Kevin D'Costa

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Industry vocabulary: an introduction to the language of mortgages

If you’re a first-time homebuyer, many aspects of the purchase process can be confusing and stressful, including financing. While the mechanics of a mortgage are relatively simple, choosing the right mortgage product can be far from it, as many of the choices available to buyers are obscured by complex and unfamiliar terminology.

To help you cut through the jargon, here’s an alphabetical list of common mortgage terms and their definitions:


Amortization Period

The amount of time it will take to pay off your entire mortgage, usually ranging from 15-25 years (although some lenders offer 30-year amortization periods). A longer amortization period means lower monthly payments, but more interest paid over the duration of the mortgage. Meanwhile, a shorter amortization period will cut down on the amount of interest paid, but monthly payments will be higher.


Closed Mortgage

A mortgage that cannot be fully paid off before the end of the term without penalty. It often comes with strict rules about lump sum payments outside the regular payment schedule. These usually have lower interest rates than open mortgages.


Conventional Mortgage

A mortgage where the loan amount does not exceed 80 per cent of the property’s value (i.e., the down payment is 20 per cent of the purchase price or higher). These mortgages do not require mortgage insurance.


Down Payment

The amount of money a buyer must produce upfront to secure a mortgage. The minimum down payment for a home purchase in Canada is five per cent. A minimum down payment of 20 per cent is required for a conventional mortgage (one that does not require mortgage insurance).


Equity

A property’s market value minus the value of the outstanding mortgage loan on the property. Equity increases as a property’s value rises and the mortgage principal decreases. Once a mortgage is paid off in full, the homeowner has 100 per cent of the equity in their home.


Fixed Rate Mortgage

As the name lets on, this is a mortgage where the interest rate stays constant for the duration of the mortgage term, which generally ranges from six months to 10 years. They are beneficial for the risk averse, as well as anyone who wants their mortgage payments to remain constant. They are also a good option for anyone who thinks interest rates will increase before the end of their mortgage term. A five-year fixed mortgage is the most common mortgage type in Canada, especially among first-time homebuyers.


High-Ratio Mortgage

A mortgage where the loan amount exceeds 80 per cent of the property’s value (i.e., the down payment is less than 20 per cent of the purchase price). This type of mortgage requires mortgage insurance, which is commonly provided by Canada Mortgage and Housing Corp. (CMHC).


Home Equity Line of Credit

A home equity line of credit (HELOC) can serve as the only loan used to finance a home purchase or as a second mortgage. In practice, they function more like a personal line of credit than a traditional mortgage product. However, homeowners must have at least 35 per cent of the equity in their home to receive a HELOC.


Interest

The cost of borrowing money. It is paid to the lender at a previously agreed upon rate on top of the principal mortgage amount.


Interest Rate

The rate at which you pay interest. Lenders generally adjust their interest rates in response to shifts in the Bank of Canada’s overnight rate (https://www.bankofcanada.ca/core-functions/monetary-policy/key-interest-rate/).


Maturity Date

The date that your mortgage term ends. When your term ends, you can either repay the remaining balance of your mortgage or renegotiate a new term at current interest rates.


Mortgage Insurance

In Canada, mortgage default insurance is required for all high-ratio mortgages (those with a down payment of less than 20 per cent). Because these mortgages are higher risk than their conventional counterparts, insurance protects the lender if the borrower defaults.


Open Mortgage

A mortgage with no prepayment restrictions. It can be fully paid off at any time without penalty. These tend to have higher interest rates than closed mortgages, but they can be a good choice for homeowners who plan to sell soon.


Portability

A type of mortgage that allows the homeowner to transfer their current mortgage conditions from one home to the next.


Pre-approval

A mortgage pre-approval guarantees a specific loan amount to a buyer before they have even begun looking at homes. Although not necessary, a pre-approval can hasten the purchase process once an offer is submitted and accepted.


Prepayment

When a homeowner pays off their mortgage in full before the maturity date. Many mortgage types levy penalties against homeowners for prepayment – usually, three months of interest or the interest rate differential.


Principal

The full amount of a mortgage loan, not including interest.


Refinancing

Mortgage refinancing involves securing a new loan that is then used to pay off an existing loan. This is often done to switch lenders and secure a lower interest rate. It can also be done as a way of tapping into home equity to pay off higher-interest debt sources, such as credit cards.


Term

The duration of the mortgage agreement between borrower and lender. Mortgage terms generally range from six months to 10 years. During the term, payments remain fixed, while interest rates may or may not follow suit, depending on whether the homeowner has chosen a fixed or variable rate.


Variable Rate Mortgage

A mortgage where the payments remain constant, but the interest rate will change based on market conditions. As a result, when interest rates rise, a larger portion of the payment will be applied to interest. However, when interest rates fall, a larger portion of the payment will be applied to the principal.



- Tyler Difley

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