What You Need to Know About Your First Mortgage

Mortgage contracts rank right up there with the cell phone provider’s terms and conditions on most people’s reading list.

Unfortunately, as the document that controls the purchase and security of the largest asset you will likely ever own – your house – an understanding of your mortgage contract is essential to feeling confident in your overall financial well-being.

While a more complete explanation of the terms and decisions that are relevant to your first mortgage can be found in the free eBook I recently penned, the cheat sheet can be found below.

Down payment: This is the upfront amount of money you will pay toward the purchase of the house. The size of your down payment will affect several aspects of your mortgage, such as the size of your periodic payments, and if you need to pay mortgage insurance through the Canada Mortgage and Housing Corporation (CMHC). To avoid this automatic extra insurance you will need to save up 20% of the purchase price of the house for your down payment. You can benefit by taking the time to save a substantial down payment for your first mortgage.

Amortization and term: Many people make confusing statements such as “I took out a 25-year mortgage from my bank.” What this usually means is that the person received a mortgage that was amortized over 25 years, but the period of time that their current mortgage term covers is almost always substantially less than that (usually five years in Canada). At the end of your first mortgage term, you are free to move your mortgage to another financial institution and/or renegotiate parts of the mortgage such as the interest rate and the size of the payments. If you opt to make the payments larger, obviously you will pay off the mortgage faster, thus lowering your amortization period (aka the amount of time it will take you to pay off the mortgage). You will likely have several mortgage terms over the length of your amortization period.

Fixed vs variable rates: Perhaps the most commonly discussed aspect of mortgages is the debate about whether to use a fixed or variable rate of interest during your mortgage term. There are even options that blend the two options. The words fixed and variable simply refer to if the rate of interest on your mortgage can go up or down throughout your mortgage term. Fixed interest rates will stay the same for the length of the term no matter what the Bank of Canada’s prime lending rate does, whereas a variable interest will rise or fall depending on the Bank of Canada’s decisions.

Closed vs open: While the majority of the “sticker rates” that you see advertising mortgage options are advertising for closed mortgages, there is an alternative option known as an open mortgage. Open mortgages allow mortgage holders to opt out of their current term agreement at any time. In exchange for this flexibility most financial institutions will charge a substantially higher interest rate on these typed of mortgages. Closed mortgages are more common and provide the bank with more long-term certainty; consequently, they are willing to reward consumers with lower interest rates. Make sure you understand what you’re getting with your first mortgage.

Breaking your mortgage penalty: The majority of mortgages (especially closed mortgages) in Canada include a penalty if you wish to get out of the mortgage term contract before the termination date. Sometimes people wish to “break their mortgage” in order to take advantage of a drop in interest rates, or because they simply want to deal with another financial institution. Obviously lenders are not big fans of these moves, and so they often insert penalties or fees that are equal to three months of mortgage payments or the interest rate differential (IFD). The IFD can be a somewhat confusing formula that takes into account how long is left on the mortgage, the specific rate, and several other variables. Every mortgage is unique and different penalties or fee preferences can usually be accommodated.

Remember that just like with most products or services in life, mortgages are always subject to negotiation. Some people are aware that interest rates can be flexible, but the truth is that everything from payment periods, to penalties and prepayment privileges can be worked into the contract before you sign anything. Don’t be afraid to ask for the mortgage options that fit your unique situation best.

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