Overview of Mortgages

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Simply put, a mortgage is a large loan secured by real estate. Other terms that will be helpful for you to learn are as follows:

The term refers to the length of time (e.g. 5 years) that a lender agrees to give you a mortgage and guarantees an interest rate.

A fixed rate mortgage provides a set interest rate over the term of the mortgage, while a variable rate mortgage has an interest rate that will fluctuate during the term. Click here to check out the latest mortgage rates.

Amortization is simply the period of time (e.g. 25 year amortization) that it will take the period of time it will take you to pay off your mortgage in full.

The Mortgage
A quick way to see how much you can afford is to use the gross debt-service formula (GDS). Here, the Principal, Interest and Taxes (PIT) on your mortgage loan should not exceed 30 per cent of your gross income. Increasingly, financial institutions will factor energy costs into the PIT formula, moving the rule of thumb GDS from 30 to 32 per cent.

You can work it out in reverse: multiply the monthly payment on principal, interest and taxes (include any condominium maintenance fees) by 40. So if your monthly payment for these items is $1,000, you'll need a gross annual income of at least $40,000. Discuss your mortgage limit and different types of mortgages with your salesperson before you begin seriously looking for a new home.

There are several different types of mortgages:

Pre-approved Mortgages: Pre-approval means that you as a buyer, have qualified in advance for a mortgage of X dollars, contingent upon the lender approving the property. Many financial institutions offer pre-approved mortgages, with your interest rate guaranteed not to rise for a certain period.

Conventional Mortgages: Most banks and trust companies offer standard loans using the property as security and require you to make a monthly blended payment including principal and interest. Conventional mortgages require at least 25 per cent of the purchase price as a down payment.

High-ratio Mortgages: If your down payment is less than 25 per cent, you may still qualify for a mortgage, but you will need mortgage insurance. Canada Mortgage and Housing Corporation (CMHC), a federal crown corporation, and GE Capital Mortgage Insurance Company, a private company, provide insurance for high-ratio mortgages.

Vendor Take-Back Mortgages: The seller underwrites part of the purchase, as a loan to be repaid by the buyer. These are often used as second mortgages, to bridge any gaps or to make the property more attractive to the buyer. In some provinces, the seller may also transfer the mortgage to the buyer.

Open and Closed Mortgages: Closed mortgage limits your ability to pay off your mortgage early, whereas an open mortgage gives you the option of paying off your mortgage in full at any time. Open mortgages allow you to make extra payments on the principal, reducing your borrowing costs. Because of this flexibility, interest rates for open mortgages are a little higher. Closed mortgages have no flexibility; you must wait until the term is up to pay your mortgage. However, interest rates for these mortgages are generally lower. In the middle, are the partially open mortgages that have some of the characteristics of both open and closed mortgages.

Just as there is a range of mortgage types, there is also a range of repayment schedules. As well as the traditional monthly payment plan, there are now semi monthly, biweekly and even weekly payment schedules. Accelerated repayment options speed up the process even more, paying down the mortgage faster and spending less on interest charges. You may also opt for a shorter amortization period, or mortgage "life". It raises your monthly payments in the short-term, but saves you in the long-term, on the interest you pay.

Those Extra Expenses
You should plan on a few extra expenses. In some provinces, you may have to pay a land transfer tax (a sales tax on property). You may also have to pay:

- a mortgage broker's fee (as much as one per cent on the principal);

- an appraisal fee;

- surveying costs (if the seller couldn't come up with a current survey); and,

- a high-ratio mortgage insurance premium.

You also face a possible interest adjustment. Mortgages are normally calculated from the first of each month: if your closing date is the same as the beginning of your mortgage, there will be no adjustment. However, if your closing date is July and you move in on June 15, those last 15 days are the interest adjustment period. Your lender will expect you to cover the cost of the interest during that time.

You'll also have to reimburse the seller for the unused portion of any prepaid property taxes or utility bills. As well, you must also pay any legal fees, and, if applicable, any REALTOR fees. Be prepared to furnish proof to your lender that you have insured your new house... that will cost, as well.

KEEP YOUR MONTHLY PAYMENTS LOW

Get a loan with no monthly mortgage insurance premiums. You may be able to reduce or eliminate them by paying a little more at closing. By putting 20 percent or more down, you can eliminate them entirely.

Consider an Adjustable Rate Mortgage. These mortgage types can be up to 3 percent lower than fixed rates.

The comments contained on this site are for information purposes only and do not constitute legal advice. Procedures and laws vary from region to region.

Source: The Canadian Real Estate Association

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