What is a Mortgage?
A mortgage is essentially a loan between you; as the mortgagor, and a financial institution; the mortgagee, whereby you agree to pay back this loan at a certain interest rate over a specific period of time. The mortgagee registers this loan against your property in the Land Titles Office to ensure that this loan is repaid in the event you sell your property. The mortgage itself also outlines what takes place should you go in default on this loan and the remedies for both parties.
For the most part there are essentially two types of mortgages that you should be familiar. To demonstrate the differences we will use an example purchase price of $100,000.
Types of Mortgages
1. Conventional
This mortgage is a maximum of 75% or the purchase price and uninsured. The financial institutions feel that if you are putting 25% of your own money down, you are less likely to walk away if you encounter financial difficulties. They also feel that the likelihood of the market falling more that 25% is remote.
| e.g. | Purchase Price $100,000 |
| 1st Mortgage (75%) $ 75,000 |
| Downpayment (25%) $ 25,000 |
2. Unconventional - High Ratio
This Mortgage is a minimum of 5% or 10% down depending on certain criteria. Here the banks feel that due to the amount of downpayment there is a possibility that you may walk away or that the market may fall 5 or 10%. So they have this mortgage insured, usually through CMHC. This then involves fees ranging from 1.5% to 3.75% of the mortgage amount.
| e.g. | Purchase Price $100,000 |
| 1st Mortgage (90%) $ 90,000 |
| CMHC Fee (2.5%) $ 2,25000 |
| Downpayment (10%) $ 10,000 |
Mortgage Term and Amortization Period
There are 2 time frames relating to Mortgages, one affecting interest rates and the other affecting the payment schedule.
Mortgage Term
This relates to the amount of time the interest rate is fixed. The most common terms range from 6 months to 5 years. Although we are starting to see some Financial Institutions offer longer terms such as 7 or 10 year interest rate terms. As a rule you will find the rate of interest rises with the length of the term.
Using the example of a $100,000 mortgage amortized over 25 years would have the following affect on the term.
Example:
| Term | Rate | Payment |
| 1 year | 5% | $582.00 |
| 3 year | 6% | $640.00 |
| 5 year | 7% | $701.00 |
Amortization Period
The amortization period refers to the length of time it will take to repay the loan in full. The most common period is over 25 years, however the shorter the amortization period the less interest you pay resulting in more savings to you.
Again using the example of $100,000 using a constant rate of 6% over the entire amortization period.
Example:
Amortization
Period | Monthly
Payments | Total
Interest | Interest
Savings |
| 25 years | $640.00 | $91,867.44 | 0 |
| 20 years | $713.00 | $70,748.24 | $21,119.20 |
| 15 years | $840.00 | $51,166.10 | $40,701.34 |
So as you can see the shorter the amortization period the larger the payments but the bigger the savings in interest payments.
PAYMENT OPTIONS
The most common payment frequencies are monthly, bi-weekly and weekly. By increasing the frequency or your payments you can allow for your mortgage to be paid off sooner and reduce the total amount of interest paid.
You may want to match your payments to your pay periods. Remember, making one extra payment a year will reduce the amount of interest paid over the lifetime of the mortgage.
PREPAYMENT PRIVILEGES
Most Financial Institutions offer prepayment privileges on their mortgages. They will vary from institution but usually they will allow you to pay a lump sum towards your mortgage at certain times during the life of your mortgage. The lump sum amount will be applied directly to the principal of the mortgage and not to interest, thereby once again reducing the amount of interest paid.
Some examples of these options are allowing you to pay an extra monthly payment so many times a year, or allow a lump sum of 10% to 20% or the outstanding balance once a year, in both cases applied to the principal.
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