Buying a home, especially for the first time, is an exciting venture, but once you’ve been pre-approved for a mortgage amount and found the perfect property you’ll need to make a decision on the right mortgage for you.
When my parents bought their first home here, after immigrating to Canada in the mid 1960’s, their choices were very limited – a down payment of a minimum of 25% and a 6% interest rate for a full 25 years. They had a mortgage payment of $101 a month and no prepayment options.
Related: How Much House Can You Afford?
Mortgages are no longer one size fits all. Many people become too fixated on the lowest interest rate, but there are numerous other choices they need to make to tailor a mortgage to best suit their needs and fit their lifestyle.
Conventional vs. high ratio Mortgage
A conventional mortgage requires a down payment of at least 20 per cent.
If you have a down payment of less than 20% of the purchase price, you’ll have a high-ratio mortgage, which must be insured. The minimum down payment you’re required to make is five per cent.
Mortgage loan insurance, usually from CMHC, protects the mortgage lender in case you aren’t able to make your payments.
The premium varies depending on the percentage you have as a down payment. Rates can be higher in certain circumstances such as irregular income, self-employment, or if more than one advance is being made. Typically they are as follows:
- 80+ – 85% = 1.75%
- 85+ – 90% = 2.00%
- 90+ – 95% = 2.75%
You can pay the premium yourself but most people choose to add the funds to their mortgage. (Remember this when looking at houses within a pre-approved mortgage amount.)
With the low interest rates available today there is often no benefit in continuing to rent while trying to save 20% to eliminate the CMHC fee.
Little known features of CMHC insurance
- If you want to renegotiate your mortgage (e.g. to get a lower interest rate), most financial institutions will charge a prepayment penalty that is the greater of three months interest or the Interest Rate Differential or IRD (the difference between your mortgage rate and the current rate on the outstanding balance for the remainder of the term). However, if your mortgage is CMHC insured the prepayment fee is always the three months interest penalty.
- The CMHC insurance paid on a mortgage after April 1, 1997 is portable to another property.
Open vs. Closed Mortgage
An open mortgage gives you the flexibility of paying down as much as you’d like at any time with no penalty. Interest rates are usually higher so it would only make sense if you’re expecting a large sum of money to come in, you get regular large bonuses during the year, or you expect to sell your home within the term.
Most mortgagers opt for a closed mortgage term.
Open mortgages are available in six-month and one-year terms.
With a closed mortgage you can choose from a six-month, or one-, two-, three-, four-, five, seven- or ten-year term. The longer the term, the higher the interest rate. Rates are most often negotiable.
When choosing a term think about how long you plan to stay in the home and any future life changes.
Fixed vs. variable rates
A fixed interest rate will stay the same for the duration of the mortgage term, whereas a variable interest rate will fluctuate based on market conditions (the payment remains the same but the amount paid to the principal will vary).
While some people are comfortable with the perceived risks of a variable rate, most people like to lock into a fixed interest rate.
Mortgages are set up to be paid once monthly, but if your cash flow allows you may consider more frequent payments. For example, many people are paid bi-weekly and choose this frequency for their mortgage payments too.
Weekly and semi-monthly payments are also available.
If you want to pay your mortgage down faster make sure you choose “rapid” frequent payments. Paying a few dollars more can lop years of the amortization and save thousands of dollars in interest.
What is the Interest Adjustment Date (IAD)?
Unlike rent, which is paid ahead, mortgage payments are paid for the period of time that has gone past. If your possession date is not on the first of the month, or you choose more frequent payments you will in most cases be charged the IAD.
Ben and Caitlyn move into their new house on Wednesday, May 1. They chose biweekly mortgage payments to coincide with their pay deposits, the next one being Friday, May 10. Since this is not a full payment period, they will pay an interest adjustment of 10 days interest on May 10 and their first full biweekly payment will be due on May 24.
Financial institutions allow different prepayment options. Amounts from 10% to 20% of the original balance can be paid once per calendar year (not only the mortgage anniversary date as many people think).
The payment can be made without penalty only once in the year. Other lump sums will be charged a fee. That means if you make a lump sum payment of $5,000 in March you can’t make a $50,000 prepayment without charge in September, even if it’s within an allowable 20%.
Related: Our Fast Track To Financial Freedom
Sometimes it’s easier to increase your mortgage payment rather than save up a lump sum. Increased payment options vary from 10% to 100% more.
Check to see if you can change this payment in the future and if there will be a charge to change it.
Buying a new home is exciting, but it can also be stressful. Taking out a mortgage is a long term and expensive commitment.
Take the time to review all the options available right from the beginning to get the best mortgage product for your needs. Set up your automatic payments and then start decorating.