Earlier in the year, my wife and I had bought our first home. Because we had done our research and had been saving diligently, we felt confident when we reached out to our realtor. After speaking to our realtor, we might actually be in the minority.
While talking to my mortgage broker, he commented how I knew quite a lot about mortgages for a first time buyer. I asked him was this not normal? He said, not not many people even know the basics.
I certainly don’t expect house hunters to know everything, but here are the mortgage basics explained.
Fixed vs. Variable rate mortgages
For most people, the two types of mortgages available are fixed and variable. Which one you decide to choose is up to you, but there are pros and cons to each.
Fixed mortgages – As the name implies, the rate you pay is fixed for the term of your mortgage. This makes budgeting easy since payments stay the same. However, you pay a premium for that peace of mind since posted fixed rate mortgages are always higher than the variable rate.
Variable mortgages – Variable rates are based on the prime rate (set by the Bank of Canada) minus a set amount. Variable mortgages are attractive when rates are high, but since rates are so low, the discount isn’t as high anymore compared to the fixed rate.
Historically speaking, variable rate mortgages have been cheaper in the long run, but we’ve also never had rates this low.
Mortgage amortization and term
Many people confuse amortization with the term, but they are two very different things.
Mortgage amortization – This refers to the length of time it would take to pay off your mortgage in full. A longer amortization means lower monthly payments, but you end up paying more in interest. If you require Canada Mortgage and Housing Corporation (CMHC) insurance, then the longest term you can get is 25 years.
Mortgage term – The mortgage term is the length that your current agreement and interest rate lasts. For example, you might get a 25-year amortization mortgage with a term of 5 years. Once that term is up, you’ll need to renew or renegotiate your mortgage.
The idea is that every time you renew your mortgage, you’ll reduce your amortization period until it’s eventually paid off in full.
Mortgage payment options
There are essentially five mortgage payment options available to you.
Monthly – This amount is based on your term and mortgage rate. Your payment will be withdrawn from your bank account on the same day every month, so that’s 12 payments a year.
Bi-weekly – Take your monthly mortgage payment and multiply it by 12. Now take that amount and divide it by 26 weeks to get your bi-weekly payments.
Accelerated bi-weekly – Similar to bi-weekly payments, you’ll still make 26 payments a year, but you’re paying slightly more each time since the amount is calculated by taking your monthly mortgage and dividing it in half.
Weekly – Take your monthly mortgage payment and multiply it by 12. Now take that amount and divide it by 52 weeks to get your weekly payments.
Accelerated weekly – This is the most aggressive payment option available. It’s determined by taking your monthly mortgage amount and dividing it by four. You’re still making 52 payments a year compared to the weekly, options, but you pay slightly more each week.
Don’t underestimate the value of making accelerated payments. You could save tens of thousands of dollars, and reduce the time it’ll take to repay your mortgage by years by simply choosing accelerated bi-weekly payments.
Mortgage prepayment options
The other major thing you want to consider with your mortgage is the prepayment options. Having prepayment options will allow you to pay down your mortgage faster, so make sure you ask your lender if they are available before signing.
Monthly prepayment – This is an optional monthly amount you’re allowed to pay on top of your regular mortgage payment. Most lenders will allow a monthly prepayment, what you’re allowed to pay in addition is set in the terms of your mortgage.
Lump sum payment – Some mortgages allow you to make a lump sum payment every year. This is great since the entire amount gets applied to the principal. If you have a 25% lump sum payment option included, technically speaking, you could pay off your mortgage in four years.
Don’t underestimate these extra options; they could save you thousands of dollars and reduce the years it’ll take you to repay your loan.
Shop around for your mortgage
Okay, I know, it’s a lot to intake. Fortunately, mortgage brokers (who’re licensed by FSCO) can help find the perfect mortgage for you.
Not only will they be able to explain the details of the different mortgage options, they’ll also be able to help you secure the right mortgage for you.
Mortgage brokers usually don’t work for a single company, so they’ll shop your business around to get you the best rate. They also won’t cost you anything since brokers get compensated by the lender for bringing them business.
That being some brokers do work for individual companies (such as a bank), and some do charge clients directly. You’ll want to ask them how they operate and how they get paid before deciding to work with them. Mortgage brokers are there to help you. I highly recommend working with one when you’re looking to buy a home.
This post covers all the mortgage basics, but there are other things you need to consider. How much will you qualify for, how much should you borrow, and who should be on your real estate team.