The right mortgage for a Canadian homebuyer depends on their budget, future plans, and extenuating circumstances. While some people may choose their mortgage by picking the loan with the lowest interest rates, doing so may not be the best decision in the long run. Before visiting a lender, it helps if a buyer understands the logic behind mortgages and their available options.
The ideal goal behind a down payment was for homeowners to put down at least 20% of the purchase price in cash. Even as home inflation continues to rise in many parts of the country, the standards remain the same for buyers of today. Because salaries haven't risen at the same steady pace as home prices, banks will use a variety of techniques to mitigate their financial risks. Homeowners who are unable to put down at least 20% in cash towards their mortgage are typically asked to pay an additional fee every month for Lenders Mortgage Insurance (LMI.) LMI is an insurance policy a lender takes out in case the buyer defaults.
Loan Amortization Formulas
Loan amortization refers to how a bank decides exactly how much a homeowner pays each month for their mortgage. It's based on the following factors:
- Length of the Loan
- Interest rates
- Type of loan borrowed
These factors determine how much the borrower will pay each month for their mortgage. Though all four factors are important (especially the amount of the principal of the loan), the interest rate is probably the most important (and possibly variable) factor in a home mortgage. For example, if a buyer takes out a loan at a 5% interest rate, they'll be paying this interest on the principal of the loan for the complete length of the loan.
Because homeowners pay the most interest at the beginning of their mortgage and less over time, they need to be careful about the term length they choose (the principal paid goes up each month as the interest expense goes down). A 30-year loan will sound attractive because the payments are usually much more affordable, but it also means a homeowner will be paying more in interest costs over the course of three decades.
Fixed and Adjustable-Rate Mortgages
An adjustable-rate mortgage (ARM) will have loan interest rates that will vary as interest rates rise and fall, while a fixed rate mortgage stays the same regardless of fluctuations. An ARM will usually offer some of the lowest interest rates, but they may not always be the best choice. Interest rates change due to both federal stipulations and general lender practices.
For example, if rates continue to rise, a buyer could end up spending far more on interest than they would have had they had chosen the fixed-rate interest mortgage option. A variable Home Equity Line of Credit is similar to that of an ARM, usually used to make repairs on older homes.
Additional Mortgage Tips
There are a few more things for buyers to keep in mind when loan shopping. For example, open mortgages are available for home buyers who want flexibility when it comes to either paying off their mortgage or discontinuing it early. While the interest rates are higher, the penalties are lower than that of a closed mortgage. Some buyers may also have to undergo a stress test before being approved for their loan. Essentially, lenders will test a buyer's ability to pay in the event that mortgage rates rise.
Finally, some home buyers may want to work with a mortgage broker over a traditional bank. Brokers may be able to fast-track mortgage applications and potentially find a buyer better terms than they'd find on their own.
There's a lot of nuance when it comes to choosing a home mortgage, and these tips only scratch the surface. For a Laurier Heights home buyer to understand their specific home mortgage, they'll first need to determine their price range (both now and in the future) before consulting with real estate professionals and reputable lenders to determine how they should best structure their home loan.
By Justin Havre