Amortization

Amortization, a cornerstone of mortgage understanding, represents the duration required to fully pay off the loan. It involves the systematic repayment of principal and interest over time. Shorter amortization periods result in higher monthly payments but lower overall interest costs, whereas longer periods lower monthly payments but increase the total interest paid. Insured and Insurable mortgages have a maximum 25 year amortization period. Uninsurable mortgages can have a maximum 30 year amortization period.

The amortization period is very important in the mortgage qualification process. The longer the amortization period, the lower the payment will be. This lower payment is used to determine how much mortgage you qualify for. I will discuss the mortgage qualification process in later chapters.

Term

The mortgage term dictates the duration of the mortgage contract. Terms typically range from 6 months to 10 years with the 5 year term by far the most chosen term. At the term's end, borrowers can opt to renew at prevailing rates, renegotiate terms, switch or transfer their mortgage to another lender or pay off the remaining balance. Understanding the impact of various term lengths on interest rates and overall mortgage costs is pivotal when selecting a mortgage product. Most mortgages in Canada have a 5 year term.

Maturity Date

The maturity date signifies the endpoint of the mortgage term. Consider a 5-year mortgage term commencing on January 1, 2023. The maturity date would be January 1, 2028. On this date, the remaining balance becomes due unless the borrowers choose to switch or transfer their mortgage to a different lender, or renew or renegotiate with their existing lender.

Loan to Value (LTV) Ratio

The Loan-to-Value (LTV) ratio determines the relationship between the mortgage amount and the property's appraised value. For instance, with a $250,000 mortgage on a property appraised at $300,000, the LTV ratio would be 83.33%. However, if that property’s appraised value is $500,000, the LTV ratio would be 50%. LTV is mostly used to determine if the mortgage has to be insured or can be insurable. All mortgages above 80% LTV are insured mortgages.

Payment Frequency

Choosing the payment frequency impacts the overall interest paid over the mortgage term. Consider a $200,000 mortgage with monthly payments versus accelerated bi-weekly payments. The accelerated schedule, while maintaining the same total annual payment, results in quicker principal reduction and less interest paid over time.

Prepayment Privileges

Prepayment privileges enable borrowers to pay down their mortgage faster without penalties. Suppose a borrower receives an annual bonus of $5,000. With prepayment privileges, they can apply this extra amount towards their mortgage principal, reducing the overall interest paid and shortening the amortization period. Most lenders offer two types of prepayment privileges: Lump sum payments and an increase in their periodic mortgage payment. For example, a lenders policy might state that their prepayment privileges are 20% lump sum and 20% increase in payment. If the borrowers original mortgage amount is $200,000 and their mortgage payment is $1,000 then the borrower’s prepayment privileges will allow the borrower to pay up to $40,000 as a lump sum at any time during the year, each year AND allow the borrower to increase their payment by any amount up to 20% more than their regular payment amount. So in this case that would mean the borrower can increase their payment to an amount anywhere between $1,000 and $1,200. These privileges are not cumulative. This means that if the borrower does not use their prepayment privileges that year, the amount they don’t use does not carry forward into the future. It is very rare that borrowers use all of their prepayment privileges.

Penalties

Penalties are incurred when borrowers breach the mortgage terms. For instance, breaking a closed mortgage before the term ends may result in penalties equivalent to a certain percentage of the remaining principal. Understanding penalty structures aids in making informed decisions regarding mortgage flexibility. We will discuss penalties in detail in a later chapter discussing Why Use a Mortgage Broker.

Fixed Rate Mortgages

Fixed-rate mortgages offer stability with a locked interest rate for the term. For example, a borrower opting for a five-year fixed-rate mortgage at 3% ensures that monthly payments remain consistent for the entire five year term, shielding them from market rate fluctuations during the term. Most mortgages in Canada have a Fixed Rate.

Variable Rate Mortgages

Conversely, variable-rate mortgages fluctuate with market conditions. Variable rate mortgages are linked to the Prime Rate. A borrower with a prime-rate-linked mortgage might see their interest rate change based on shifts in the prime rate, affecting monthly payments and overall interest costs. Some lenders offer variable rate mortgages but the mortgage payment does not change. In these types of mortgages, if interest rates go down the mortgage is actually getting paid off faster (the amortization period is reducing), whereas if the interest rates go up the mortgage is actually not getting paid off according to the original amortization schedule.

Closed Mortgages

Closed mortgages limit prepayment options, providing stability with lower interest rates. A borrower with a closed mortgage aiming to make lump-sum payments beyond the prepayment allowance may face penalties, restricting their flexibility. Most mortgages in Canada are Closed Mortgages.

Open Mortgages

Open mortgages offer flexibility but with much higher interest rates. Borrowers can make extra payments or pay off the mortgage entirely without penalties. However, this flexibility often comes at the expense of higher interest rates. The only time a borrower would choose an Open mortgage is if they are planning to switch lenders or if they are planning to pay the amount off in full soon.

Cash Back Mortgages

Cash-back mortgages provide borrowers with a lump sum upon closing. Borrowers might receive, for example, 5% cash back on a $300,000 mortgage. While this immediate cash can assist with initial expenses, borrowers should weigh it against the higher interest rates associated with such mortgages. The higher rates means higher mortgage payments and less purchasing power.

Collateral Mortgages

Collateral mortgages use the property as collateral for multiple mortgages. For instance, a homeowner might access additional funds through a secured line of credit while maintaining the mortgage, offering financial flexibility but potentially limiting the ability to switch lenders easily.

Home Equity Line of Credit (HELOC)

HELOCs allow homeowners to borrow against their property's equity. Suppose a homeowner with a $400,000 property value and $200,000 outstanding mortgage takes out a $50,000 HELOC. This revolving line of credit provides flexibility in borrowing against the available equity while requiring interest payments only on the borrowed amount.

Understanding these mortgage terms empowers borrowers to make informed decisions aligned with their financial goals, ensuring a smoother path towards homeownership.