This is a guest post from our friends at RateHub, where Canadians can learn to make wise mortgage decisions.
For most people, buying a home is the largest purchase they’ll ever make. And of course, the vast majority will require a mortgage to do so. Before getting a mortgage, there are a number of things to think about.
Whether it’s fixed-rate or variable-rate mortgage, the term of the mortgage or even whether you can really afford to buy, you’ll want to give serious thought in advance of signing on the dotted line. We’ll walk you through some of the issues to ponder if you think a mortgage is in your future.
Fixed vs. variable
When it comes to the interest rate you’ll pay on a mortgage, you’ll have to choose one of two options. First, you can go with what’s called a fixed-rate mortgage. With a fixed-rate mortgage, the interest rate is locked in for the term of the mortgage. What you see at the beginning of the term is what you’ll pay, and there won’t be any surprises.
You can also go with what’s known as a variable-rate mortgage. As the name implies, the interest rate on a variable rate mortgage fluctuates. The rate increases or decreases based on changes in the prime lending rate. Prime is the rate at which banks will lend to their best customers. For a variable-rate mortgage, interest is calculated as the prime rate plus or minus a certain percentage.
So if the prime rate is 2% and you have a prime-plus 0.4% mortgage, the rate will be 2.4%. If prime falls, the rate will fall, and vice versa. It’s important to know that prime rates often rise and fall based on interest rate decisions by the Bank of Canada, the country’s central bank.
Term
Some people probably assume that when they get a mortgage, they’re signed on with the same bank and on the same terms until the loan is paid off. In fact, almost everyone who gets a mortgage will need to renew the terms many times. And some will end up with a different financial institution than they started. Mortgage terms can range from anywhere as short as six months to as long as 10 years. In Canada, the most popular term length is five years.
Depending on your circumstances, you’ll probably want to choose either a longer or shorter term. If you want the certainty of knowing what interest rate you’ll pay, for example, you might choose a fixed-rate mortgage with a long term (say five years or more). On the other hand, if you think you may end up selling your place in the near future, a shorter term is better as you can hopefully avoid prepayment penalties (in other words, paying off your mortgage early).
Another consideration is whether or not you’re worried about rates going up. If that’s not a concern for you, a shorter term may be fine. But if the possibility of rising rates does keep you up at night, a longer term with a fixed rate will be better.
Amortization period
In addition to the term, you’ll need to choose what’s known as an amortization period. This is just a fancy way of saying how long it’ll take to pay off your mortgage. The sooner you pay off your mortgage, the less interest you’ll pay. That said, paying off your mortgage earlier does mean your regular payments will be a bit higher than with a longer amortization period. The typical amortization period is 25 years.
Down payment rules
With recent changes to rules regarding mortgages, you have to have a down payment of at least 5% of the home’s value that’s $500,000 or less. The down payment must be 10% for every dollar over and above this level.
How much can you afford?
If you’re wondering how much of a mortgage you can afford, RateHub has a handy mortgage affordability calculator you can use. You can also search for the best mortgage rates if you decide to buy a home.
RateHub.ca is a website that compares mortgage rates, credit cards, high-interest savings accounts, chequing accounts, and insurance with the goal to empower Canadians to search smarter and save money.
