By Madhavi Acharya-Tom Yew
Moneyville
Understanding the nuts and bolts of your mortgage may seem intimidating at first, but it’s not as difficult as it sounds. Learning more about how mortgages work could save you thousands of dollars in interest or penalties.
There are three basic parts to a mortgage: the amortization, the term, and the interest rate, which could be fixed or variable.
• Amortization: This is the total number of years it will take to pay off your mortgage completely. The maximum is 30 years. The longer the amortization, the lower your monthly payments, but you’ll end up paying more interest over the life of your mortgage.
• Term: The term is the length of time you have agreed to a certain interest rate and payment schedule. It can range from six months to 25 years, but homebuyers tend to go for terms of three or five years. Ten-year terms have become more popular recently, because fixed mortgage rates are at historic lows.
• Variable rates: The interest rate on a variable-rate mortgage is tied to the bank’s prime rate. The prime rate, in turn, goes up and down according to the overnight rate, which is set by the Bank of Canada. A variable rate mortgage can typically be locked-in at a fixed rate, but sometimes there is a fee. Ask your lender for more details!
• Fixed rates: These rates are locked in for the length of your term, and they tend to be higher, but you’re paying for peace of mind. The payments, and the amount of interest that you owe, will not change during the term. These rates are dictated by supply and demand in the bond market, which, in turn, is influenced by world events — anything from the European debt crisis to the health of the Chinese economy to the health of Canada’s manufacturing sector can push these rates up and down — that’s why it’s so difficult even for experts to know where rates are headed.
• Open: An open mortgage means you can pay the mortgage down or off entirely at any time without any penalties. These typically carry a higher interest rate.
• Closed: A closed mortgage means that you will be restricted to how much of the principal you can pay down ahead of schedule. Most mortgages allow what are known as pre-payments or extra payments towards the principal of about 20 per cent per year. Check with your lender for more details! Some mortgages allow you to double up on your payments.
Your monthly mortgage payment consists of interest and principal. Early on in your mortgage, most of your payment will go to interest.
Q. What happens when the variable rate goes up?
A: Either your monthly payment will increase, because you will now owe more interest on your mortgage, or the payment could stay the same, and you will end up making the payments for a longer period of time.
Q. What happens if you pay off your mortgage early?
A: You may face a penalty of either three months interest or what’s known as interest-rate differential, whichever is greater. Interest-rate differential is the difference between the interest rate charged at the time you signed your mortgage and the interest rate available at the time of refinancing. This could add up to thousands of dollars. Ask your lender for more details!
• Pre-approval: A lender will typically pre-approve you for a maximum mortgage amount based on your income level at a certain rate for 120 days. If rates drop during that time, you should qualify for a lower rate. If rates increase, you’ll still get the lower rate.
Keep in mind that just because you’ve been pre-approved doesn’t mean you will get the financing for your home. Whether you are approved for a mortgage depends on the home you want to buy in the end. Your lender will need to know the total cost, including property taxes or maintenance fees, and conduct an appraisal before lending to you.
Q. How much do I need for a down-payment?
If your down-payment is 20 per cent or more of the home price, you will qualify for a conventional mortgage. If it is less than 20 per cent, you will be required to insure it with mortgage-default insurance from the Canada Mortgage and Housing Corp. These premiums can either be paid in a lump sum or amortized over the length of the mortgage. The larger your down-payment, the less you will need to borrow and the less you will pay in interest.
The Home Buyers’ Plan allows those who are eligible to withdraw up to $25,000 tax-free from their Registered Retirement Savings Plan to buy or build a home. It is a loan and must be repaid within 15 years. To be eligible, the buyer must not have owned or occupied a home as a principal residence at any time for four years. Check with your lender or financial advisor to see if you qualify!