Mortgage Primer
First, let’s understand the meaning of the key terms you will hear as soon as you wade into the world of mortgages. A mortgage is a loan, and, like all loans, you pay it off by making payments over a period of time. Your payments include amounts that go toward the principal (the amount you borrowed) and interest (the cost of borrowing the money). The amount of interest you pay depends on the interest rate charged on the loan.
Mortgages are amortized over a long period (the length of time the money is loaned to you), normally for 15, 20 or 25 years. But mortgage contracts are for terms (the time during which the interest rate and other conditions are fixed), which is normally from six months to five years. The mortgage is renewed at the end of each term, meaning conditions of the contract may change, including the interest rate. Even during a term you may have flexibility to make lump sum payments or speed up payments, and this will save you considerable interest in the long run.
For instance, with a $150,000 mortgage at 7 per cent amortized over 25 years, your total interest payments would be $165,188, but the same mortgage amortized over 15 years would result in interest payments of $91,177, a difference of more than $74,000.
If you make a down payment of at least 20 per cent of the purchase price, you can obtain a conventional mortgage. However, more than half of Canadian home buyers put down 20 per cent or less and many can manage a down payment of only 5 per cent, the minimum. Any mortgage for more than 80 per cent of the cost of the house is considered a high ratio mortgage and by law it must be insured to protect the lender if the borrower defaults.
These mortgages require mortgage default insurance, which is available from CMHC or Genworth Financial Canada. With mortgage insurance, the lender is repaid by the insurer if you default.
There are other kinds of insurance available to protect you while your home remains mortgaged, including mortgage life insurance to cover the balance in case you die and mortgage disability insurance to cover your payments should you be unable to work through accident or illness.
There are many other terms related to mortgages, such as fixed rate, variable rate, open mortgages, closed mortgages, equity and so
on, that you may run across in your search for a mortgage. Don’t hesitate to ask your mortgage specialist to define any term that you do not understand.
It’s a bewildering topic at first, but a little study and some comparison shopping will help you find a mortgage that suits your needs. Financial experts make several points that will save you considerable amounts:
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a shorter amortization period will mean higher monthly payments but will substantially reduce the total amount of interest you pay;
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if you have the flexibility, increase your regular monthly payment or make lump sum payments whenever your financial circumstances permit;
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increase your payment schedule from monthly to bi-weekly or even weekly if you can.
The savings from these steps can be very significant indeed. For instance, if you have a $150,000 mortgage with an 7 per cent interest rate over 25 years but make an annual prepayment of $2,000 over the life of the mortgage, your total interest payments would fall from $165,188 to $113,975 – saving you $51,213!
If your mortgage conditions do not allow these money-saving steps, you may be able to negotiate changes at the end of each term.
