What Type of Mortgage you Should Get

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If you are buying a home with less than 25% down payment your choices of mortgage products and terms are somewhat limited...3 year fixed rate or longer under the regular CMHC Program and 5 years fixed rate or longer under the 5% down program.

However, if you are not constrained by the insurance requirements of a high-ratio mortgage there are many options available...they are summarized below. (Note: Not all lenders offer all types of mortgages.)

Short-term risk and Variable If rates are low and stable, and/ or you have decided to take the "staying short" strategy regardless...you can generally pay a significantly lower rate (by up to 2%). This is achieved by simply rolling over your term every 6 months, or having your rate float against prime - with the option of locking in to a longer term at a later date. This is not for everyone, however, as sudden upward rate movements - not unknown in Canada - can cause severe stress.
Long-term Any term 3 years or longer is considered "long term" in today's economy. Because long-term rates are usually higher than short-term rates, many Canadians who have a choice do not select this option. There are many, however, that consider a long term mortgage necessary due to their exposure to rate increases relative to their inability to manage a significantly higher payment.
Split Term A mortgage which allows you to minimize - or hedge - your interest rate risk by splitting your mortgage into 3 to 5 parts.For example: A $150,000 mortgage could be split into five $30,000 segments with terms of 6 months, 1, 2, 3 and 5 year terms negotiated at today's best rates. The average rate (say, 6.25%) would rise or fall much more slowly than changes in the market, however, as only the shorter terms are affected by even the most volatile rate movements over the first few years.
Protected Variable In 1993 several Canadian Banks introduced the protected variable rate mortgage, which floats at about prime minus .50% and is capped at (i.e. will never exceed) the posted 3 year rate. It does offer a way to reduce the risk of floating, while preserving an acceptable long-term rate. (This type is also known as the "capped" variable rate mortgage).
Prepayment Options Annual prepayments... traditionally, 10% to 20% of the original principal balance have been allowed as a lump sum prepayment once a year, often on the "anniversary date". Recently, options of up to 20% of the original balance payable on any payment date have been added to this feature. Finally, the "double-up and skip-a- payment" feature has been included in many offerings. This allows a borrower to "bank" extra mortgage payments for a rainy day, at which time they can just "skip", with the added benefit that, if it never "rains", principal is permanently reduced, along with the interest cost.
Payment Changes Most mortgages now allow the amortization to be adjusted by increasing the payment on closed terms by 10% - 20% per year, once annually.
Payment Frequency Most mortgages now come with the option to pay your mortgage at a frequency that matches your cash flow - weekly, bi-weekly or semi-monthly. The added benefit of the "accelerated" weekly and bi-weekly payments is that by dividing a regular monthly payment into two or four respectively, and deducting it at the new interval, an extra payment a year is made directly against principal. The surprising effect of this one extra payment a year is to reduce the amortization of the average mortgage by up to 6 years, with enormous savings of cash at the end of the mortgage term.
Summary
If you are risk-avoider...go for a fixed rate long-term mortgage, or hedge your bets with a protected Variable Rate Mortgage. If you're a risk-taker, simply stay with a short-term mortgage and watch closely for the signal to lock in a longer term deal. Wherever you can stand the additional cash flow requirement, increase your payment frequency and amount, and prepay principal wherever possible. Remember...because mortgage interest is not tax-deductible, every dollar you pay off your mortgage gives you an AFTER TAX RETURN of whatever your rate is, because you're saving interest you'd otherwise have to pay with after-tax dollars!

 

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