Essential Knowledge Series
Most people know what a mortgage is and have a general idea of how it works. For those that don't, or are looking to know more, this post is for you.
There are 5 factors that affect your mortgage.
Mortgage Principal (Balance)
Mortgage Amortization (Length)
Payment Frequency
Interest Rate
Mortgage Term
1. Mortgage Amount
The mortgage principal is the balance you borrow from the lender. For example, if you purchase a home for $500,000 and put down a $100,000 down payment, you'll have a $400,000 mortgage. As you pay off your mortgage, this amount will decrease.
2. Mortgage Amortization (Length)
Your mortgage amortization is the length of time you have decided to pay off your mortgage. The most common amortization in Canada is 25 years. For traditional A and B lenders, the amortization can be increased up to a maximum of 30 years.
Your amortization will affect your payment amount. The longer you plan to pay off your mortgage, the lower your payment will be. The quicker you plan to pay off your mortgage, the higher your payment will be. Let's use the $400,000 mortgage again. If you set your amortization to 25 years at a 3.50% interest rate, your payment will be $1,997 per month. Increase the amortization to 30 years and your payment decreases to $1,791.
You might be thinking, why wouldn't I always go with a 30-year amortization if it reduces my payment? That's a good question and the answer is that when you increase your amortization, you will incur a premium on your interest rate and will pay more interest over a longer period of time.
3. Payment Frequency
Your payment frequency determines how often and the interval in which you will be paying off your mortgage. The most common frequency is a monthly payment. Aside from a monthly payment, you can pay bi-weekly, weekly and semi-monthly.
The more frequently you pay, the quicker you will pay down your mortgage. In other words, if you pay bi-weekly or weekly, you will reduce the amortization because you will fit more payments into a year. For example, let's compare bi-weekly payments to semi-monthly. Paying semi-monthly equals 24 payments a year. However, paying bi-weekly equals 26 payments a year. Those extra two payments lead to you paying down your mortgage faster and reducing your amortization.
4. Interest Rate
The interest rate is arguably the most important aspect of your mortgage. This percentage will determine how much of your mortgage payment goes to the principal vs the interest. It will also help determine your mortgage payment and how much you can qualify for. It's important to look for the best rate when applying for a mortgage.
Let's look at our $400,000 mortgage again. With a 25-year amortization and an interest rate of 3.50%, your monthly payment would be $1,997. Of that amount, approximately 57% of the payment is going to interest and the rest to the principal. If we increase the rate to 4.50%, the interest portion increases to 66%. That is a pretty drastic change and something to heavily consider when looking for interest rates.
When looking for mortgage rates, there are two types of rates that can be obtained from traditional lenders. Fixed and variable. A fixed-rate remains the same over the entirety of the term. However, a variable rate will fluctuate with the prime rate of your lender. If you're not sure what type of rate is right for you, click here. Under the right circumstances, fixed rates can be right and under other circumstances, variable rates can be right. It will all depend on your specific situation. Generally speaking, if you don't mind taking on a bit more risk, variable rates are for you. As the saying goes, the higher the risk, the higher the reward.
5. Mortgage Term
In Canada, we have what are known as mortgage terms. This is the length of time you will have a set mortgage rate. Generally speaking, most people will go with a 5-year mortgage term but they range from 6 months all the way up to 10 years. The benefit to being able to choose your mortgage term is that you can plan out your future. For example, if you are planning to sell the home in 3 years, you can avoid a large payout penalty by taking a 3-year term. When mortgage rates are fluctuations consistently, shorter terms benefit you more as the consumer. If you were in the US and had to lock in for 15 or 30 years, you might miss out on interest rates decreasing over your term.
This was a lot of information packed into one blog post so if you still have questions, contact us or comment below! We're always open to questions and enjoy talking with our community!
Questions/Comments?
Give us a shout in the comment section or find our contact details on the main page of our website at www.triedandtruemortgages.ca
Comentarios