Mortgage Terminology: The Basics Explained

Choosing a mortgage can, to say the least, be confusing.  Understanding the basic terminology can make understanding your options and lot less frustrating.  Below you'll find a list of basic terminology that I hope will help alleviate a little of the frustration when it comes time to financing your new home.

Basic Mortgage Terminology

Downpayment: A down payment is the amount of money that you pay at the time of purchase toward the price of your home (your mortgage loan covers the rest).

Amortization Period: the number of years it will take you to pay off the principal and interest owing on your mortgage. The lengths may differ, extending your amortization period decreases your regular payment and increases the amount of interest you'll end up paying over the life of the mortgage.

Mortgage Term: This is the period of time, usually measured in years, in which the parameters of a mortgage are binding for both parties.

Closed Mortgage: This type of mortgage locks you into paying the mortgage for a set period of time ( see Mortgage Term above).  If you decide to make changes to the mortgage (ie. selling or refinancing) there is a financial penalty involved. (Note: the interest rate with closed mortgages is generally lower than an open mortgage with a comparable term).

Open Mortgage: This type of mortgage has no term and as a result you are able to pay off the mortgage at any time with zero penalty.  Typically, however, there is a premium associated with this type of mortgage and it generally comes in the form of a higher rate of interest.

Fixed Rate Mortgage: *Available with Open or Closed Mortgages* This means that the interest rate is locked in for the full term of the mortgage with payment amounts set out in advance for the term.

Variable Rate Mortgage: *Available with Open or Closed Mortgages* In this type of mortgage the interest payments fluctuate when the prime lending rate increases or decreases.  This can affect your payments in one of the two following ways:

  • your payments may be predetermined at the start of the mortgage and then if interest rates go down more of the payment may be applied to the principal and if the interest rates go up less of the payment will be applied to the principal (therefore more to interest).
  • your payments aren't predetermined and they fluctuate based on rates.

Choosing between Fixed and Variable: So how do you choose between a fixed and variable interest rate mortgage?  Here is the advice that CMCH (Canada Mortgage and Housing Corporation) lays out:

A fixed interest rate mortgage may be better for you if:
A variable interest rate mortgage may be better for you if:
  • you want to know your interest rate or the amount of your regular payments is not going to change over the term of your mortgage
  • you prefer knowing in advance how much of your mortgage will be paid off at the end of your term
  • you think there is a good chance that market interest rates will rise over the term of your mortgage.
  • you can handle an increase in your mortgage payment if interest rates increase
  • you are comfortable with the possibility that
    • – your mortgage interest rate and payments could increase
    • – you could pay more in interest over the term of your mortgage than you would have paid with a fixed interest rate
  • you follow interest rates closely
  • you think there is a good chance of interest rates staying the same or dropping over the term.

Payment Options: Most financial institutions will offer a number of payment frequency options including: 

  • Monthly: one payment per month for a total of 12 per year
  • Semi-Monthly: twice a month for a total of 24 per year
  • Biweekly: a payment every two weeks; 52 weeks per year divided by 2 equals a total of 26 payments (equal to the same as making monthly payments)
  • Accelerated biweekly: a payment of half the monthly payment every two weeks, 52 weeks per year divided by 2 for a total of 26 payments.  With this payment frequency you will make the equivalent of one extra monthly payment per year.
  • Weekly: one payment per week for a total of 52 per year
  • Accelerated weekly: a payment of one quarter of the monthly payment every week.  With this payment frequency you will make the equivalent of one extra payment per year.

High Ratio Mortgage: The down payment for the property is less than 20% of the purchase price.  If this is the case you will have to pay mortgage default insurance (see below).

Conventional Mortgage: The down payment for your property is at least 20% of the purchase price.  If this is the case mortgage default insurance is generally not required.  There may be exceptions to this, for example if your salary is not paid to you on a regular basis.

Mortgage Default Insurance: Also referred to as Mortgage Loan Insurance, protects the mortgage lender in the case that you are unable to make your payments.  It does not protect you, and your mortgage lender will make the necessary arrangements for you if it is required.  The premiums (or the cost of mortgage default insurance) will vary depending on the percentage you have in a down payment; the bigger your down payment the lower your mortgage default insurance premium.  (According to CMCH the rates vary from 0.5% t0 3%.

Pre-Approval: This is a preliminary discussion with a potential mortgage lender to find out how much you can afford to borrow and at what interest rate.  Some of the benefits to gaining pre-approval include:

  • locking in an interest rate in case interest rates rise before you purchase a home ( the length of the interest rate varies by financial institution)
  • knowing the amount of a mortgage that you qualify for so that you don't waste time shopping for a home you cannot afford
  • estimating your mortgage payments so you can include them in your budget.

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