Cecilia Gatchalian

RE/MAX Real Estate Services

Cell 604-880-3077

Office 604-263-2823

Email: cgatchalian@remax.net

Thinking of Selling

Thinking of Buying

Home Search

Understanding Mortgages and Downpayments
 

Most Canadians buy a home by taking out a mortgage, which is simply a kind of long-term loan. Determining how big a mortgage you can comfortably afford depends on the answers to these two questions:

  • How large a down payment can you put toward the home?
  • How large a mortgage payment can you make every month (or at other intervals, depending on your payment plan)?

For many people, coming up with the down payment can be a daunting task, even though this payment can be as little as 5 per cent of the purchase price of the home. Some ways to manage it are:

  • Set aside money every month in an interest-bearing account until you have enough for the down payment
  • Draw funds from your RRSP (you can use up to $25,000 of these funds without paying tax on it, under certain conditions)
  • Use other income, such as gifts from parents or relatives
Choosing the Kind of Mortgage You Need
 

When you obtain a mortgage, it will be one of two kinds:

  • Conventional mortgage This type of mortgage requires a down payment of at least 20 per cent of the purchase price. It doesn't have to be insured against default, so it's cheaper than a high-ratio mortgage (see below).
  • High-ratio mortgage Also called an insured mortgage, this is your only option if your down payment is less than 20 per cent of the purchase price. A high-ratio mortgage is more expensive than a conventional mortgage because you must pay for mortgage loan insurance, which protects the lender if you default on the mortgage. Payment for this insurance can usually be rolled into your regular mortgage payments.

In either case, you'll have to decide on the mortgage term, which is the length of time that the mortgage agreement is in force. At the end of the term, which can be from six months to several years depending on the options you choose, you'll need to renew the mortgage at whatever interest rates are applicable at the time.

Choosing the mortgage term is always a bit of a gamble. If interest rates are low now but are expected to increase, a longer term will be to your advantage because your mortgage will be locked in at the lower rate. If they're expected to drop, it could be preferable to lock in for a shorter term so you can renew when the rates do go down.

Both conventional and high-ratio mortgages come with several options. The first set of options includes closed, open and convertible mortgages.

  • Closed mortgage A closed mortgage has fixed monthly payments that can help with your budgeting. However, you may pay a penalty if you need to pay off the mortgage before the end of the mortgage term (for example, if your term is five years and you sell the home at the three-year point). If you expect to stay in the home for several years, a closed mortgage may be best for you, since these mortgages tend to have lower interest rates than open or convertible mortgages (see below).
  • Open mortgage Unlike a closed mortgage, you can pay off an open mortgage at any time, without penalty. It's ideal if you expect to move in the near future, or if you think interest rates are going to fall. However, you'll normally pay a higher interest rate for an open mortgage that you will for a closed mortgage.
  • Convertible mortgage This mortgage can be converted to another type of mortgage during its term. You could,  for example, take advantage of a drop in interest rates by converting it to a closed mortgage at the lower rate.

Two other options cover the way the interest rate on your mortgage will be managed.

  • Fixed-rate mortgage In this case, the interest rate remains the same during the entire mortgage term, and your payments are fixed for the period of the term.
  • Variable-rate mortgages With a variable-rate mortgage, your payments also remain the same throughout the term. However, if the lender's overall mortgage interest rates drop, more of each payment is applied to the principal, which means that your mortgage will be paid off more quickly. This, in turn, saves you money. However, the reverse is also true if rates rise, more of each payment goes to interest and less to the principal, which costs you money.