Choosing Mortgage Terms
The global mortgage industry is a multi-trillion dollar industry. The total value of mortgage loans outstanding is US$17.6 trillion in the US alone. In Canada, the latest available numbers suggest that households carry $1.6 trillion worth of residential mortgages. Yet when it comes to financial literacy around the established mortgage mechanisms, Canadians are not as aware as they can be. According to a survey conducted by the Financial Consumer Agency of Canada and the Bank of Canada, only 49 percent of the Canadian mortgage consumers could appropriately identify what mortgage terms meant, implying that more than half of the consumers could not do the same.
In this article, we will go over some basics of mortgage terms so that when you decide to buy a house or change your mortgage terms, you can do so with eyes wide open!
Table of Contents
What is Mortgage Term?
At its core, your mortgage term is the notifier of the length of time your mortgage contract is in effect. It also explains your contract outlines and the interest rate applicable for the tenure. Mortgage terms could be as short as a few months or as long as five years or more.
Reaching the end of your mortgage term implies that the contract is up for renewal. You might renew it for multiple terms to fully pay back what you had borrowed. Another important term that you should know of is mortgage amortization. An amortization period is the number of years you would take to pay off a mortgage in its entirety, based on the interest rate applicable. The maximum amortization period offered in Canada is 25 years, though there may be some exceptions.
Historical Mortgage Rate in Canada
There are two types of mortgage rates: the varying yearly rate and the five-year fixed rate. In 1975, the variable rate was 8.7%, while the five-year rate was 11.50%. In 1985, the variable rate increased to 10.20%, while the five-year fixed rate remained almost the same at 11.75%. By the time it was 1995, the yearly variable rate had come down by a significant margin to 7.95%, while the five-year fixed rate also got reduced to 8.95%.
As we reached the new millennia, mortgage rates took a deep plunge. In 2005, the yearly variable rate was as low as 3.95%, and the five-year fixed rate was 6.05%. A decade later, the yearly rate went down further to 2.55%, while the fixed rate was 4.64%. In 2022, the lowering of the yearly variable rate has continued to reach 2.15%, while the five-year fixed rate has gone up a bit to 4.79%.
Choosing Mortgage Terms
Types of Mortgage Terms
Short term mortgage: Short term mortgages are typically those with a term of less than five years. You can choose between a fixed or variable interest rate and get a lower interest rate at the time of signing up. The shorter the term of the mortgage, the sooner you have to renew it.
Long term mortgage: Long term mortgages are typically those with a term of more than 5 years. Long term mortgages usually have a fixed interest rate and you may have to pay a prepayment penalty if you sell your house within the first five years. The longer the term of the mortgage, the more likely you will get a lock-in interest rate over a long period of time.
Convertible term mortgage: A convertible mortgage term starts off as a short term contract and gets extended into a long term contract. With the extension comes the change in interest rate (usually the same rate applied to a long term mortgage).
The longer the amortization period, the lower the monthly installment payments. On the other hand, the longer it takes to pay off the mortgage, the more interest you will pay over the years.
Payment Timeline and Frequency
Getting the optimum repayment timeline and frequency of payments implies a careful understanding of the dynamics between the interest rate and the amortization period. Lending institutions opt for higher interest rates if the loan term is longer as they usually consider the inflation and the depleting purchasing power of money over time.
How Mortgage Terms Affect You
The interest rate on your mortgage is the primary deciding factor of how much payment you will have to shell out every month. The longer the amortization, the higher your interest, and the heftier your instalment payments.
Lending institutions project their future cash flows depending on the payments to be received over a period. The longer the repayment period, the more these lending institutions earn as interest. Any disruption in this estimated flow, such as renegotiating your contract or paying off your entire mortgage before the end of the term, may result in penalties. Having said that, a lender cannot stop a consumer from wanting to get rid of the debt quicker than the pre-agreed term.
A prepayment penalty is levied if you repay your mortgage in full before the tenure ends. The penalty amount depends on the mortgage amount and the period over which you were to pay it back. Since this amount can go into thousands of dollars, it is always advisable to look at your life situation and future plans. Then decide on an optimal term and stick to it.
Mortgage Comparison Websites
ThinkHomeWise is one of the most well-known best mortgage locators in Canada. Its comparison engine runs through a vast network of more than 30 banks and lenders. Data published on their official website suggests that borrower benefits can be US$10,000 on average. Accessing ThinkHomeWise is easy. The user answers some simple questions before a consumer profile is built. Next, the website goes through its network of lenders to find the best available mortgage, befitting the unique customer profile.
The platform deploys a mix of AI-based and human-powered services. The AI engine helps locate the best deals, while a personal advisor guides the consumer through each step, starting from approval to close. The platform has helped Canadians access mortgage financing worth more than $2.5 billion, according to the latest available numbers.
On this website, you take a short quiz and based on your answers to locate the best mortgage, suitable to the users’ needs. It also helps compare home insurance schemes, a crucial aspect of ensuring the utility of the customer’s investment. In a few clicks, you get to know your ideal mortgage payment amounts, whether you qualify for the mortgage, and whether a fixed or variable mortgage model would suit your needs.
LowestRates requires you to go through a few qualifying questions. For instance, you need to specify whether your inclination is towards a new home, refinancing, or renewal. It takes a little more than a couple of minutes to run through its network of more than 75 Canadian banks and brokers to develop the best available quotes. The process is free and requires no prior commitments. When a consumer finalizes the best quote available, the platform asks to talk to a licensed broker or agent.
Nesto is an online brokerage that provides commission-free mortgage rates from 10+ lenders with the convenience of applying through the website itself. Nesto also has advisors that guide you through the entire mortgage purchase process.
Qualifying for a Mortgage
The credit score of the consumer is an obvious qualifying criterion. One can qualify for a standard mortgage, as a Canadian resident, with a score of 680 or above. Qualifying for a mortgage with a score of less than 680 requires one to go through the Newcomer to Canada route. However, the down payment requirement stays the same.
The minimum down payment in Canada is 5%. Anyone paying less than 20% f the purchase price will also have to take out a mortgage insurance such as CHMC. This insurance protects the lender in case you are unable to pay your instalments.
Your source of income is a major deciding factor when it comes to qualifying for a mortgage. Both part-time and full-time employees need a letter from the employer confirming their income. If your income is from self-employment, rents, properties, support or alimony payments, or pensions, you will have to submit copies of your last two year’s tax returns and settle any outstanding taxes before applying.
Mortgage pre-approval can give you a guaranteed mortgage rate while you are still deciding on a home. A pre-approval gives you a guaranteed rate for three to four months. Pre-approval also comes with information on of how much mortgage you can afford. Mortgage pre-approval signals your seriousness as a buyer to both realtors and sellers. It also offers a safeguard in a highly competitive and fast fluctuating market.
Our Final Thoughts
Choosing mortgage terms that are right for you depends on a variety of factors. Evalutate your budget, project your future cash flows and opt for a pre-approval so that you get a clear idea of your mortgage amount and amortization period.
Frequently Asked Questions
The maximum you can stretch your mortgage term in Canada is 25 years, though there are some exceptions. Earlier the maximum period was 40 years. However, since 2008 mortgage regulations in Canada have become much stricter and the government has eliminated the 40-year plan. A longer mortgage term means higher interest. Moreover, “A” lenders like banks and credit unions are not keen to offer 35+ year mortgages.
According to the latest available data, the average new mortgage in Canada comes with a 25 year amortization period. The longer the amortization period, the higher interest one has to bear as part of their repayments. Home buyers try to strike a balance between the time and instalment amount, which is why most people settle for a tenure of 25 years.
A mortgage term denotes the time a mortgage contract is in effect, implying you are locked into all the conditions stated in your mortgage contract. Upon completing the term, you can choose to renew it with your existing lender or find a new lender and a new term contract based on new interest rates. On the other hand, an amortization period is the number of years take a mortgage consumer to pay off the mortgage in full, staying compliant with the agreed interest rate and payment schedule.