Mortgages 101

Let’s start with the basics – a mortgage is a loan you get to buy real estate, usually the price of your purchase minus your down payment, plus insurance, interest and property tax. You pay it back over time. Once you’ve figured out all the details and learned some of the terminology, it’s pretty straightforward.

First things first – get pre-approved
Before you even start looking, figure out what you can actually borrow. It’ll help you figure out your budget – and keep you from falling in love with a place you can’t afford. It also helps things move faster once you’re ready to buy. Read more about pre-approvals here.

Your mortgage will depend on a few things….
How much you need to borrow is based on the size of your down payment, the going interest rate, how long you plan to take to pay it back, and whether you want to go with a fixed-rate or variable-rate mortgage (more on those below).

The down payment
If you’re buying a $600K condo, here’s what you’re looking at:

If you put down less than 20%, you’ll also need to factor in mortgage loan insurance – it’s mandatory and protects your lender in case you default. Try these mortgage calculators to run your own numbers.

Amortization (how long it’ll take to pay off)
Most amortization periods are 20, 25 or 30 years. (Though if you have an insured mortgage, it has to be 25 years or less.) Longer periods have lower monthly payments, but you’ll pay more interest over time.

Term

You may be taking 25 years to pay off your mortgage, but that’s divided up into terms, usually between 1 to 5 years. At the end of each term, you’ll need to renew things with your lender or switch to a new one (but heads up – if you go with a new lender, your loan will be subject to the stress test.)

Generally, longer terms have higher interest rates. If rates are really low, and there’s the possibility they’ll go up, it makes sense to lock into that rate for a longer term, even if you pay a bit more interest. But if you think rates might drop, a one-year term might make more sense, so you’re not stuck paying a higher rate for a long time. But don’t worry, you’re not alone in your decision: your lender or mortgage broker will help you figure all of that out.

Interest rates
Interest is what you pay to borrow money. The rate you agree to when you first buy won’t be what you pay for the life of the mortgage, just for that term. And how much interest you pay will depend on the rate the bank is offering, the length of your term, and whether it’s fixed or variable.

What you pay is based on these three rates:

• The Bank of Canada (BoC) rate is set to influence/moderate the economy, and banks lend and borrow money using it as a benchmark.

• Your lender’s prime rate. This is usually a few points higher than the BoC rate, and each bank sets its own prime rate as the basis for all its lending. When the BoC rate goes up, so do prime rates.

• Your mortgage rate: whatever you negotiate and/or qualify for. This is based on your lender’s prime rate, plus the term and type of mortgage you agree on. Keep in mind that the mortgage rates you actually get will always be at a heavy discount off the bank's posted rates, which are usually over 5%. If you have strong credit, you will usually pay 0.75%-1.5% over the Bank of Canada’s lending rate.

Variable vs. fixed-interest
In a fixed-rate mortgage, you’re locked into one interest rate for your mortgage term (usually 1-5 years, not the entire length of your mortgage). Need predictability? This is a good choice – your payments will each be the same for the whole term. But the price of that dependability is a higher interest rate.

With a variable-rate mortgage, the amount you pay each month depends on fluctuations in your lender’s prime rate. If the rates stay the same or go down, it works out cheaper than a fixed rate. However, and here’s where the risk comes in, if interest rates trend upwards because of a strong economy, your payments will go up as well.

Interest adds up fast – a smart decision could save you thousands. So what’s right for you? Your financial planner and your mortgage broker can help you figure that out.

The appraisal
Before saying yes to your mortgage, the bank has to agree that the property you’re buying is actually worth what you want to pay for it. In a market where heated bidding wars can jack up a condo’s selling price beyond its true value, lenders want to protect themselves - and their customers. This step happens after your offer has been accepted, but before the mortgage has been finalized. More on appraisals here.

Getting approved
First off, make sure your credit is in decent shape. A bad score can make it a lot harder to get a mortgage – lenders could require a co-signer, approve you for less than you need, or turn you down completely.

They will look at your score, your financial assets, your income, and your debt. Be ready to show them:

• ID

• Letter of employment

• Pay stubs or other proof of income

• If you’re self-employed, your CRA Notices of Assessment for the last couple of years

• Credit card balances and limits

• Car payment records

• Lines of credit

• Student loans

The stress test
If you’re going with a government-regulated lender like one of Canada’s big five banks, you’ll have to pass the mortgage stress test. That means you have to qualify for a higher interest rate (2 basis points higher) than what you’ll actually be paying. It shows you’ll be able to handle your payments if rates go up. If you negotiated a rate of 2.89%, for example, you’d have to show you can qualify for 4.89%.

Try this Mortgage Qualifier calculator to see if you’d pass the stress test, or come to our first-time buyer seminar to chat with a mortgage broker or a financial consultant. A mortgage broker can help you explore your options.

Paying your mortgage
Your mortgage is a regular payment, just like an internet bill or a car payment. You can pay it monthly, semi-monthly or bi-weekly. But because it’s for such a large amount, it’s structured so you pay the interest first so the lender's risk is reduced. In the early years of the mortgage, expect to pay mostly interest. So make sure you’re paying enough each month to be chipping away at the principal (the amount of the actual loan) and not just paying interest.

Thinking about paying it off faster? Lenders make money off interest, so letting you do it sooner means they make less. Some will let you pay more than your monthly amount, but if you pay too much at once, you could face repayment penalties.

There is one great (and very easy) strategy for paying off your mortgage faster and saving money on interest: bi-weekly payments. Going monthly means you’ll make 12 payments a year. But you do it bi-weekly (paying half the monthly amount), you’ll be paying the equivalent of an extra month each year, which means you’ll pay less interest and get your principal down faster. It’s an easy way to shave YEARS off your mortgage.

Breaking your mortgage contract
If your mortgage is no longer the best option for you (e.g. if interest rates have dropped), you can renegotiate or switch to another lender. Keep in mind that there will be fees/penalties involved, so you’ll need to figure out if paying those instead of the higher interest rate gets you further ahead.

Want to learn more about the ins and outs of buying your first home? Check out our First Time Buyers Hub - a great resource where you can get the scoop on everything you need to know about buying a condo in Toronto and the GTA.