Choosing Mortgage Terms

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!

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.

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%.

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).

Amortization

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.

Interest Rate

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.

Penalty

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.

HardBacon

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.

Credit Score

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.

Down Payment

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.

Income Source

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.

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.