Purchasing a home, whether you are buying a house for the first time or a seasoned pro, is a very exciting time. However before you are able to purchase, you must have your financing in order. This can be done with a traditional bank or mortgage broker. It’s important to consider all factors, not just going with the best mortgage rate.
When it comes to mortgages, there are two main types or mortgage rates: variable and fixed rate mortgages. Having a good understanding of these two type will allow you to make a better decision when it comes to picking which is best for you.
The purpose of this blog is to guide you through the mortgage process and help you make a more informed decision.
In today’s slowing real estate market, with the return of conditional offers, many people will have a financing condition. However, it’s always good to get pre-approved first. This way, you’re less likely to need a financing condition or may even decide you want to pursue a bully offer if the right property comes along.
How do I get the best mortgage rate?
When you meet with your lender or bank, they will work to pre-approve you. This pre-approval gives you the value of mortgage that you will qualify for. Note that a pre-approval is not a guarantee!
It means that based on the information you have provided the bank at the time of pre-approval, they approve you for a certain amount at the best mortgage rate they can. This pre-approval is usually good for a certain time frame.
The way to get the best rate is to be consistent, organized and honest. Your mortgage broker or bank will require documentation such as proof of income (T4), your debt and more. There is no point in trying to fool them or omit information. This is because a credit check will eventually be pulled with a company such as Equifax. The better your credit, the more likely it will be that you’ll get the best mortgage rate available.
Once you purchase a house, you will need to re-qualify with your lender or mortgage broker. This will in order to get a mortgage at closing. If that time passes, you will need to re-qualify at the new mortgage rate.
First: what is a mortgage?
When you buy a home, you may only be able to pay for part of the purchase price. The amount you pay is a down payment. To cover the remaining costs of the home purchase, you may need help from a lender, or in most cases a bank. This loan is a mortgage that you get with a traditional bank or mortgage broker. The lender will work to get you the best mortgage rate possible.
A mortgage is a legal contract between you and your lender. It specifies the details of your loan and it’s secured on a property, like a detached house, townhouse or a condo.
With a secured loan, the lender has a legal right to take your property if you don’t pay. They can do so if you don’t respect the conditions of your mortgage. This includes paying on time and maintaining your home.
Unlike most types of loans, with a mortgage:
- the loan is secured by a property
- there may have a balance owing at the end of your contract
- you’ll normally need to renew your contract multiple times until you finish paying your balance in full
- there are qualification requirements, including passing a stress test
- you’ll need a down payment minimum of 5% and in some cases 20%
- you may need to break your contract and pay a penalty
- the loan is typically for an amount in the hundreds of thousands of dollars, depending on the purchase price
Things to consider when getting a mortgage
When you shop for a mortgage, your lender or mortgage broker provides you with options. Common terms used when talking about a mortgage include:
- mortgage term
- mortgage principal amount
- amortization
- payment frequency
Mortgage term
The mortgage term is the length of time your mortgage contract is in effect. This consists of everything your mortgage contract outlines, including the interest rate. Terms can range from just a few months to 5 years or longer.
At the end of each term, you must renew your mortgage if you can’t pay the remaining balance in full. You’ll most likely require multiple terms to repay your mortgage.
The length of your mortgage term has an impact on:
- the penalties you have to pay if you break your mortgage contract before the end of your term
- how soon you have to renew your mortgage agreement
- the interest rate and the type of interest you can get (fixed or variable)
Mortgage Principal
Mortgage principal refers to the outstanding balance of your mortgage. This is the amount borrowed from the lender, minus the amounts repaid to the lender. As a result, it applies to the reduction of principal. As monthly mortgage payments are made, the mortgage principal is reduced.
Amortization
The amortization period is the length of time it would take to pay off a mortgage in full. This is based on regular payments at a certain interest rate. A longer amortization period means you will pay more interest. A shorter amortization pays less interest. As an example, common amortization terms are 25 years, but 20 and 30 year periods are also relatively common.
Frequency
This is how often your mortgage is paid to the lender. For example, some options are monthly, semi-monthly, bi-weekly or weekly. There is also an accelerated option as well. This is more about your personal preference, as some people prefer more frequent payments. Some people like one larger monthly payment as it’s easier to budget.
What is a Variable Rate Mortgage?
| Option | Formula | Payments per year | Amount per payment | Total paid per year |
|---|---|---|---|---|
| Monthly | $1,000 ÷ 1 | 12 | $1,000 paid once per month | $12,000 |
| Semi-monthly | $1,000 ÷ 2 | 24 | $500 paid twice per month | $12,000 |
| Bi-weekly | $1,000 x 12 ÷ 26 | 26 | $461.54 paid every second week | $12,000 |
| Accelerated bi-weekly | $1,000 ÷ 2 | 26 | $500 paid every second week | $13,000 |
With a variable rate mortgage, the interest rate will fluctuate throughout the term. The rate determined by the Bank of Canada’s lenders’ prime rates, which are the interest rates on loans that the banks are currently offering to their best customers (see the current prime rate here).
The variable mortgage rate is set at prime plus/minus a discount or premium. So, let’s say you’re given a mortgage rate of prime -0.5% or prime +0.2%. As a result, if the prime rate increases during the term, so does your mortgage rate, and a larger portion of your mortgage payment will be used to pay off interest while a smaller portion will go toward the principal.
If the prime rate decreases, the opposite is true. Variable rate mortgages allow you to lock into a fixed rate at anytime without penalty. If prime rate starts to increase, you will be able to lock into a fixed rate for the remainder of your term. This can help secure a lower rate if prime rate drastically increases.
Some benefits of a variable rate mortgage are:
- The variable rate usually offers the best mortgage rate vs the fixed rate (often below market rate)
- They tend to be less expensive over the term of the mortgage
- An initial lower payment may help you qualify for a larger loan
What is a Fixed Rate Mortgage?
As the name suggests, fixed rate mortgages have a fixed interest rate throughout the term. Fixed-rate mortgages are determine by the Government of Canada’s bond yields at the time of purchase and doesn’t change even if the bond yields do. With fixed rate mortgages, your monthly payments do not change. Therefore, you know exactly how much of your mortgage payment will go toward interest and principal for the length of the term.
Some benefits of a fixed rate mortgage are:
- Fixed-rate mortgages are easier to understand, but are not necessarily the best mortgage rate
- Mortgage payment amount will remain the same throughout the term of the mortgage
- You have a sense of security knowing what to expect
- It’s easier to budget for your household costs
- As the principal is reduced, the interest charged will also be reduced — and more of your payment will go towards the principal.
Another thing to consider when looking at mortgage rates is what the purchase price of your home will be. There are minimum CMHC requirements for home purchases above $1 million, for below and above this threshold as well.
Which is better for me, a fixed or variable rate?
This is all based on your own risk tolerance and personal preference. Therefore, it’s not always about the best mortgage rate. Your choice can come down to three questions:
- Can you sleep calmly at night, knowing the risks involved with a variable rate?
- Can your budget handle a 3 to 4 percentage increase in your mortgage rate (higher mortgage payments) if prime climbs dramatically?
- Do you plan to sell your property within three years, or want a faster way to pay down your mortgage?
Generally, if you are most risk tolerant, a variable rate is the route for you. Over the past decade in Canada, a variable rate has been the better option long term. However, with uncertainty around rising interest rates, a fixed rate may be better for those who are less risk tolerant.
I already have a mortgage. Can I port my mortgage to a new home?
Sometimes, people have a great rate on a mortgage and don’t want to give that up if they decide to move. In some cases, you can port your mortgage- that is, transfer the mortgage terms to your new home.
Porting a mortgage depends on a variety of factors:
- What does your current mortgage contract say?
- Has your income decreased since you last qualified? You will need to re-qualify.
Get in touch
Beth and Ryan are Guelph Real estate agents also always available to answer any questions you might have. Feel free to give them a call or email for mortgage recommendations and questions!
Many of the terms found in this blog come from our list of common real estate terms
