Since buying a home is probably the biggest single investment you will ever make, it is extremely important that the terms of financing are done correctly. Along with the obvious factors like location, a mortgage is also a big consideration. All of the mortgage terms and choices can be confusing – especially for first time buyers.
Here are a few key mortgage terms everyone should know about…
Fixed vs. Variable
A fixed mortgage has a set time period (called a term) with a fixed interest rate. It can be broken but it usually involves a hefty penalty (see below).
A variable mortgage is dependent on the prime rate set by the Bank of Canada (currently 3%). If a variable mortgage is 2.5%, it would be called “prime -0.5%”.
A fixed mortgage is best if you think rates will head up soon or will not be selling anytime soon. A variable mortgages makes sense if you might sell in the near future (lower penalty) and rates are low.
The penalties for a fixed mortgage are usually quite steep compared to a variable mortgage. This is because the penalty for a fixed mortgage is based on the difference between the interest rate on the mortgage and current rates (called the interest rate differential).
Related: How to Reduce Your Mortgage Penalty
If rates have dropped significantly and there is a lot of time left in the mortgage, the penalty would be very high.
On the other hand a variable mortgage penalty is usually simple: the total of 3 months of interest (obviously this is higher the more money is owing and the higher the rate).
Open vs. Closed
An open mortgage can be repaid at any time without penalty. The interest rate is usually a bit higher for having this convenience and could cost you over the long term if you don’t plan on repaying the full amount in the near future.
A closed mortgage cannot be repaid without a penalty. Most closed mortgages allow for some repayment (ie. maximum 20% per year) but not all. The interest rates are usually lower and could save you a lot of money over the long term.
As the name implies, a portable mortgage is one that can be moved to a new property under the same terms. If you bought a property while still owning your current one, you could ‘port’ the mortgage into the new property and save the penalties.
A mortgage term is the length of time that the financing agreement covers. Terms range from 6 months to 10 years. Most people choose a 5 year term (or less) with the higher terms usually having a higher interest rate.
The amortization period is the length of time it will take to pay off the entire mortgage. The longer the term, the lower the payments and the higher the interest costs. Most mortgages are amortized over 25 years.
Choosing the Right Mortgage
Which mortgage to choose depends on your own personal situation.
If you don’t plan on selling the property in the near future and likely won’t pay off the full amount, a closed, fixed rate mortgage might make the most sense.
If you plan on selling in the near future or want the flexibility of paying off the entire mortgage without penalty, an open, variable rate mortgage might make more sense.
We chose a fixed rate (closed) mortgage for our current home and our rental property. We did this because we don’t plan on selling either in the near future, we won’t be paying off the full amount in the near future and we wanted to take advantage of today’s crazy low interest rates.
I was able to successfully negotiate a very good rate for both properties which makes our costs even lower. For our house we have a 3 year mortgage at 2.60% and the condo is at 2.09%. I got a lower rate for the rental property because of our perfect payment history with our lender.
Conclusion: Choosing a mortgage is a big deal – with house prices so high, getting the right mortgage for you can save you thousands. Whatever you choose, it’s important to negotiate in order to get the best rate possible.
How did you choose your mortgage?