Purchasing or refinancing a home is a big step in someones life. Do you really understand all the terms? Has someone gone through what is required to get a mortgage? Do you really know what you are getting? Check out a blog I wrote titled Mortgage 101 to answer some of the questions. This blog is dedicated to all those terms and words you hear when speaking with a bank or a broker. This is YOUR purchase/home and you should be fully aware of what you are receiving. Ask the questions and make sure you understand the answer. If the person cannot answer your questions then it is probably wise to go elsewhere.
Following is a list and explanation of some of the more popular mortgage terms in the industry you need to be aware of.
Number of years it takes to repay the entire amount of the mortgage, most often twenty-five years. The longer the amortization, the lower your regular payments but the more interest you pay in the long run.
An assumable mortgage allows any future buyer of your home to take over the balance of your mortgage if you sell your home, assuming all your obligations and releasing you from the mortgage. This can be a particularly attractive selling feature if your existing mortgage provides a better rate than is currently available at the time of sale. This feature may or may not be available with the lender you selected.
A closed mortgage means that If you want to renegotiate the rate or payoff the balance before the end of the term, you will be subject to a prepayment penalty. Interest rates for closed fixed-rate mortgages are generally lower than for open fixed-rate mortgages. Closed mortgages are available in a range of terms from six months all the way up to twenty-five years.
Canada Mortgage and Housing Corporation, a federal crown corporation, provides mortgage default insurance to financial institutions so Canadians can buy a home with as little as 5% down instead of 20%.
A conventional mortgage requires a down payment of at least 20% of the purchase price. Conventional mortgages have the lowest carrying costs because they do not have to be insured against default.
The portion of the purchase price that the buyer must pay up front from their own resources (not borrowed funds).
Fixed rate mortgages have a set interest rate that is constant for the entire term of the mortgage. Fixed rate mortgages are available in open or closed terms.
A mortgage in excess of 80% of the appraised value must be insured against payment default. CMHC, Genworth or Canada Guaranty are the only providers of default insurance in Canada.
The cost you pay to borrow money. The interest rate is usually expressed as an annual percentage rate, compounded semi-annually. In some cases for Adjustable Rate Mortgages the compound period may be monthly.
Interest Rate Differential
If the mortgagor wants to payout the mortgage prior to the term ending, the lender will often charge the greater of 3 months interest or an IRD penalty (Interest Rate Differential.) IRD Calculation Example: Let’s assume the following:
• $100,000 5 year fixed rate mortgage
• Rate = 6.5
• Discount = 0 bps
• Mortgage broken after 3 years
• Prevailing rate = 5%
The prevailing rate is the posted rate for the closest remaining term minus the most recent customer discount. Note: The most recent customer discount refers to the discount the customer received in the original mortgage or since the last renewal – that is, the discount they received on the mortgage they are now discharging
|Prevailing Rate||5% (posted rate for the closest remaining term minus the most recent discount)|
|IRD||6.5% – 5% = 1.5%|
|Remaining Term||2 years|
|IRD Compensation||$100,000 X 1.5% X 2 years = $3,000 (equal to Bank’s lost revenue|
Please note this example is for illustration purposes only. Please refer to your Standard Charge Terms for the specific calculation with your selected mortgage.
A mortgage is your personal guarantee to repay your loan as well as a pledge of the property as security for the loan.
Mortgage Broker Fee
In most cases, mortgage brokers are paid a fee by the financial institution who is providing you with the mortgage funds. However, if you have had difficulty in qualifying for credit in the past, are self-employed, or have problems in providing documentation, it may be your responsibility to pay the broker’s fee. The fee varies from broker to broker.
A lender who advances mortgage funds to a borrower and uses the property as collateral for the loan.
A borrower who receives mortgage funds in return for a personal guarantee to repay the monies and pledges the property as collateral for the loan.
Open mortgages offer greater flexibility than closed mortgages since they can be repaid either in part or in full at any time without a prepayment penalty. Open mortgages are good options for buyers who are planning to move again in the near future, are expecting to receive a sum of funds and they want to accelerate the pay down of their principal, or believe that interest rates will be moving downward. Interest rates for open mortgages are generally higher than for closed mortgages because of the added flexibility.
A regular installment usually made up of principal and interest, by which you repay the mortgage over its term to maturity. The Mortgagor can choose between a weekly, bi-weekly, semi-monthly or monthly payment schedule. Increasing the payment frequency can reduce the interest cost over the life of the mortgage.
If you decide to sell your home, subject to geographic and lender restrictions, portability allows you to transfer the terms, conditions, and interest rate of your existing mortgage to your next home. For example, this may allow you to keep a low interest rate and avoid paying a prepayment penalty if you sell one house and buy another.
If not in default, the lender generally offers you a generous combination of options to accelerate the pace at which you can pay down your mortgage without penalty. These accelerated payments generally allow the following options:
• Prepay from 10% – 25% (depending on lender) of the original principal amount of the mortgage without charge each calendar year,
• In addition, the mortgage payment can be increased by up to a maximum of 100% (double up) over the term of the mortgage. If it is too difficult for the customer to maintain the higher payment, it can be decreased to the original mortgage payment amount. With some lenders, each double up payment made allows the mortgagor to skip a payment. Please refer to your Standard Charge Terms for the specific prepayment privileges with your selected mortgage.
Lump sum prepayments, permanently increasing your mortgage payments and the ability to make extra payments are powerful money saving options. Anything you pay over and above your regular payment amount will go directly towards your principal.
A penalty paid to an existing lender to get out of a closed term in part or in full prior to maturity of the mortgage term. The penalty is generally the greater of 3 months interest or Interest rate differential. (IRD – see example above)
The amount of money you need to borrow, usually the difference between the purchase price of the property and the down payment. As you repay the loan over time, the amount of principal declines.
If the term selected is less than 5 years, or if the mortgage is Variable, the greater of the 5 year Bank of Canada Benchmark rate or the customer rate will be used as the qualifying rate. If the term is 5 years or greater, the actual customer rate will be used as the qualifying rate.
The length of time that a specific mortgage agreement covers is generally between six months to ten years. When the term matures or expires, you generally renegotiate the remaining balance for another term at rates and conditions in effect at that time. Generally the longer the term, the higher the rate.
Total Debt Service Ratio (TDS)
The percentage of the borrower’s gross monthly income that will be used for monthly payments of principal, interest, taxes, heating and other outstanding loans and debts.
Variable Rate Mortgage
A variable rate mortgage implies a rate that is variable, or fluctuates according to the rate set by the Bank of Canada. If interest rates go down, more of the payment is applied to reduce the principal; if rates go up, more of the payment is applied to interest.
Again a mortgage is a important aspect in someones life and you need to educate yourself in order to get the best deal for your current situation and needs. I take the time to explain this to all my clients no matter if they are buying today or need help and a plan to buy in the future. I do not charge a fee for residential mortgages.
As always comments and suggestions are encouraged and appreciated.
Eric Gall is the owner of Avanti Mortgages (operating as a mortgage specialist for TMG Atlantic). If you are purchasing, refinancing or renewing your mortgage contact Eric or check out his website and apply online.