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I’ma be really honest. When we bought our house and signed our mortgage paperwork, I had NO idea what on earth we agreed to. Terms, interest rates, renewals – I didn’t understand a thing, I just knew that I wanted to own my house, and I initialed and signed where I was told to. I’ve had a mortgage now for five and a half years, and admittedly, I’ve only learned about them in the last six months. And a lot of this info I’ve learned in researching for this post! Today we are digging into everything you need to know about mortgages to make a more informed decision than I did when I first got mine!
What is a mortgage?
Simply put, a mortgage is a loan used to buy a house or property. You borrow money from a bank or lender and pay it back, with interest, over a set amount of time.
What is interest?
That big loan doesn’t come for free – you have to pay interest! Interest is a fee charged to you for borrowing the mortgage. The interest rate refers to how much that fee is, a percentage of your total loan amount.
Current mortgage rates in Canada (as of July 2020) are around 2.5%.
You may get a fixed interest rate, where you lock into a set percentage for the length of your term. OR you can agree to a variable rate, which will fluctuate during your term.
While interest rates on a variable may be lower, you run the risk of them going up – and so too does the overall cost of your home!
I’m way too type A and anxiety-ridden for a variable rate on anything – I like predictability and consistency, so fixed-rate is what I go for!
How long will you have a mortgage?
The quick answer – as long as it takes you to pay it off.
There are two different time frames for mortgages: amortization (how long it will take you to pay the mortgage in full); and a term (how long the interest rate is locked in for).
For example, I’m currently in a 20-year mortgage, but a 5-year term. So my interest rate is locked in until 2025, and if I keep paying on my current payment schedule, my mortgage will be completely paid off by 2040.
However – my goal is to pay my mortgage off as fast as possible, certainly before 2040!!
The shorter your amortization period is, the higher your monthly payments will be because you will pay your mortgage off in less time. However, the faster you pay it off, the less you will pay in interest in the long run. In my opinion, shorter is better!
What is a downpayment?
A downpayment is a percentage of the mortgage’s total cost that you are expected to pay in cash at the time of purchase.
The amount of your downpayment is dependent on the amount of your mortgage. For mortgages less than $500,000, the minimum downpayment is 5%. For mortgages over $500,000, the minimum is 5% on the first $500,000 and 10% of everything above that.
These numbers are the minimum amount you can put down. But, the more you can put down, the better it is. Reducing the principal balance of your mortgage quickly means you’ll pay less interest over time. That is more money in your pocket long term! Win!!
How do payments work?
You get to choose how often you pay your mortgage – monthly, bi-monthly (twice a month), and bi-weekly (every two weeks).
The amount will depend on your interest rate and your amortization length. If you have a higher interest rate, your payments will be higher. If you sign into a 30-year mortgage (meaning they stretch those payments over 30 years), your payments will be lower.
However, over time you’ll pay waaaay more in interest, the longer you stretch it out.
Your payment amount first goes towards your interest, and then the remainder goes towards the principal of your loan.
This is tricky, and it has taken me some time to understand, so bear with me while I try to explain it to you!
You get a $300,000 mortgage at a 2.5% interest rate. Your monthly payment is $900. $625 of that goes towards interest (2.5% of the balance, split between 12 months), and only $275 pays down your principal. So, the bigger your mortgage amount, the more interest you are going to pay!
SO – with all that said – the faster you pay down the balance on your mortgage, the smaller your interest payments are, and the more of your money goes towards the balance of the loan.
In the same term, once you have your balance down to $200 000, at the same 2.5% interest rate and $900 payments, the amount each month going to interest is only $208 – leaving $692 of your payments going towards the principal! That’s a big difference!
The more money going to the principal, the less money you will pay in the long run.
This is also why a bigger down payment is good – anything you can do to reduce the amount the loan will save you money on interest.
What about extra payments?
I have the option to make an annual, extra lump sum payment on the principal on my mortgage. When I renewed my mortgage earlier this year, I made sure that I had this type of flexibility. I can pay down up to 20% of the balance of my mortgage each year. Which is a HUGE chunk of money, but also leads to a HUGE chunk of savings on interest in the long run.
If paying off your mortgage quickly is one of your goals, make sure that your mortgage agreement lets you make these extra payments. (My original lender only allowed a $10 000 additional payment each year, which slows down how fast I could get it paid off, AND puts more money in the bank’s pocket.)
How do you get a mortgage?
There are two paths to take to obtain a mortgage: a bank or a mortgage broker. Banks offer mortgages, and you can book an appointment to get pre-approved before you start home shopping, so you know the budget you are working with and can shop with confidence.
You can also deal with a mortgage broker who shops around and gets you the best rate possible based on your mortgage needs. I prefer dealing with a broker – my broker was amazing to deal with and made the process easy and seamless! They take a look at your specific needs and match you with a lender that is the best fit.
How much can you afford?
Here is where things can get tricky, and I will warn you to be careful. Many years ago, we connected with a mortgage broker. She pre-approved us for a LOT of money. We were deeply in debt, irresponsible, and she wanted to secure a $700,000 loan for us. Had we gone through with it, we would not have been able to afford food, let alone the expenses that come with a house.
So, make sure that the amount you borrow and your monthly payments is an amount you can afford. The amount of the mortgage payment should be a factor, but you also need to consider the added expense of home insurance, property taxes, and maintenance. Houses are not cheap. Use a budget to get an understanding of your finances and have a clear picture of how much you can actually afford.
What’s the deal with mortgage insurance?
Here’s another place we went wrong when we signed our first mortgage. We were offered mortgage insurance – an amount paid each month so that if something happened to us, our mortgage would be paid off. I spent the same amount each month, and as the mortgage balance went down, so too did the benefit of the insurance. Basically, in my opinion, this is not a good product to give you security in case of an emergency.
Instead, we now have term life insurance. No matter how much we owe on our mortgage, we get a set amount if something should happen. And, it costs less per month than the mortgage insurance was!
When should you get a mortgage?
It seems like from the moment I graduated high school, I’ve been moving from one milestone to another. Move out, get a degree, get a job, get a husband … buying a house feels like an expectation in the journey of life.
If you feel rushed to get this checked off the list, I get it. However, heed my advice: wait until you are debt-free. Wait until you can afford it. Wait until you are ready.
There is nothing about a mortgage that makes you more of an adult. It is not a box to check on your life list. So, dig deep and find the patience to be ready, so that your dream home doesn’t become a nightmare.
If you already have a mortgage, paired with a pile of debt, believe me when I say – no judgment here. We were drowning when we bought our home. Just let that be the motivation you need to get out from under the weight of your debts.
New Mortgage Rules in Canada
As of July 1, some of the rules around obtaining a mortgage have changed. Here is a recap of the new regulations:
- You cannot use borrowed money (from credit cards, lines of credit, or bank loans) to fund your downpayment. These funds must come in the form of cash from savings.
- You need a 680 credit score to be approved (up from 600). If your score is too low, you’ll need to take steps to increase it – paying down your debt load is the best way to do this. Not sure of your score? Check it for free here!
- The amount you will be approved for has been reduced to help protect buyers from overextending and not pay back the loans.
As I said at the start of this post, mortgages are a bit of a mystery for me. Even having gotten one, renewed it, and paid it diligently for the past six years – I still had to do a fair amount of research to write this post. I hope that this has shed some light on mortgages for you. If you are still seeking more information about mortgages in Canada, check out the Canadian government financial toolkit!
PLUS! If you already have a mortgage and you want to pay it off fast, check out this list of tips to help you get there as fast as possible!