Features
1. Prepayment
- Ensure that you have some form of prepayment clause in your mortgage that will allow you to pay down your mortgage with a lump sum, or an extra payment, without penalty.
2. Portability
- This means you can transfer the terms and conditions of your mortgage to your next home. For example, this may allow you to keep a low interest rate if you sell one house and buy another. This feature may also save you from having to pay a penalty for breaking your existing mortgage.
3. Assumeability
- This means someone may be able to take over the existing mortgage on the property. This feature is attractive especially if the mortgage carries a lower interest rate than the prevailing market. In addition, this feature can also save the existing mortgage holder from having to break the mortgage term in order to sell the property and thereby incurring a penalty
