Are you considering your next mortgage move? Here are the mortgage 101 basics that you need to know to make the best decision.
Amortization period
The amortization period refers to the number of years it will take to pay off your mortgage through regular payments. Most mortgages are amortized over 25 years, but they can be more or less than that number.
DID YOU KNOW? You can pay off your mortgage sooner and save potentially thousands of dollars of interest by:
- Making payments more frequently, for example bi-weekly instead of monthly;
- Making an extra principal or lump sum payment on the anniversary date of your mortgage;
- Increasing your payment on the anniversary date;
- Making the same payments each month (or better yet: biweekly), even as you make progress on your mortgage and the total principal amount goes down.
Fixed-rate mortgage vs variable or adjustable-rate mortgage
Simply put, a fixed-rate mortgage is where the interest rate on your home loan is set or “fixed” for the term of your mortgage, typically five years. A fixed-rate offers security in the knowledge that your mortgage payment won’t change even if interest rates go up.
Contrast that to a variable rate mortgage, where the interest fluctuates with the market. With a variable rate mortgage, the payment each month remains the same, just the proportion of the amount going towards principal and interest changes. If the interest rate goes up, the amount going towards your principal goes down, and it could take longer to pay off your home loan.
With an adjustable-rate mortgage, also known as an ARM, the payment can fluctuate with the interest rate. The advantage of this type of mortgage is that your principal payment is always the same, so you stay on track to pay off the mortgage.
When considering which mortgage type to choose, you have to weigh the pros and cons of each. Fixed-rate mortgages protect you from rates rising in the near future. Variable and adjustable-rate mortgages allow you to benefit from rates if they go down in the near future.
Gross debt service (GDS) ratio and total debt service (TDS) ratio
GDS refers to the percentage of your household’s gross monthly income that goes toward your housing payments – mortgage (principal + interest), property taxes, heating and, if applicable, 50% of condo fees.
TDS refers to everything that your GDS ratio considers plus your other debts and financing (i.e., car loans, credit cards, etc.).
Lenders use your GDS and TDS ratios to assess your mortgage application and determine how much to loan you and what interest rate to apply.
High-ratio mortgage vs low-ratio mortgage
A high-ratio mortgage is where you put less than 20% of the home’s cost towards the down payment. All high ratio mortgages need to be covered by mortgage insurance.
Low ratio mortgages, also known as conventional mortgages, are where you have put down 20% or more of the home purchase price. Mortgage insurance is not required for this type of mortgage.
Open mortgage vs closed mortgage
Mortgages can either be open or closed, depending on the lender and the mortgage product being offered. An open mortgage typically gives the borrower the ability to repay part or all of the mortgage amount at any time, with minor or no penalties.
A closed mortgage usually refers to a mortgage product that requires you to make regular payments and doesn’t allow for early prepayment without typically hefty penalties.
Closed mortgages usually have lower interest rates, but they give the borrower less flexibility and fewer options.
Mortgage loan insurance
Also known as “mortgage default insurance” or just “mortgage insurance,” this financial product is mandatory on all high-ratio mortgages. Contrary to how it sounds, this insurance protects the lender, not the borrower, in the event that the borrowers defaults on their loan.
You can either pay the mortgage insurance upfront in one lump sum or you can blend it into the mortgage over time.
Mortgage protection insurance
This form of insurance protects the borrower if they can’t make their mortgage payments due to illness, loss of work, or other less pleasant situations.
Mortgage term
Not to be confused with amortization, mortgage term refers to the time period covered by your mortgage agreement. It can range from one to five years or more.
When your mortgage term comes up your current lender may offer to renew your mortgage, typically at current interest rates. You also have the opportunity to pay off the mortgage in full or renegotiate your mortgage with another lender.
Principal
The principal is the amount initially borrowed for your home purchase. The principal of your mortgage goes down as you make payments. Near the beginning of the life of your mortgage, the majority of your regular payment goes towards interest instead of principal. This switches towards the end of your home loan, where the majority of your payment pays down the principal.
Now that you have a solid understanding of the mortgage 101 terms, you’re ready to talk to a mortgage broker and make sure you’re getting the best deal on your mortgage.