A mortgage is a loan used to purchase property, like a house (detached, townhome, condo) or Commercial space (Office space, Warehouses, standalone buildings, mixed-use buildings, hotels, motels, etc.).
Mortgages are normally obtained by individuals or companies; money is borrowed from banks, credit unions, monoline banks and Private Lenders.
Mortgages are generally the largest loan most people will take out in their entire lives; as of 2016, the median mortgage debt for Canadian families was around $180,000 (Source: Stat Canada).
Mortgages are always secured by some sort of asset. That asset is the property that’s being purchased. Due to the asset being collateral in case a borrower defaults, Mortgages generally have lower interest rates of any type of credit such as a line of credits, Credit cards etc.
How does Mortgage work?
Mortgages are complex, and it normally requires a professional to understand them. This is why some people end up paying too much when they take out a mortgage; luckily, you’re in the right place –Asim Ali Mortgage Team is all about giving you the information you need to choose better. Knowing just the basics of how mortgages work goes a long way.
Let’s start with some key components of a mortgage, such as your mortgage rate, amortization period, payment frequency, and down payments.
Mortgage interest rate
Your mortgage interest rate is the percentage that the bank will charge for lending you money. If you were to borrow $1000 at a 3% interest rate, you would pay an additional $30 per year to the bank. This may be a very simplified example; however, it’s essentially the same process used in a mortgage.
Mortgage rates either come as fixed or variable rates. The difference is variable rates can go up and down (when the bank of Canada decides to decrease or increase their prime rate), while fixed rates are locked in for the term of your mortgage contract, which is typically 5 years.
There are a plethora of reasons why you may pick variable over fixed or fixed over a variable. Looking into this factor alone could save you tens of thousands of dollars.
Before you take a Mortgage, Ask yourself some questions. Is there a good likelihood that you are going to keep the property you are purchasing for the next five years?
Is this your dream home where you may stay for 10-15years or you may upgrade in the future if an opportunity arises? What is the likelihood that your finances will improve in the near future, if so would that be the likely factor you may think about purchasing another property? Or do you have any family overseas, which is planning to come to Canada and live with you?
Are you expecting that your family will grow in the future, such as kids? Are you buying an investment property? If so, what’s the likelihood that you will sell if prices were to jump next year or the year after.
Asking these questions may seem a bit overwhelming, but this would allow you to understand yourself and the actions you may take in the future. Another factor to consider is your age; the younger you are, the more likely you will break your Mortgage Term.
The reasons you want to ask the questions above are, when breaking your mortgage contract early, usually because of a refinance or the sale of your property or for another reason, you will, unfortunately, have to pay your lender a penalty called a prepayment penalty. The amount you pay will depend on a variety of factors, including the day you signed your original mortgage contract, the term of that contract and your existing mortgage balance, rate type and mortgage rate.
One of the biggest drivers of your mortgage penalty is whether you have a variable or fixed mortgage rate. Fixed-rate holders pay the greater of interest rate differential or three months interest, while variable rate holders pay just three months interest.
Penalties on a fixed rate Mortgages usually are extremely high; five years is a very long time, so make your decisions wisely.
The amortization period of a mortgage is the total length of time in which you will pay off your mortgage. The typical amortization period for a mortgage in Canada is 25 years for all INSURED mortgages. For Mortgages with a 20% down payment or more, You may ask your bank for a 30-year amortization to reduce your monthly mortgage payments.
Note: Your amortization period is different from your mortgage term. Your mortgage term is how long you sign with a particular lender, and it’s normally 5 years (although it can range from 1 -10 years). After your term, you’ll need to renew your mortgage with a new term, either with the same or a new provider.
The payment frequency is how often you make your mortgage payment. Typical frequencies are monthly, bi-weekly, and weekly. Some providers also offer accelerated payment options to pay off your mortgage faster.
Closed vs. open mortgages
In addition to a variable or fixed-rate mortgages, mortgages can be either closed or open. A closed mortgage is best if you don’t plan on paying off your mortgage in full in the short term. If, however, you want to pay off the mortgage before the specified date, you’ll have to pay a penalty. By agreeing to keep your mortgage for the full term, you’ll receive a lower interest rate than in an open mortgage. With an open mortgage, you have the flexibility to pay off the mortgage at any time without a penalty.
The cost of this increased flexibility is a higher mortgage rate. Since closed mortgage rates have a lower interest rate, you may be curious as to why anyone would choose to have an open mortgage. Individuals who select an open mortgage may expect to receive a large amount of money in the near future that will enable them to pay off their mortgage. This could be from an inheritance or from selling their home. If, however, you don’t expect to receive a lump sum of money anytime soon, a closed mortgage is better because you’ll receive a much lower interest rate.