Area of Law: Real Estate Law
Answer # 407
Getting the right mortgageRegion: Ontario Answer # 407
Most people need to take out a loan to finance the purchase of a home. Although the loan is often referred to as a mortgage, the “mortgage” is actually what the bank takes as security for giving the loan. By taking a mortgage on your home, the bank has legal rights to your home, and can sell it if you become unable to repay the mortgage loan.
Different financial institutions offer mortgages with a variety of different features. The mortgage that suits you best will depend on your particular lifestyle and preferences.
First, a mortgage can be open or closed. An open mortgage means that you have the flexibility to make extra payments on your mortgage loan beyond your regular set payments, and you can pay off your mortgage completely at any time without penalty. For example, if you received a $2,000 bonus from your employer, an open mortgage would allow you to pay that money toward your outstanding mortgage amount. However, open mortgages usually have slightly higher interest rates and are usually for a shorter term.
Closed mortgages generally have a lower interest rate, are for a longer term, and have reduced flexibility. In most closed mortgages, you can only make your regular set payments, and you cannot pay off your mortgage at any time without penalty. If you are expecting a promotion to a higher paying job in the near future, or if you think interest rates are going down, you may prefer the flexibility and shorter term of an open mortgage.
Fixed and variable interest rate
Second, a mortgage can also have a fixed or variable interest rate. A fixed interest rate means that you lock in at a certain interest rate for a set term. A variable interest rate means that your interest fluctuates with changing market conditions. The benefit of a fixed interest rate is the security and certainty of a set interest rate. The drawback of a fixed interest rate is that it is usually higher than the variable interest rate. If you think interest rates are on the rise, or if you dislike risk, you may prefer a fixed rate of interest. However, if you think interest rates will go down, and if you do not mind taking a risk, a variable interest rate may be better for you.
Short or long-term?
Third, a mortgage can be for a short or long-term. A term is the length of time during which your agreement with the bank exists. Terms usually range anywhere from six months to five years. During this time, you agree to pay a certain interest rate on a certain schedule. When interest rates are low, short-term mortgages usually have lower interest rates than long-term mortgages. When interest rates are high, short-term mortgages usually have higher interest rates than long-term mortgages. If you think interest rates are going to drop, you may want to opt for a short-term. However, if you think interest rates are going to rise, you may want to lock in a long-term.
The term of a mortgage is usually different from the amortization of a mortgage. The amortization period is the total length of time you will be making payments on your mortgage before it is completely paid off. The traditional amortization period is 25 years, although it can be longer. For home buyers with less than a 20% down payment, however, the maximum amortization period allowed is 25 years. In addition, the CMHC will not insure mortgage loans with amortization periods that exceed 25 years. The length of your amortization period affects the amount of your monthly payments and the total amount of interest you will have paid on your mortgage loan once it is completely paid off.
Shorter amortization periods result in higher monthly payments, but greater total savings because you will pay less interest. Longer amortization periods result in lower monthly payments, but more will be spent in interest overall. The term and the amortization period are usually not the same. At the end of the term, if the amortization period is longer than the mortgage term, you will still owe money to the lender and will either have to repay it or arrange further financing.
Many financial institutions are prepared to do innovative things to satisfy their customers. For example, you can often arrange a weekly or bi-weekly payment schedule as well as make extra payments in addition to the regular monthly payment. Also, many financial institutions will now pre-approve customers for a mortgage. Rather than waiting until you have a particular home in mind, the bank will consider your financial situation in advance, and guarantee you a mortgage loan for a certain amount before the actual purchase. With this certainty, you can to look for homes that you know are within your price range. Your offer to purchase will also be more attractive to the seller if the agreement is not conditional on financing.
More information about mortgages is available from Canada Mortgage and Housing Corporation.
If you are buying a home and want to know how much of a mortgage you qualify for, use the Scotiabank mortgage calculator .
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