By understanding the key mortgage terms, you will be in a better position to make an informed decision concerning your mortgage.
Mortgage Terminology
Down payment
- The down payment is the amount of your own funds that you must put towards the purchase of your home.
- You must have your down payment, through savings or other means, before applying for a mortgage.
- The minimum down payment is 5% of the purchase price of the home. However, a down payment of 20% of the purchase price of the home is preferable in order to avoid additional costs associated with mortgage insurance.
- The Homebuyers’ Plan allows you to withdraw funds from your Registered Retirement Savings Plan (RRSP) for the purchase of a home under certain conditions.
Mortgage Principal
- The amount that the financial institution will lend you for the purchase of your home.
- The mortgage principal is generally the difference between the purchase price of the home and the down payment. However, this can vary if you require additional funds, for example, for renovations.
Mortgage Insurance
- Mortgage insurance, such as Canadian Mortgage and Housing Corporation (CMHC) Insurance, allows you to increase the principal amount of your mortgage up to 95% and therefore reduce the required down payment for your mortgage.
- A premium is required for this insurance and is added to the principal amount of your mortgage.
Closed Mortgage
- Generally, a closed mortgage cannot be paid in full prior to the end of the term, unless you pay a penalty.
- Certain institutions allow additional mortgage payments during the year or the doubling of payments for closed mortgages; this can vary depending on the different mortgage options.
Open Mortgage
- An open mortgage allows the repayment of the mortgage, in part or in full, at any time, without penalty.
- An open mortgage provides flexibility with regards to making additional payments and the mortgage can be repaid in full at any time; terms will vary depending on the financial institution.
Amortization Period
- The period of time that you choose to repay your mortgage in full.
- The amortization period will determine the amount of your mortgage payments.
- A shorter amortization period will increase your mortgage payments and reduce your interest costs.
- A longer amortization period will decrease your mortgage payments and increase your interest costs.
Payments – Principal and Interest
- The amount of the mortgage payments is calculated based on the terms of the mortgage.
- Mortgage payments are comprised of two parts: the repayment of the mortgage principal and interest costs.
- Principal payments reduce the balance of the mortgage.
- Interest is calculated on your mortgage balance and must be paid first. The remainder of the payment will be applied towards the principal amount of the mortgage.
- At the beginning of the amortization period, the interest is higher, therefore a larger portion of the payment covers the costs of the interest.
- Over the course of the amortization period, the mortgage balance is decreasing and therefore interest costs will decrease; therefore, a larger portion of the payment is applied towards the principal amount of the mortgage.
Term
- The period of time that your mortgage is in effect with the financial institution.
- At the end of the term, the mortgage comes due and new terms must be negotiated with your current financial institution or the mortgage can be transferred to another financial institution of your choice.
- Term lengths typically range from 1 year up to 10 years.
Interest Rate
- The interest rate determines the interest costs and is calculated on your mortgage balance.
- The interest rate depends on the type of mortgage (open or closed), the term of the mortgage (1 year to 10 years) and the type of interest rate (variable or fixed).
Variable Interest Rate
- A variable interest rate can fluctuate during the amortization period of the mortgage.
- If the interest rate increases, the mortgage payments may be increased in order to respect the amortization period of the mortgage.
Fixed Interest Rate
- The interest rate will remain the same throughout the term of the mortgage (1 year to 10 years).
- With a fixed interest rate mortgage, the mortgage payments will also remain fixed for the term of the mortgage.
Typical Mortgage Types
Open mortgage with a variable rate
- You can pay this mortgage in full at any time without penalty.
- The interest rate can fluctuate during the amortization period of the mortgage.
Closed mortgage with a fixed rate
- This mortgage cannot be paid in full until the end of the term of the mortgage.
- The interest rate and the mortgage payments are fixed for the term of the mortgage.
- Terms typically range from 1 to 10 years.
Closed mortgage with a variable rate
- This mortgage cannot be paid in full until the end of the term of the mortgage.
- The interest rate can fluctuate during the term of the mortgage.
- Terms typically range from 1 to 10 years.