Mortgage Terms Everyone Must Know!
I hope you guys are all safe and isolated yourselves during this crisis due to COVID-19. Real estate is an essential service and that is why we have to keep working (from home). More reasons why you must own real estate!
Today, I want to discuss the mortgage terms that anyone must know and understand when they are looking into purchase, finance or refinance real estate. The more you read, the more knowledge you have and the more at ease you will be. Also, you will be able to save more.
The amortization period is simply the number of years it will take to pay off your mortgage through regular payments. Most mortgages are amortized over 25 years. While your payments may be lower with 30 year amortization but you will be paying a lot more in interest.
Fixed rate mortgage
With a fixed rate mortgage, the interest rate on your home loan is set for the term of the mortgage. Fixed rate mortgages offer the peace of mind of consistency. You will know how much is your mortgage going to be monthly. That way, you will be able to budget easily and you will have peace of mind. You will know exactly how much you will owe at the end of each mortgage term.
Variable rate mortgage
Also known as a floating rate mortgage or adjustable rate mortgage, this type of mortgage has an interest rate that fluctuates with the prime lending rate. The main benefit of variable rate mortgages is lower interest rates, but in return, mortgagors (homeowners) take on risk. If the prime rate goes up, a larger chunk of your mortgage payment will go toward the interest, not paying down your principal. The result: your mortgage could take longer to pay off and cost you more in interest. Personally, I like variable rate mortgage because I like to monitor where my money goes. If variable rate goes up, you can always switch back to fixed rate.
Gross debt service (GDS) ratio
GDS refers to the percentage of your household’s gross monthly income that goes toward your housing payments – mortgage (principal + interest), property taxes, heating and, if applicable, 50% of condominium fees. Lenders use your GDS and TDS (total debt service) ratios to assess your mortgage application and to determine how much to loan you and what interest rate to apply.
Total debt service (TDS) ratio
TDS refers to the percentage of your household’s gross monthly income that goes toward housing costs (i.e., mortgage, property taxes, heating, etc.) plus your other debts and financing (i.e., car loans, credit cards, etc.). Banks use this calculation, along with your gross debt service ratio, when assessing your mortgage application.
A high-ratio mortgage is one for which the homebuyer makes a down payment of less than 20% of the cost of the home. All high-ratio mortgages must be covered by mortgage loan insurance (also known as “mortgage insurance”). This is CMHC.
Also known as a conventional mortgage, a low-ratio mortgage is one where the home buyer has made a down payment of 20% or more of the home’s purchase price. No mortgage insurance is required for this type of mortgage.
Quick tip: Did you know you could use your retirement savings to help you buy a home? The federal government's Home Buyers' Plan is the solution. It lets you borrow money from your RRSP to put towards downpayment of your first home. So how does it work? Current HBP lets first time home buyer to borrow up to $25,000 from their RRSP. RRSPs are a great way to secure your future while enjoying tax benefits today. Please speak to your accountant and financial institution for details. Consult with CRA. However, you must consider the following:
The amount you withdraw from your RRSP, must be repaid within 15 years, beginning in the third year after the withdrawal.
You can create an RRSP with borrowed money and use the tax refund as a down payment.
You can establish an RRSP with borrowed money and withdraw the money as a down payment through HBP.
Mortgage loan insurance
Also known as “mortgage default insurance” or just “mortgage insurance,” this financial product is mandatory on all high-ratio mortgages. Your mortgage lender pays the insurance premium and then passes the cost on to you; you can pay it in one lump sum or carry it on your mortgage for monthly payments.
Not to be confused with amortization, mortgage term refers to the time period covered by your mortgage agreement. It can range from one to five years or more. After each term expires, the balance of the mortgage principal (the remaining loan amount) can be repaid in full, or a new mortgage can be renegotiated at current interest rates.
Principal is the amount initially borrowed for your home purchase. The balance of this amount will decrease as you make regular mortgage payments. (Your mortgage payments go toward a portion of the principal, as well as the loan interest and, for those with high-ratio mortgages, mortgage insurance.)
I hope this article enabled you to learn new terminology. If you have any questions, feel free to ask!