Mortgage Basics

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Mortgage Basics

Besides the actual type of mortgage you select, there are other important characteristics of your mortgage that determine exactly how much you will pay – both monthly and over the life of your mortgage.

Mortgage Down Payment Options

From a low down payment mortgage to using your Registered Retirement Savings Plan (RRSP) as a source of funds, buying a home has never been easier.

Closed, Open and Convertible Mortgages

Can’t decide between a closed, open or convertible mortgage? There are many factors to consider such as your financial goals and how soon you want to pay off your mortgage.

Variable and Fixed Rate Mortgages

From the security of a fixed rate mortgage to the flexibility of a variable rate mortgage, you have several choices when it comes to interest rates.

Mortgage Amortization

Choosing the length of your amortization period is an important decision that can affect how much interest you pay over the life of your mortgage.

Mortgage Prepayment Charges

One factor about a mortgage that most people need help better understanding is mortgage prepayment charges – when it’s required, how it’s calculated, how you can avoid it and what you should consider when you are choosing between different types of mortgages.

 

 

Mortgage Down Payment Options

From a low down payment mortgage to using your Registered Retirement Savings Plan (RRSP) as a source of funds, buying a home has never been easier.

The down payment is that portion of the purchase price you furnish yourself. The balance is obtained from a financial institution in the form of a mortgage. The amount of the down payment (which represents your financial stake, or the equity in your new home) should be determined well before you start house hunting.

Conventional Mortgage

A conventional mortgage requires a down payment of at least 20% and is offered on either a fixed or variable interest rate basis. Conventional mortgages have the lowest carrying costs because they do not have to be insured against default.

Low Down Payment Insured Mortgage

Most lenders now offer insured mortgages for both new and resale homes with lower down payment requirements than conventional mortgages-as low as 5%. Low down payment mortgages must be insured to cover potential default of payment; as a result, their carrying costs are higher than a conventional mortgage because they include the insurance premium.

Mortgage default insurance is a one time premium paid when your purchase closes. You can pay the premium or add it to the principal amount of your mortgage. Talk to your mortgage specialist to find out which option is best for you;

Mortgage Default Insurance General Disclosure (opens PDF in new window)

Using Your RRSP as a Down Payment

Under the federal government’s Home Buyer’s Plan, first-time home buyers are eligible to use up to $25,000 in RRSP savings per person ($50,000 for couples) for a down payment on a home. The withdrawal is not taxable as long as you repay it within a 15-year period. To qualify, the RRSP funds you plan to use must have been in your RRSP for at least 90 days.

Even if you already have enough money for your down payment, it may make sense to access your RRSP savings through the Home Buyers’ Plan.

For example, if you have already saved $25,000 for a down payment-and assuming you still had enough “contribution room” in your RRSP for a contribution of that amount, you could move your savings into an RRSP at least 90 days before your closing date. Then, simply withdraw the money through the Home Buyers’ Plan.

The advantage? Your $25,000 RRSP contribution will count as a tax deduction this year. Use any tax refund you receive to repay the RRSP or other expenses related to buying your home.

However, the money you borrow from your RRSP won’t earn the tax-sheltered returns it would if left in your account. Ask your financial planner if this strategy makes sense for you.

Saving Money with a Larger Down Payment

It’s to your advantage to put down as much money as you can because interest costs for a smaller mortgage are lower-adding up to significant savings over the long run.

The table below shows how an average homeowner can save more than $25,000 in interest costs on a $100,000 home by making a down payment of 25% versus the minimum down payment of 5%.

Down  Payment % Down Payment Amount Mortgage Principal Total Interest Paid(1)
5% $5,000 $95,000 $122,512
10% $10,000 $90,000 $116,063
25% $25,000 $75,000 $96,717

No matter the size of your down payment, be sure to reserve some funds to cover your home inspection, closing costs, moving and other potential expenses. Ask your real estate agent how much you might want to set aside.

 1. Total interest paid assuming a constant interest rate of 8% repaid over a 25-year amortization period. The scenario does not include the default insurance premium.

Closed, Open and Convertible Mortgages

Can’t decide between a closed, open or convertible mortgage? There are many factors to consider such as your financial goals and how soon you want to pay off your mortgage.

Closed Mortgage

Closed term mortgages are usually the better choice if you’re not planning to pay off your mortgage in the short term. Interest rates for closed term mortgages are generally lower than for open term mortgages. Closed term mortgages offer you the ability to save on interest costs and payoff your mortgage faster. You will pay a prepayment charge if you wish to renegotiate your interest rate, prepay more than your mortgage allows or pay off your mortgage balance prior to the end of its term.

Convertible Closed Mortgage

A convertible mortgage gives you the same benefits as a closed mortgage, but can be converted to a longer, closed term at any time without prepayment charges.

Open Mortgage

Open term mortgages may be appealing if you are planning to pay off your mortgage in the near future. They can be repaid either in part or in full at any time without prepayment charges. Open mortgages can be converted to any other term, at any time, without a prepayment charge. Interest rates for open mortgages are generally higher than for closed mortgages because of the added pre-payment flexibility.

Variable and Fixed Rate Mortgages

From the security of a fixed rate mortgage to the flexibility of  the Bank’s unique RateCapper mortgage, you have several choices when it comes to interest rates.

Fixed Rate Mortgage

The interest rate for a fixed rate mortgage is locked in for the full term of the mortgage. Payments are set in advance for the term, providing you with the security of knowing precisely how much your payments will be throughout the entire term. Fixed rate mortgages can be open (may be paid off at any time without breakage costs) or closed (breakage costs apply if paid off prior to maturity).

Variable Rate Mortgage

With a variable rate mortgage, mortgage payments are set for the 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. Variable rate mortgages may be open or closed.

A variable rate mortgage provides you with the flexibility to take advantage of falling interest rates and to convert to a fixed rate mortgage at any time.

 

Mortgage Amortization

Choosing the length of your amortization period, which means the number of years you will need to pay off your mortgage, is an important decision that can affect how much interest you pay over the life of your mortgage.

Historically, the standard amortization period has been 25 years. However, shorter and in some cases longer time frames may be available depending on the amount of down payment you  have available.

A shorter amortization saves you money as you will pay less in interest costs over the life of your mortgage. Your regular mortgage payment amount would be higher than if you had selected a longer amortization, as more of your payment goes towards paying down your principal balance. However, the benefits are that you build the equity in your home faster and are mortgage free sooner.

A longer amortization provides you lower monthly payments and because of this it is appealing to many people. However, it does mean that more interest will be paid over the life of the mortgage and you will build the equity in your home at a slower pace.

Note: If you choose an amortization over 25 years, you must have a down payment of at least 20%.

Example: Extended Amortization — 5 Year Fixed Rate Closed Mortgage

The chart below shows the impact of two different amortization periods on the monthly mortgage payment and total interest costs (over the full amortization). It is important to be aware that the total interest costs increase significantly if the amortization period exceeds 25 years.

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        Example: Extended Amortization — 5 Year Fixed Rate Closed Mortgage        
Details 25 Year 30 Year
Mortgage Principal $150,000.00 $150,000.00
Default Insurance Premium @ 90% LTV $3,000.00 $3,300.00
Total Mortgage Principal $153,000.00 $153,300.00
Monthly Mortgage Payment (P & I)               (5 yr Term @ 4.00%) $789.04 $713.28
Interests Costs for Full Amortization $86,707.04 $106,779.45

Chart Summary

<!–Choosing the longer 30-year amortization would reduce your monthly mortgage payment by $67.04; however, you would also pay an additional $34,298.58
(20)
in total interest costs over the full amortization than you would with a shorter 25-year amortization.–> Choosing the longer 30-year amortization would reduce your monthly mortgage payment by $75.76; however, you would also pay an additional $20,072.41(20)  in total interest costs over the full amortization than you would with a shorter 25-year amortization.

 

Understanding Mortgage Pre-Payment Charges

With interest rates at historical lows, you may be thinking about renegotiating your mortgage rate to take advantage of lower rates. However, if you break your closed term mortgage, you will be assessed a prepayment charge.

Why is there a prepayment charge for a closed-term mortgage?

The purpose of a prepayment charge is to compensate the lender for the economic costs it incurs when a prepayment amount exceeds the prepayment privileges permitted under the mortgage.  These costs include prepayment transaction costs, plus the full term amount of interest that was designed, in part, to acquire the mortgage which the lender will not recover when a mortgage is prepaid.

How is the prepayment charge for a Closed Variable Rate or RateCapper Mortgage calculated?

The prepayment charge is 3 months’ interest on the amount prepaid using the

  • The Interest Rate if you have a Variable Rate mortgage
  • The RateCapper maximum rate if you have a RateCapper mortgage

How is the prepayment charge for a closed fixed rate mortgage calculated?

The prepayment charge for a fixed-rate mortgage is the greater of

  1. three months’ interest on the amount prepaid at the interest rate; or
  2. interest for the remainder of the term on the amount prepaid, calculated using the “interest rate differential” (IRD).

The interest rate differential is the difference between the interest rate and our posted rate on the prepayment date for a mortgage with a term similar to the time remaining in the term and having the same prepayment options as the mortgage less your rate reduction.

In completing this calculation one of the components used is a financial concept called “present value”.  This concept recognizes that interest income to be received in the future is less valuable than the same amount of money received today.  The interest rate differential calculation also takes into account the fact the mortgage balance for the remaining term declines on each payment date.  The use of these financial concepts in the calculation reduces the amount calculated using the interest rate differential.

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