May 22, 2013

Mortgage ABC’s

The mortgage process can be confusing for many of us.  There are many elements involved and there is a lot of terminology.  In today’s post, I am going to simplify some of the most common features of a mortgage.  The list is alphabetical so you can jump ahead if you already know some of these items. Happy reading!

Amortization

Amortization is what refers to the entire life of a mortgage, typically 25 years, however you can have shorter or longer amortizations.  The length of amortizations is being hotly debated in today’s current market:

http://www.theglobeandmail.com/report-on-business/economy/housing/flahertys-concerns-throw-thirty-year-mortgages-in-spotlight-again/article11900963/

Typically, people choose a shorter amortization when they want to pay off their mortgage faster (however, this is not the only way to do so and is not always advised).*  Currently in Canada, if you have put 20% or more as a down payment, you may be eligible to access up to a 30 or 35 year amortization.  Longer amortization periods allow for lower monthly payments, but do cost more in overall interest over the life of the mortgage.

You can adjust the length of your amortization when your specific mortgage term comes up for renewal or by making a lump sum payment or increasing your payment during the term.

Assumability

This refers to a mortgage feature whereby someone else can assume or ‘take over’ your mortgage. Assumability of a mortgage comes up in certain circumstances – such as someone wanting to sell their property and have the buyers assume the mortgage.

Credit

A credit score is produced by two Credit Bureaus here inCanada, Equifax and Transunion.  Banks use credit scores to evaluate the risk profile of customers.  The higher your credit score (also known as beacon), the better.  There are many factors which make up your score including how much you borrow, your capacity to pay back your debts, how many credit products you have and how long your credit history has been.

The most important factor regarding credit is your ability to make payments on time.  Whether it is monthly payments on your credit card, car loan or line of credit, you want to make sure that you are paying these balances on time.

You want to be careful not to get too close to the maximum limit on your credit cards and credit lines.  When you start to borrow over 75% of what is available to you, your credit score gets lowered.  It is OK to reach these limits from time to time, but make sure your balance doesn’t stay there for too long and that you never go over your limit.

One of the biggest mistakes new homebuyers make is taking on more credit once they have been approved for a mortgage, but before the closing of their new home.  The banks may review your application right before your closing date and if you have just taken on a debt such as a car lease or a furniture lay-away, this will change what are called your debt-servicing ratios, which will impact your ability to purchase your home.

Not putting all of your eggs in one basket in another important thing to remember with regards to credit.  Many clients like to have all of their banking and mortgage products housed by the same institution, but there are benefits to establishing a borrowing relationship with more than one financial institution.

Down Payment

Depending on your situation, a 5% or 10% down payment will be the minimum requirement for the purchase of a new home.  Any down payment under 20% will need to be insured by the Canadian Mortgage and Housing Corporation (CMHC).

CMHC has a tiered system for insurance premiums – the premiums lower with every additional 5% you put down.  If you are a self-employed borrower or you have an income property, your premiums may be slightly higher.

The premiums are outlined on CMHC’s website:

http://www.cmhc-schl.gc.ca/en/co/moloin/moloin_005.cfm

Payment Options:

There are six different mortgage payment options to choose from. There are monthly, semi-monthly, bi-weekly or weekly; along with accelerated bi-weekly and accelerated weekly payments.  Many people select their mortgage payment structure based on their pay structure with work.  You can set-up your mortgage payments to be withdrawn from your account on your work pay days, to provide convenience.

Accelerated payments increase your payment amount to equal one more monthly payment per year.

There is much debate regarding the best payment structure.  If you are looking to pay down your mortgage faster, essentially, the more frequently you pay, the faster you pay it off.  The difference however, is quite minimal in today’s low interest rate environment.

For example on a 5 year, 2.89% $400,000 mortgage with a 25 year amortization, the savings per year by going bi-weekly vs. monthly is $19.87.  In the case of minimal difference, it is advised to go with the payment structure that is most convenient for you.

Portablilty

Almost all mortgages are portable, which means they can be transferred from one property to another.  This can come in handy if you are selling and buying in the middle of your term and do not want to break your mortgage.  Along with porting your mortgage you are able to increase your mortgage if you were to purchase a property which costs more.

Pre-payments

Pre-payment privileges are outlined in all mortgage documentation and allow mortgage lump sum payments of anywhere between 10%-25% of the original mortgage balance during each year of your mortgage term.  It is important to note whether this payment is allowed at multiple stages throughout the year (payments that in sum total the maximum percentage allowed), or if it is only allowed on a specific date each year.

In addition to lump sum payments, mortgage payments can also be increased by the given percentage amount.  For example, if your pre-payment privileges are at 15%, you can increase your monthly payments by 15% each year during your mortgage term.

Pre-payment privileges come in handy in cases of expected or unexpected inflows of money – raises, commission increases or inheritances.  Pre-payments are one way of paying down your mortgage faster.

Rates

Mortgage interest rates are tied to the Canadian bond market and adjust accordingly.  We are currently in a market where the bond rate is low, and therefore interest rates are low.

Variable rate mortgages have two components to them. Your variable portion is prime rate which is set by the Bank of Canada (currently 3%) . The BOC meets 8 times per year to decide if they are going to increase or decrease prime rate. You lock in a spread above or below prime when negotiating your variable mortgage. A typical variable rate today is 2.6% (prime -0.4%). As prime rate changes so will the amount of interest and principal you pay each month.

Fixed rates remain the same from the beginning to end of a given mortgage term.  Fixed rates give more risk-adverse borrowers the peace of mind that their rate will not rise, and therefore, their payments will not increase.

Qualifying for interest rates depends on your income, down payment and credit score and the type of property you are purchasing.

Term

A mortgage term can be any of the following: 6 months or 1,2,3,4,5, 7 and 10 year terms.  The longer the term you choose, the higher your interest rate will be.  Also, typically, the longer the term you choose the higher your penalty can be if you break it.

The most common mortgage term is 5 years.  In today’s low interest rate environment, many borrowers are opting for a 10 year term to take advantage of the historically low rates.

 

There is a lot of terminology surrounding mortgages.  This list is quite extensive but it is not all encompassing.  If there are any elements missing that you wish to inquire about, or if you have any questions about what I wrote about today, please do not hesitate to reach out!

kelly@safebridgefinancial.com or find me on LinkedIn: ca.linkedin.com/in/kellydrinkwater/

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>