You’ve found the home you want and your offer has been accepted. Now it’s time to get down to the nitty-gritty, making sure you get the right mortgage to address your financial circumstances.
By understanding these basic mortgage concepts, you will be better able to tailor your mortgage to your specific need:
- Principal. The amount of money you need to borrow, usually the difference between the selling price of the property and the down payment.
- Interest. The amount you will pay for borrowing the money.
- Mortgage Payment. A regular installment; usually made up of principal and interest, with which you repay the mortgage over its term to maturity.
- Amortization Period. The actual number of years it will take to repay the entire mortgage. Your amortization period can range from 5 years to 35 years.
- Term. The length of time that a specific mortgage agreement covers, generally between six months and ten years (although 25 year terms are also available). When the term matures or expires, the balance of the mortgage is generally renegotiated for another term at rates and conditions in effect at that time.
- Equity. The value of your property over and above all claims; usually the difference between market value and the outstanding principal of all mortgages relating to the property.
Interest Rates: Fixed, Variable, or Both
The interest rate for a fixed-rate mortgage is locked in for the full term of the mortgage. Payments set out in advance for the term, providing buyers with the security of knowing precisely how much their payment will be throughout the entire term.
With a variable-rate mortgage, mortgage payments are generally set up for a specific term even though interest rates may fluctuate during that time. 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 payment of interest.
Or you can choose both fixed and variable-rate mortgages. If you have at least 20% equity in your home, you can diversify your mortgage and enjoy the advantages of both variable and fixed rates. You can select a variable portion that allows you to take advantage of potential long-term interest savings, and a fixed-rate portion that protects you if rates rise. If this sounds like a strategy that would work for you, ask me how!
Your Mortgage Payment Options
Making more frequent payments is one of the ways you can pay off a mortgage sooner. You have the choice of weekly, biweekly, semi-monthly, or monthly payments. Weekly and bi-weekly payments can be accelerated, which means that you make a slightly larger payment each time, which amounts to the equivalent of one extra monthly payment a year.
How frequently you make payments will make a substantial difference to your total interest costs.
Closed, Open, and Convertible Mortgages: Security vs. Flexibility
Mortgages are available on a closed, open or convertible basis. Your choice of a closed, open or convertible mortgage will ultimately reflect your short-term plans and your desire for a longer-term interest rate security.
Closed mortgages are usually the right choice if you’re not planning to pay off your mortgage in the short term. Their interest rates are generally lower than rates for open mortgages and offer the security of knowing exactly how much your payment will be over a set period of time. Closed mortgages are generally available in terms from six months to twenty-five years. Prepayment charges will apply if you renegotiate your interest rate or pay off your mortgage balance prior to maturity.
Open mortgages may be appealing if you’re planning to pay off your mortgage in the near future. They can be repaid either in part of in full at any time without prepayment charges. Interest rates for open mortgages are generally higher than for closed mortgages because of the added repayment flexibility.
Convertible mortgages offer the same benefits as closed mortgages but a convertible mortgage can be converted to a longer, closed term at any time without prepayment charges.
Your mortgage specialist can help you decide which mortgage solution works best for you based not only on your budget but also your future plans.
Everyone today is familiar with the impact of interest rates. The lower the interest rate, the less you pay for your mortgage over time; the higher the interest rate, the more you pay for your mortgage over time.
The table below illustrates the impact of various interest rates on monthly payments for a $100,000 mortgage amortized over 2.5 years. In this example, a difference of only 3% in the interest rate can represent a difference in payments of $181 or more each month.
Interest Rate Monthly Payment
See for yourself how much your monthly payments will cost based on differing interest rates. Visit www.rbcroyalbank.com/mortgagecalculators.
The lengths of mortgage terms vary widely – from six months right up to twenty-five years. In general, the shorter the term, the lower the interest rate; the longer the term the higher the interest rate.
While you will obviously want to choose the lowest rate possible, you will also want to safeguard against fluctuations in interest rates. How then do you select the best term for you? The decision is based on your personal situation and the degree of risk you find acceptable. Here are some examples:
- If you plan to see your home in the short term, you may find a short-term mortgage is your best option.
- If you are a first-time buyer, you may prefer the security of a longer-term mortgage, at least early on, so that you are better able to budget for and manage your monthly expenses.
Your amortization period is the amount of time it takes to pay off your mortgage. Customize your amortization period depending on how much you can afford. Paying off your mortgage sooner saves you interest costs, while a longer amortization period (up to 35 years) reduces your regular payment amount and gives you more room to manage your cash flow.
Because extended amortization means increased interest costs and paying down a mortgage more slowly, this option isn’t for everyone. A 25-year amortization period should be the starting point for your consideration as stretching the amortization to 35 years can increase your total interest costs by 50% over the life of the mortgage.
If you decide a longer amortization is appropriate, consider a strategy to reduce amortization over the life of the mortgage.
Choosing a Shorter Amortization Period
A shorter amortization period means higher regular payments, but it also means that you will pay significantly less interest over the life of the mortgage. You can choose a shorter period when you set up your mortgage or when you renew it.