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Choosing A Mortgage

An article from the Globe and Mail

You’ll find lots of choices when you go shopping for a mortgage. And every lender promotes their products differently. Here are some key choices you’ll need to make.

4 key choices

1. Amortization period

This is the total length of time you’ll take to pay off your mortgage in full. Most people choose between 15 and 25 years. If you have a government-insured mortgage, the longest amortization period is 25 years.

2. Mortgage term

Mortgage terms are shorter than the amortization period – in most cases, from 1 to 5 years. At the end of the term, you’ll have to renew your mortgage. The longer the term, the higher the interest rate. That’s because you’re getting a set rate for many years — no matter if interest rates go up or down.

3. Type of mortgage

Open or closed

An open mortgage gives you the option of paying your mortgage back in full, at any time. Interest rates tend to be higher for open mortgages. Closed mortgages are more restrictive. You may be able to pay back part only of the principal, only at a specific time. And there may be penalties.

Ask yourself how likely is it that you will have extra money to pay off your mortgage. You pay for flexibility when you get an open mortgage.

Fixed or variable rate

A fixed rate mortgage has the same interest rate for the entire term. The interest rate on a variable mortgage changes as the Bank of Canada changes interest rates.

Consider a fixed rate mortgage if:

You think interest rates are going up soon.

You are worried about penalties if you sell your home before the end of the term of the mortgage.

Consider a variable rate mortgage if:

You think you may sell your home before end of the mortgage term.

You are comfortable letting your mortgage rate float with interest rates.

4. Prepayment options

Ask your lender about these options for paying your mortgage down more quickly:

paying extra on your payment dates (often called “double up”)

increasing the amount of your payments

making annual lump-sum payments.

There are limits on how much you can increase your regular payments by and the amount of a lump-sum payment. It usually ranges from 10% to 20%, depending on the lender and the mortgage. For example, a lender may offer a “10+10” prepayment option that lets you increase your payments by 10% and make a lump-sum payment of up to 10% of your principal once each year.

Mortgage penalties for exiting early

If you decide that you want to leave a closed mortgage early, be aware that you will likely incur a penalty. This penalty will be calculated in one of 2 ways:

3 months’ interest – This penalty is calculated as the interest you would pay in 3 months at your current mortgage rate.

Interest rate differential (IRD) – The calculation for an IRD penalty can vary from lender to lender. Generally, it estimates the difference in the amount of interest the lender would receive on your remaining principle, based on current interest rates. The rate used depends on the lender, but, for example, if you have 2 years left in your term, the interest rate used would likely be the fixed 2-year closed rate.

Lenders will usually charge the greater of the two penalties. If interest rates are going down, IRD tends to be higher. Check the penalty with your lender before choosing a mortgage. Ask your lender to estimate the penalty if you leave mid-way through your term as an example.

Along with the penalty, other fees may apply when exiting your mortgage early, such as administration fees and an amount equal to any initial discount on the rate you received. Use this calculator to estimate the penalty you might pay – for an exact rate and other fees check with your lender. Most major lenders also offer penalty calculators on their websites.

Keep track of interest rates. Some lenders will let you switch from a variable to a fixed rate mortgage as interest rates start to rise. This is called “locking in.”