Mortgages

Mortgage Basics

There is no such thing as "just a mortgage". There are numerous types of mortgages and payment options designed to meet the unique requirements of every homeowner. If you’re considering purchasing a new home, you should be aware of the basic mortgage components, which include:

Principal - The amount of money you need to borrow; usually the difference between the selling price of the property and the down payment.

Interest - A percentage of the principal that is charged by the mortgage lender for borrowing the money.

Mortgage Payment - A regular instalment usually composed of principal and interest that is paid towards the mortgage over its term to maturity.

Amortization Period - The actual number of years it will take to repay the entire mortgage, generally a period anywhere between 15 and 25 years.

Term - The length of time a specific mortgage agreement covers. When the term matures or expires, the balance of the mortgage is often renegotiated for another term at rates and conditions in effect at that time.

Equity - The value of the property over and above all claims. This is generally calculated as the difference between market value and the outstanding principal of all mortgages relating to the property.

By understanding these definitions, you will gain a better understanding of the many options available and how to tailor your mortgage to your specific needs.

Types of Mortgages

Mortgages are available on a closed, open, or convertible basis and at fixed or variable rates. Your decision will ultimately reflect your short-term plans, your desire for longer-term security and whether you believe interest rates are going up or down.

Closed, Open and Convertible Mortgages

In a closed mortgage, the interest rate is locked in for the full term of the mortgage and, if you want to renegotiate the interest rate or pay off the balance before the end of the term, you will have to pay a discharge fee to the mortgage lender.

Closed mortgages are usually the better choice for purchasers who suspect that interest rates may be on the rise and for those who are not planning to move in the short term. Interest rates for closed mortgages are generally lower than for open mortgages. Closed mortgages are available for terms of 6 months to 10 years. First-time purchasers often choose this type of mortgage in the early years as they are more secure knowing exactly how much their mortgage payments will be over a certain period of time.

Open Mortgages offer greater flexibility than closed mortgages since they can be repaid either in part or in full at any time without discharge fees. Open mortgages are generally available in terms of 6 months or 1 year. Open mortgages are good options for purchasers who are planning to move in the immediate future or who believe that interest rates are going down. Interest rates for open mortgages are typically higher than for closed mortgages because of the added flexibility.

A convertible mortgage is a short term closed mortgage with a fixed interest rate that can be converted to a longer, closed mortgage at any time without penalty. If you think rates may change, this allows you the flexibility to choose the right time to lock in your rate.

Fixed-Rate Mortgages and Variable-Rate Mortgages

The interest rate for a fixed-rate mortgage is locked in for the full term of the mortgage. Payments are set in advance for the entire term, which provides purchasers with the security of knowing precisely how much their payments will be and how to budget accordingly. Fixed-rate mortgages may be either open or closed.

With a variable-rate mortgage, the amount of interest paid fluctuates with interest rates. For example, if the interest rates go down, more of the payment is applied to reduce the principal. However, if rates go up, more of the payment is applied to payment of interest. Variable-rate mortgages can be open or closed.

A variable-rate mortgage provides the purchaser with the flexibility to take advantage of falling interest rates. If the variable rate mortgage is open, the entire mortgage may be paid off without discharge fees.

How to Minimize Mortgage Costs

For most homeowners, paying off their outstanding mortgage is a top priority. Paying any additional amounts to your principal early in the mortgage term can reduce the life of your mortgage and dramatically lower the amount of interest you will have to pay. However, regardless of how far you are into the term of your mortgage, any pre-payments you can make will save you a lot of money in interest. The reason for this is that the interest portion of your mortgage payment is determined by the principal amount outstanding. As the principal lessens, so does the amount of interest and more of your mortgage payment goes to the mortgage balance. Other methods that can be used to minimize your mortgage costs and pay off your mortgage more quickly include the following:

• Increase Mortgage Payment Frequency

  The more frequent payments are made the more years can be taken off your amortization period and can save you thousands of dollars in interest.

• Round up your Mortgage Payments

  Adding even a nominal amount, for example an extra five dollars to each mortgage payment, can a have surprising effect on how much interest you will save over the amortization period of your mortgage and is a relatively painless expense at the time of the payment.

• Do not reduce your Mortgage Payments if Interest Rates fall

  If you are able to continue to make the same mortgage payments when the interest rates fall, more of your payment will be put towards your principal balance.

• Raise your Mortgage Payments incrementally with increases to your After-Tax Income

  While the extra disposable income would be enticing to spend on other items, by proportioning it to your mortgage payments, the long term benefits will outweigh your short term sacrifice. Pre-payment policies may vary depending upon your financial institution and type of mortgage you possess. Before deciding on how you wish to reduce the life time of your mortgage, review your mortgage agreement to see what options are available to you.