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MORTGAGE 101

There are many types of mortgages available but the most common type is called a Constant Payment Mortgage. This type of mortgage is designed to be payed off over a set period of time, known as the ammortization period. Each payment consists of interest and principal. An example of a mortgage that doesn't need to be paid off over a set period of time would be an Interest-only Mortgage, where the borrower only needs to pay interest and not any principal. With a Constant Payment Mortgage, you are building equity with each payment and the interest portion of each payment decreases over time. The following topics are the basics of Constant Payment Mortgages.


Mortgage Term

The mortgage term should not be confused with the ammortization period. In some places it is the same, but here in BC it is not. The ammortization period is the total amount of time that it takes to pay back the mortgage. In BC, the most common limit is 25 years. The mortgage term is the contract between the borrower and the lender, which usually last up to 5 years but possibly 10 years in some cases. So, if you have a mortgage with an ammortization period of 25 years and a mortgage term of 5 years, after the 5 years, you will have to renew your mortgage terms, possibly with new rates and conditions. In general, the shorter mortgage terms have lower interest rates.


Fixed Rates VS Variable Rates

A fixed rate mortgage rate means that you will have the same interest rate throughout your mortgage term. A variable rate means that your interest rate can change throughout your mortgage term. The variable rate is pegged to the prime rate and is unpredicatable in the long term but is usually lower than it's fixed rate counterpart. The risk for variable rates is that if mortgage rates go up, your regular payments will go up and may become unaffordable. The risk of a fixed rate mortgage is opportunity cost. If mortgage rates go down, you would not be able to take advantage of them until your mortgage term expires. The benefit of a fixed rate is that your mortgage payments will be predictable over your mortgage term.


Conventional vs High Ratio

A conventional mortgage means that your down-payment meets the conventional requirement, which is currently 20%. A high ratio mortgage refers to any mortgage where the downpayment is less than 20%. The benefit to having a conventional mortgage is that you won't be required to pay mortgage insurance. It is much easier to find a lender and get the best rates and terms if you are shopping for a conventional mortgage. If you are looking for a high ratio mortgage, you can put down as little as 5% or even 0% in some special cases. You will be required to pay a small premium for CMHC mortgage insurance if you are making a down payment of less than 20%.


Open vs Closed

An open mortgage allows you to make additional payments to your mortgage over and above the minimum payments, in order to reduce the amount of interest you pay over time. You are even allowed to pay off the entire mortgage at any point if you choose. In a closed mortgage, you are not allowed to pay off the enitre mortgage until the end of the term. If you do want to pay off your mortgage early in a closed mortgage, you would have to pay some penalty charges. Some lenders may allow you to make some additional payments in a closed mortgage, but there will be a limit to how much extra you can contribute each year. Closed mortgage rates are usually lower than their open counterparts. Tip: If you are getting a closed mortgage, look for options like 'Portable' and 'Assumable'. Read below for more details.


Payment Frequency

The payment frequency refers to how often you make your mortgage payments. The most common options are monthly, bi-weekly, or weekly. The more frequently you make payments, the less interest you pay in the long term. A good mortgage will allow you to change your payment frequency at any point during your mortgage term.


Portable

Portability refers to whether or not you can transfer your mortgage to another property. The benefit to a portable mortgage is that you can sell your home and buy another during your mortgage term without having to pay any excessive penalties.


Assumable

An assumable mortgage would give you the option to transfer the mortgage to the buyer if you decide to sell your property. This is just another option that may be available for you to avoid paying penalties in a closed mortgage. Keep in mind that the buyer would have to agree to assuming your mortgage for this to be an option.


Click here to read more about mortgages on the CMHC website.

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