Very few people have enough cash on hand to purchase an entire home or property outright. If you’re like most, you’ll need a mortgage.
But here’s the deal: not all mortgages are created equal. With so many different choices available, which one is the best choice for you?
There are many types and different ways to categorize mortgages, so let’s go over some of the basic types and which ones are best for your circumstances.
Mortgage 101: The Basics You Need to Know
After selecting your dream home, the next step is to find the right mortgage. This is an important decision that you need to get right.
What is a mortgage? A mortgage is the legal agreement you make with a lender that outlines the value of the loan, the frequency of payments, the various renewal periods, and the amortization period (total length of the mortgage). It’s important that you stay on top of your payment schedule as the lender has the right to take your property (foreclosure) if you fail to make your mortgage payments.
Mortgages come in a variety of forms, from fixed to variable and range in payment frequency, renewal length, and amortization periods.
Calculating Mortgage Payments
The first question in every homebuyer’s mind is probably “how much will this cost me?” Determining the payment amount is multifaceted for this type of loan.
Mortgages come in two parts: the principal and the interest. The principal is the amount to be loaned—the interest is the additional amount, a percentage of the principal, that the lender adds as part of the agreement. Because you are essentially gaining access to funds immediately and only paying off eventually, the interest is just the fee for doing so.
- Length of the mortgage term
- The buyer’s credit history
- The buyer’s employment status
- The type of lender (bank, credit union, etc.)
- The current interest rates as outlined by the Bank of Canada
The next step is finding out the amortization, or the total length of time it takes to pay off the mortgage. The longer it is, the more interest you have to pay but ultimately the less money you need each month since the amount is more spread out.
To understand the full cost of a loan, the metric known as annual percentage rate (APR) exists that combines the amount of the loan, the total interest, and any applicable fees.
The Many Types of Mortgages
- Down payments: Some require a certain percentage of the principal or the value of the home itself. These can differ immensely.
- Qualifications: Some loans require an excellent credit score, while others are designed specifically for those with poorer credit.
- General guidelines: Guidelines can be relatively relaxed or act as stringent rules.
Determining the category of mortgage changes the payment plan and how flexible the contract is. Typical ways to categorize mortgages include the following.
Amount of the Down Payment
- Low Ratio: These are the mortgages with a down payment of less than a fifth of the property value. Low ratio contracts are the most conventional and usually do not require mortgage protection insurance.
- High Ratio: On the other side of the coin, a high ratio mortgage represents a down payment of over 20% of the purchase price. Mortgage insurance is necessary for most of these plans.
Interest Rate Types
- Fixed Rate: The interest rate is predetermined and locked for the payment period, though sometimes you are allowed to make early payments.
- Variable Rate: Known as variable rate mortgages (VRM) or adjustable rate mortgages (ARM), a variable rate may change the size of each payment or the amortization period at a later point based on market conditions.
Flexibility of Terms and Conditions
- Open: Under this plan, you have the option of paying extra to complete the payment early. The result is more flexibility at the cost of usually more interest. An open mortgage is ideal if you think you’ll have extra money on hand or plan to sell your property soon.
- Closed: By contrast, a closed contract has a lower interest rate but also limits the amount you can put in each year. Choose this type if you think you’ll keep the home for the loan’s full term.
- Portable: As the name suggests, a portable mortgage allows the transfer of the terms and conditions of a previous contract to a new home. Choose a portable deal if you’re thinking of selling your property and buying a new one. A portable plan avoids the penalty of breaking the contract early.
- Assumable: Some homeowners don’t want to start a new mortgage and just take control of someone else’s. This setup works when the original owner wants to change homes and can find someone else to take over. The exact legislation regarding assumable mortgages is rather complicated, so talk with your lender.
- Convertible: Under a convertible system, a homeowner may change the type of mortgage partway into the term. For instance, you might be on an open mortgage but want to switch to closed in the future.
- Hybrid: In a similar vein, a hybrid mortgage combines the characteristics of multiple types of mortgages. This contract is only recommended for homebuyers with a fleshed-out financial plan.
- Reverse: This option is intended for homeowners older than 55. You can actually convert your home’s equity into monthly cash payments that you can use for living expenses.
Other Features To Look Out For
Ask your vendor about optional features on top of the required terms and conditions of your contract.
- Cash back: The cost of the home isn’t the only consideration for the homeowner. There might be extra legal fees, for example. In this case, it can help to have a certain amount of the mortgage in cash right away. Keep in mind that interest may go up if you opt for cash back.
- Home equity lines of credit (HELOC): Sometimes treated as an alternative to a mortgage, a HELOC allows the lender to use the property as collateral to ensure that the buyer repays the loan. It’s sometimes referred to as a “readvanceable mortgage” and takes the form of a revolving line of credit.
- Title insurance: A “title” is a legally protected term that determines who “owns” the property. Having title insurance protects against identity fraud, specifically whenever a malicious individual sells the home or tries to apply for a new mortgage.
- Additional insurance options: Extra products to add to a mortgage might include life, disability, or illness insurance. In case you lose your job or suffer critical health problems, you can still make your mortgage payments this way.
Finally, ask your vendor about first-time assistance programs if you’re a first-time buyer. There are likely specialized mortgage contracts for you, as well as a first time homebuyer’s credit.
Ready to Purchase Your Dream Home? I’m Here to Help
It’s no secret that the mortgage approval process can be intimidating. First time homebuyers have a lot to think about, especially when it comes to your mortgage.
Are you interested in exploring what options you have available to you? Even if you haven’t started the mortgage approval process, you can start searching for your dream home.
Get in touch with me today and let me show you what options you have available to you.
Hi, I’m Joel, a real estate professional based in Toronto.
My approach is simple—I put you first. I believe in open communication, total transparency, and meaningful results. I’ll guide you through the real estate process, market values, and always keep the focus on you—and your needs.