Mortgages are complicated. That's a fact. So complicated that that mortgage agents and brokers require specialized training to learn the financial and legal concepts. Most homeowners will never need to know all the details since a trained agent or broker will always handle their mortgages. But that doesn't mean you can't learn some of the language. In this article, we define several standard terms encountered when arranging or renewing a mortgage.
Amortization Period
Let's start with an easy one. For mortgages or any loan, amortization refers to spreading the payments out over time. The time required to pay the mortgage off in full, plus any interest, is called the amortization period. Most Canadian homeowners amortize their mortgages for between 15 and 25 years. Shorter amortization means that your principal payments will be larger. Many first-time homebuyers opt for longer amortization to reduce the payment amount, though this can mean that you end up paying more in interest.
Mortgage Term
It is common for people to confuse the amortization period with the mortgage term. However, they are not the same. The mortgage term refers to the length of time your agreement with your mortgage lender is in effect. Your mortgage agreement includes the interest rate, repayment terms and other conditions set out by the lender. Mortgage terms can range from 6 months to 10 years, but 5-year mortgage terms are the most common.
Stress Test
Regulated financial institutions in Canada have strict criteria they must follow to qualify borrowers for mortgages. One of the tools used to determine eligibility is the mortgage stress test. In simplified terms, the stress test uses a calculation of the ratio of debt to income using a higher interest rate than your mortgage agreement states. If you still qualify for your mortgage at the higher rate, you effectively 'pass' the test. We wrote a whole blog on the stress test if you'd like to learn more.
Pre-Approval
Mortgage applications take a lot of work and can take several days to weeks to finalize. Not something you want to do often or that you can accomplish quickly. However, pre-approval refers to a simplified application process in which mortgage lenders look at only some of the criteria needed for a complete application. After applying a few assumptions, they calculate the maximum amount you can borrow. Pre-approval usually comes with an interest rate offer that the lender will guarantee 90 or 120 days.
High-Ratio Mortgage
The 'ratio' in high-ratio mortgage refers to the amount of money borrowed compared to the home's value. So if you purchase a home valued at $1 million and borrow $750,000, the ratio of loan-to-value is 0.75 or 75%. High-ratio mortgages have a loan-to-value ratio of 80% or more. This matters because high-ratio mortgages require the homebuyer to purchase some form of mortgage insurance.
Mortgage Insurance
Sometimes called mortgage default insurance, mortgage insurance protects the lender against the risk that you could default on your payments. In Canada, mortgage insurance is provided by the Canadian Mortgage and Housing Corporation (CMHC) and is mandatory for most high-ratio mortgages.
Open Mortgage
When you finalize a mortgage, you agree to a set of terms and conditions laid out by the lender. Some of those conditions relate to how much of the loan's principal you can pay off during the mortgage term. An open mortgage allows you to pay all or a significant portion without incurring any penalties. In contrast, closed mortgages may cost you a bunch in penalties and fees if you try to break the mortgage or pay it down faster.
Variable Rate Mortgage
Your mortgage term could last five years or more. During that time, mortgage rates tend to fluctuate with the economy. Variable-rate mortgages were introduced to give homebuyers the chance to take advantage of these fluctuations. They have interest rates that are based on the prime lending rate set by the Bank of Canada. For example, your interest rate on a variable rate mortgage may be stated as Prime + 0.5% or similar. With a variable rate mortgage, if the prime rate increases, your mortgage interest rate increases. If the prime rate falls, your mortgage rate falls in lock-step.
Mortgage broker
A mortgage broker is a highly-trained expert that knows far more than the simple definitions above can convey. Mortgage brokers help match lenders offering the best fit for interest rates and repayment options to meet the needs of individual homebuyers. While banks and large financial institutions only offer their own mortgage products, mortgage brokers work with many lenders to give homebuyers more choice. There are lots of good reasons to work with a mortgage broker. So many that we also write a blog about that.
If you are starting your search for a new home, need to renew your mortgage or simply have questions about mortgages, give us a call. We've got the answers and are here to help!