The features of mortgages vary from one financial institution to another. Consider these features in order to make sure you choose a mortgage that meets your needs.
The term and the amortization period
The mortgage loan term is the term of the mortgage contract, which is usually between six months and five years. The amortization period is the estimated time it will take you to repay your mortgage loan in full. This period is generally between 15 and 25 years. When the term expires, you’ll have a number of options, including renewing your mortgage contract, finding another lender or paying off the loan in full.
A fixed, variable or blended interest rate?
The interest rates posted by financial institutions change over time according to various factors, including the Bank of Canada key interest rate and the interest rates of bonds available on the market.
Bank of Canada key interest rate
The key interest rate This link will open in a new window is the target interest rate at which major financial institutions borrow and lend one-day (or “overnight”) funds among themselves. The Bank of Canada reviews this rate periodically.
Changes in the rate influence other interest rates, such as each financial institution prime rates and interest rates on mortgages.
Financial institution prime rates
Each financial institution sets a prime rate, which it uses to set variable interest rates on mortgages and other loans.
Example: If a financial institution sets its prime rate at 3.5% and charges you its prime rate minus one percent (prime - 1%), you’ll pay 2.5%.
Note: The prime rate applies to all the financial institution’s customers, but a different formula is used depending on the customer’s credit report and negotiating power.
Fixed rate mortgage loan
The applicable interest rate remains the same for the entire term of the loan. For example, if you choose a 5-year fixed rate mortgage, your interest rate will remain the same for five years. With this type of mortgage, you will therefore know how much your mortgage payments will be, and those payments won’t change even if interest rates on new mortgages do. You can choose the length of the term; however, if market rates go down during that time, you won’t benefit from the decrease unless you’re coming to the end of your mortgage.
This type of interest rate could be right for you if:
- you think interest rates will go up
- you don’t want any uncertainty about the interest rate you’ll be paying
- you don’t have enough money in your budget to handle fluctuations in the payment amount
Variable rate mortgage
The applicable interest rate changes with the market rate. It can either increase or decrease over time. Depending on your contract, if the interest rate increases, two things may happen:
- Your mortgage payments may go up to take the higher rate into account, in which case the term of the loan will remain the same
- The term of the loan may increase to take the higher rate into account, in which case your mortgage payments will remain the same, but you’ll pay less principal and more interest with every payment. When this situation occurs, it increases the term of your mortgage.
The opposite may occur if interest rates drop. Some lenders may allow you to switch your variable rate mortgage to a fixed rate mortgage if interest rates go up. Check what terms apply, such as whether the rate used will be the fixed interest rate posted by the financial institution or a lower rate? In either case, the fixed rate you get would take the interest rate increase into account.
If, for example, the interest rate on your variable rate mortgage were to increase and you were concerned about the possibility of further rate increases, you could switch your variable rate mortgage to a fixed rate mortgage; however, since interest rates would have gone up, you would likely get a higher rate than the one you had when you originally got the mortgage.
If you choose a variable rate mortgage, the rate won’t be guaranteed, but the formula for calculating the rate may be.
For example, you could be granted the financial institution’s prime rate minus 1% if:
- the prime rate is 3.5%, you’ll pay 2.5% (3.5% - 1% = 2.5%)
- the prime rate increases to 4%, you’ll pay 3% interest (4% - 1% = 3%)
Blended interest rate
- Capped variable rate mortgage (protected)
The interest rate fluctuates with the market rates but won’t exceed a predetermined threshold for the duration of the term.
- Instalment interest rate mortgage
You divide your mortgage up into instalments. Each instalment has its own features, such as its own amortization period, term and interest rate. Doing this could, for example, allow you to expose a portion of your mortgage to the advantages of a variable rate and to keep the other portion of your loan secure with a fixed interest rate.
Closed, open or convertible mortgage
Whether you have a fixed rate or variable rate mortgage, there are other factors to consider:
The number and amount of your mortgage payments are set. You can’t pay back a larger amount than what is specified in the contract.
Some contracts offer you the option of increasing your payments up to a set limit. Contracts differ greatly on this point: some may allow you to increase your payments by as much as 15%, while others may let you double your payments if you want.
Some contracts also offer you the option of prepaying a portion of the loan each year. However, there are limits on how much you can prepay, and if you exceed them, the penalties can be quite high. Financial institutions generally limit such prepayments to between 10% and 25% of the initial borrowed amount.
You can repay some or all of this type of loan whenever you want without any penalty. You can also renegotiate it before the term is up. In order to be able to offer this kind of flexibility, an open mortgage may sometimes have a higher interest rate than a closed mortgage. Before choosing this kind of mortgage, compare the rate with the rate for a closed mortgage. Make sure that the difference in rates is worth it, because the cost can be high.
This type of loan allows you to renegotiate the interest rate before the end of the term and to choose a longer term. For example, you could have a convertible mortgage with a fixed interest rate for six months and then convert it when you want a mortgage with a longer term.
Fee reimbursements and other perks
Many financial institutions offer perks. Some will offer to reimburse the notary or property appraisal fees or give you cash back or interest rebates, for example. Negotiate and properly estimate the value of these perks. For example, will the interest rate charged in return for them be higher than what is charged by other lenders?
This option could allow you to keep your loan if you move and thereby avoid penalties. Some financial institutions also let the seller of a property transfer the loan to the buyer under certain conditions. You may have to pay administrative and legal fees.
Penalties for breaking a mortgage
Financial institutions usually charge penalties for breaking a closed mortgage early. These penalties can be very high. The reasons why you might want to break a mortgage early are as many as they are varied and include: separating from your spouse, experiencing a cut or increase in your income, having children (or, on the other end, becoming an empty-nester), having to relocate for a new job, or wanting to benefit from a drop in interest rates on new mortgages or live in a smaller, larger, newer or more luxurious home.
Contrary to popular belief, making mortgage payments every two weeks will only save you a few dollars a year. This type of payment is often confused with accelerated payments.
|You make a payment...||Periodic payment||Annual payment||Time required to repay mortgage|
|accelerated bi-weekly||$524||$13,621||21.90 years|
|accelerated weekly||$262||413,621||21.88 years|
If you borrow $200,000 at an annual interest rate of 4%, your monthly payment will be $1,048, for an annual repayment amount of $12,574.
- If you make bi-weekly payments, you will pay $484 every two weeks, for an annual repayment amount (26 two-week periods) of $12,574.
- If you make bi-weekly accelerated payments, you will pay $524 every two weeks, representing the monthly instalment divided by 2. You would therefore pay $13,621 per year instead of $12,574. In this example, bi-weekly accelerated payments cut the repayment period down by 3 years, saving you about $16,000 in interest.
When you make accelerated payments, you save on interest because you pay more every year, which means you repay the principal more quickly. You don’t save on interest by making bi-weekly, instead of monthly, payments.
How to choose the frequency of your mortgage payments
An easy way is to synchronize them with your pay day. Do you get paid every two weeks? Then making bi-weekly mortgage payments will make it easier to manage your budget.End of the insight
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