If you are a first-time homebuyer, you likely want to learn everything you possibly can about mortgages. But, more particularly, how the payments work and how often you need to pay. Mortgage payments work in various ways because each type of mortgage has a different length, payment schedule and interest rate. So, it’s essential to choose the right mortgage for you.
If you work with a mortgage advisor, they can guide you through the process of buying a home. The problem? How can you explain to your mortgage specialist what you want and need in a mortgage if you aren’t sure what your options are? Let’s break down how mortgage payments work and what mortgage is best for you.
What is a mortgage?
Before you get to know your mortgage payment process, it’s crucial to understand how a mortgage works. A mortgage is a loan that helps you buy a home so that instead of coming up with the entire purchase price, you’re only initially responsible for a down payment.
Buyers use a mortgage lender to help pay for a seller’s property. To find a lender willing to help you buy a home, you first need to get pre-approval by proving your financial stability. Pre-approval requires giving lenders access to your assets, income and debt levels. More specifically, you need to prove to your lender that you are employed, inform them of any additional assets, and that you have the financial ability to pay for your down payment plus closing costs. You will also need to share information about your debts, including student loans, credit card balances, and lines of credit.
With pre-approval, you will know the maximum mortgage you are eligible for, an estimate of what your mortgage payment might be, and depending on your lender, you may be locked in at interest rate from 60 to 120 days. Keep in mind that your maximum mortgage should not be your end goal. You do not want to stretch your budget too far, given that you will also have to pay for closing costs, moving expenses, and the increase in the price of homeownership.
“Pre-approvals tell you what you can afford and give you a rate guarantee with no obligations,” says Robert McLister, founder of RateSpy.com. “They’re a free option.” Once you’ve successfully gotten pre-approval, you can start to make offers on homes.
From there, you’ll go through the process of putting in an offer, negotiating to have the offer accepted or denied, and eventually — you will become a homeowner.
Step one: Choose your mortgage amortization period
Once you buy a home, you must repay the lender the initial cost plus interest and mortgage fees you’ve borrowed to become a homeowner. Typically the repayment period ranges anywhere from five to 25 years, with the most popular mortgage term being 25 years. You can choose the length of time you have to pay off your mortgage, and this is called amortization. The longer the amortization, the smaller your monthly payments, but the higher your total interest paid.
Angela Calla, accredited mortgage professional and host of The Mortgage Show, says that typically, mortgage specialists will set you up with your minimum monthly payment and longest amortization period. This way, homeowners are protected from potential unexpected expenses in the first few years of adjusting to their new cost of living.
If owners are willing to increase their payments and pay off their mortgage sooner than the initial timeline, they can look at available prepayment privileges. Additional payments will also help to reduce your high-interest costs and put more of your repayment towards the initial loan.
Step two: Choose your mortgage rate terms
Once you have your amortization period, you also need a mortgage rate term. Although it can be confusing, there is a difference between the two. As we mentioned previously, your amortization period is the total length of your mortgage. Your mortgage term is the length of a contract, which calls for renewal after about six months to 10 years. For example, you could have a 25-year mortgage with a 5-year term.
When it comes to the mortgage term, the options for interest rates are a fixed or variable rate. A fixed-rate mortgage does not change for the period of borrowing, whereas variable rates adjust over time in response to market changes.
Fixed-rate mortgages are the choice for Canadian homebuyers, considering 66% of all mortgages are on a fixed rate. The reason fixed-rate mortgages are popular is that once you’ve got your set rate, you have consistency in your mortgage payments for the chosen term length. The only reason fixed-rate mortgages aren’t always the best choice is that you may pay a much higher rate than where the market currently sits.
Variable-rate mortgages, although less accessible, are historically less expensive throughout a mortgage. Although, the uncertainty with price increase can be enough to stop any homeowner from taking the risk.
If interest rates are low, it might be the right time to lock in a fixed rate. If you anticipate the rates may drop in the near-term then a variable rate might be the best option.
“Canadian mortgage rates have been down-trending for four decades, in line with falling inflation and economic growth,” says McLister. He notes that historically, the lowest rates (usually variable or short-term fixed rates) tend to outperform. Right now, interest rates sit around 2%. In the end, though, McLister says that personal risk tolerance will likely be what matters most when deciding between fixed and variable mortgage rates. Once your mortgage term ends, you can renew and make the decision, yet again, of what type of mortgage rate works for you.
You will also need to choose between an open mortgage or a closed mortgage. An open mortgage allows for flexibility to pay off your mortgage at any time. A closed mortgage has more strict requirements, and you cannot pay off your mortgage before the term ends.
To help choose, consider your personal needs. An open mortgage will result in the ability to pay off your mortgage at any time, but will typically hold higher interest rates. A closed mortgage limits your ability to pay down your mortgage on an accelerated timeline but holds desirable interest rates. Most Canadians choose the conservative option, which is a closed mortgage with a fixed interest rate.
Ultimately, your mortgage needs to be tailored to your financial needs. McLister says that although rate sites are great for providing education, it helps to reinforce best practices by speaking to a professional. “Ask them to outline all the ‘got ya’s’ of the rate you’re interested in, so there are no surprises after closing.”
Step three: Choose your payment schedule
When the purchase on your home closes, and you officially become a homeowner, it doesn’t take long for the payments to start flowing. Your first mortgage payment is usually due at the start of the first full month after closing. So, because mortgage interest is paid after it’s accumulated, your August 1 payment would include interest for the portion of the month you owned the property in July.
Before you make any payments (or sign your mortgage), your mortgage broker will ask you what type of payment schedule you prefer. Each month, the buyer is responsible for making mortgage payments. Part of that payment goes towards the initial borrowed amount (principal) and the remainder of the payment will go towards interest.
You can make payments monthly, bi-weekly, accelerated bi-weekly, weekly, and accelerated weekly. Most homeowners choose to pay their mortgage per their payment schedule at work. For instance, if you receive bi-weekly paychecks, you will pay your mortgage bi-weekly.
The most popular payment options in Canada are monthly, bi-weekly, and accelerated bi-weekly. There are differences in your overall payment total, depending on when you make your monthly payments. For example, accelerated mortgage payments can help with the equivalent of one additional monthly mortgage payment each year. Although you’ll be paying slightly more each month for your mortgage payments, you can save thousands of dollars on interest.
“It’s all about balance,” says Calla. Your mortgage broker should help you come up with a strategy that suits your needs as a borrower. Calla says that for homeowners, it’s vital to protect your equity, build wealth and avoid accumulating debt.
Buying a house is an exciting chapter in your life. The best way to tackle that chapter is by doing research, speaking to professionals, and considering your budget.