Toronto Mortgage Basics

Principal. Terms. Amortization. Fixed rate. Variable rate. High-ratio. Need some help understanding mortgage terms? This overview of mortgage basics will help you be a more informed borrower.

Term
The term is a period of time where you pay your mortgage at a specific rate (i.e. 5% for five years). At the end of those five years – or six months or 10 years, whatever you have chosen – you will come to the end of your term, and will need to renew your mortgage at a new rate. That is a great time to talk to a mortgage specialist, who can offer you more options than an individual lender.

When it comes to choosing your term, you have plenty of choices. What you decide on should be based on the market, your comfort level and how important stable payments are to your budget.

Long term: If interest rates are low and you are afraid they will go up (or you want the stability of knowing exactly how much you will be paying every month), your best bet is to lock in for a longer term like 5, 7 or 10 years.

Short term: This may be a good idea if interest rates look like they are going down. If you are comfortable with a bit of fluctuation, something like a 6-month variable rate mortgage takes advantage of low rates, but allows you to lock in if rates start going up.

Amortization
This is the number of years (15, 20, 25) it would take to completely pay off your mortgage based on the rate and payment amount you choose at the beginning of your term. The longer the amortization, the more interest you will pay. However, there are ways to change your amortization period. You can shorten it by doing lump sum payments or renewing at a lower rate. Or, if you need to lower your monthly payments, you can extend your amortization – just remember that you will end up paying more interest in the long term.

Fixed or variable rate
Fixed-rate means you pay the same amount every time you make a payment during the term. The upside is that your payments stay the same, even if interest rates go up. The downside? They will not change if interest rates go down, either.

Variable-rate means your payments are based on the lender’s prime lending rate. On the plus side, you will never pay more than the going rate. On the down side, however, there is more risk – if rates go up, your actual monthly payment may not change, but the percentage that goes to interest will, which means you will end up paying off your principal more slowly.

Closed vs. open
The difference between an open and closed mortgage has to do with whether (or how often) you can put more than your usual monthly or bi-weekly amount towards your principal.

An open mortgage lets you repay your loan anytime with no penalties. These types of loans tend to have higher interest rates and shorter terms.

A closed mortgage sets limits on how much you can put towards your principal above and beyond your usual payments – paying a large chunk will likely incur a penalty. These days, though, closed mortgages often allow some prepayment – sometimes up to 20% of your principal per year.

Payment frequency: monthly, bi-weekly or weekly
Paying every two weeks instead of once a month can make a big difference. Say your monthly payment is $1000 (I know that’s on the low side, but it’s a nice round number). If you make 12 monthly payments of $1000, that adds up to $12,000. If you go with the bi-weekly option, though, you will make 26 payments of $500, which works out to $13,000. That extra thousand will go directly to paying off your principal, which means two things: your mortgage gets paid off faster, and you save on interest.

High-ratio vs. conventional
A high-ratio mortgage is one where you put down less than 25% and the mortgage is for more than 75% of the purchase price. Lenders consider it higher risk, and require that it be insured by the Canada Mortgage and Housing Corporation (CMHC) or Genworth Financial.

A conventional mortgage is one where you put down 25% or more of the purchase price. Conventional mortgages do not normally require mortgage insurance, but some lenders may require insurance depending on location and property type.

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