Are you planning to buy your very first home, cottage or other kind of property? Then you better be prepared to comprehend just what exactly a mortgage is, how it works and why you’re going to need one.
By definition, a mortgage is a loan obtained from a bank, or other lender, that will help you finance your real estate purchase. There are a variety of mortgages to pick from, but typically, each type will consist of two parts: the principal sum (in other words, the amount borrowed) and interest (in other words, the cost of borrowing that money).
It’s a given that the best option is always one which minimizes the amount of interest you pay. Although, that kind of oversimplifies the whole thing. Mortgages are more than just math, after all!
Let’s take a closer look at them here, with part one of my Ultimate Mortgage Dictionary!
ADJUSTABLE RATE MORTGAGE
This type of mortgage is reviewed at intervals and then adjusted based on the current prime rate, the rate at which a commercial bank’s optimal customers can borrow money. This rate adjustment affects both the monthly payment, as well as the interest rate of the loan. If you have an adjustable rate mortgage and the interest rate drops, then you benefit from the lower mortgage rate, instead of being locked into the higher mortgage rate, as you would be with a fixed mortgage. The risk is that if interest rates rise, then you are on the hook for those increase in payments as well. Adjustments can happen without much notice, and frequently. Adjustable rate mortgages are beneficial if you can withstand fluctuation in monthly payments, but want to take advantage of lower rates.
CASH BACK MORTGAGE
This type of mortgage offers you a percentage of the to-be-purchased property as cash upfront, and can be used for anything other than the down payment. The interest rate for this type of loan is high, generally costing the borrower almost twice the value of the cash. This option is traditionally used by people who require cash immediately following the purchase of their home, for anything from moving expenses to furniture.
This type of mortgage meets the requirement of having a 20% down payment, with the remaining 80% being provided by the lender. These have a low loan-to-value ratio, which means that the amount of the loan is low, relative to the value of the property. Before mortgage insurance was introduced in the 1950s, almost all mortgages were conventional mortgages, with borrowers paying at least 50% of the cost of the home upfront.
FIXED RATE MORTGAGE
This type of mortgage features an interest rate that doesn’t change, or is ‘fixed’, for a set period of time, often between one and five years. It’s easier to manage a budget with a fixed rate mortgage, since your payments won’t change during that fixed term. The interest rates for fixed mortgages tend to be slightly higher than other types of mortgages where the rate changes. But what you gain in stability, you pay for with a higher mortgage interest rate. Fixed rate mortgages are most beneficial when interest rates are low and expected to rise over the length of the term — although predicting rate increases and decreases is not exactly a science. Five-year fixed rate mortgages remain amongst the most popular Canadian mortgage products.
VARIABLE RATE MORTGAGE
This type of mortgage is another where the interest rate of the loan fluctuates based on the current prime rate. With a variable rate mortgage, though, your monthly payment remains the same, because the fluctuating amount is the same amount as the payment that’s applied to the mortgage principal. This allows you to keep some stability in terms of consistent monthly payments, but also reap the benefits if interest rates fall. Moreover, rates are typically lower with a variable rate mortgage than they would be with a fixed rate mortgage.
I hope that helped, and please stay tuned for part two!