The following article came from the Alberta Consumer and Corporate Affairs Department. It was written in 1992, but the information contained in the article is still useful to understanding your options when getting a mortgage.
What is a mortgage?
Most people have to borrow money when they buy a home. A loan for a home is called a mortgage. To get a mortgage, you sign a mortgage document with a moneylender. Examples of moneylenders are banks, credit unions, trust companies, Alberta Treasury Branches, life-insurance companies, finance companies, and private lenders.
The mortgage document lists the rules for paying the debt (that you owe on your home. The mortgage document also pledges the home as security to the financial institution until you pay the debt. If you don't pay the debt, the financial institution can repossess your home.
How much can you afford?
Moneylenders use two guidelines to decide how large a mortgage payment you can afford each month. the Gross Debt/Service Ratio (GD/SR) and the Total Debt/Service Ratio (TD/SR). Different institutions may calculate these amounts in different ways. Some institutions may include the cost of heating in the calculations. If yours is a two-income family, the lender may use both incomes in the calculations.
Gross Debt/Service Ratio
The GD/SR is the amount that lenders think that you can afford to spend on your monthly mortgage payment and taxes: 30 percent of your gross monthly income. If your gross monthly income is $2,000, your mortgage payment and taxes should not be more than $600 per month ($2,000 x 30%).
Total Debt/Service Ratio
The TD/SR is the amount that lenders think that you can afford to spend on your monthly mortgage payments, taxes, and all other debts that you have:40 percent of your gross monthly income. If your gross monthly income is $2,000, your mortgage payment, taxes, and all other debts should not be more than $800 per month ($2,000 x 40%).
The down payment
Financial institutions require a down payment of at least five percent of the purchase price. It's usually a good idea to make as large a down payment as you can. The larger the down payment, the smaller the mortgage, and the less interest you will pay in the long run.
Conditions of the mortgage
When you know how large a mortgage you can afford, you're ready to decide the conditions of the mortgage:
Amortization period
Amortizing a mortgage means paying the debt off over a specific period of time. You make regular instalments to repay the principal (the amount that you borrowed) and pay for the interest. Mortgages can be amortized between five and 25 years, but most people choose a 25 year period when they initially take out their mortgage. The following example shows how much more you will pay by taking a longer amortization period.
Term
Term is the length of time for which the loan is issued; usually six months to five years. The term is usually much shorter than the amortization period, which states the time within which the entire mortgage is to be repaid.
The term is important, because your interest rate may be fixed according to the term. (See Type of Interest Rate) Suppose you get $60,000 mortgage amortized over 20 years at seven percent for a five-year term. The balance of the mortgage is due at the end of five years. Unless your can pay off your mortgage at the end of five years, you must renew and renegotiate your mortgage then.
The interest rate when you renew may be higher or lower than the previous rate. If the interest rate is higher, your monthly payment increases. If you want the monthly payment to remain the same, you may want to lengthen the amortization period (but this will cost more money in the long run). If the interest rate is lower when you renew, your monthly payment is lower. You may want to have the same monthly payment and shorten the amortization period, which saves you money over the life of the mortgage.
Deciding on a term depends partly on whether you think that the interest rate will go up or down. When the interest rate is low, many consumers lock in the rate for long terms. When the rate is high (or fluctuating greatly), many consumers choose shorter terms. You may want to get advice from several sources.
Method of repayment
There are different ways to repay your mortgage. The most common way is to "blend" the payment of principal and interest. Each month, the amount of your payment that goes to interest decreases slightly, and the amount that goes to principal increases slightly. In the early years of the amortization period, most of your payment pays interest on your loan. Toward the end of the amortization period, most of your payment pays principal. Interest is calculated on the principal of the mortgage, so having a smaller principal means that you pay less interest.
Frequency of payments
If you negotiate a mortgage with weekly payments, you make fewer extra payments per year. However you pay less interest.
For example, let's say that your monthly payment is $600. In one year you $7200.
By making weekly payments, you pay $150 each week. In one year you pay $7800 ($150 x 52).
By making weekly payments, you pay an extra $600 during the year. This amount is deducted directly from the principal.
Interest is calculated on the principal of the mortgage, so having a smaller principle means that you pay less interest.
Type of interest rate
The interest rate may be defined as fixed or variable. A fixed interest rate remains the same throughout the term of the mortgage. A variable interest rate floats (varies) during the term of the mortgage. If the interest rate increases, then more of your payment goes toward the interest. if the interest rate decreases, then more of your payment goes toward the principal.
Type of mortgage
You can get a conventional mortgage or a high-ratio mortgage.
With a conventional mortgage, you usually can't borrow more than 75 percent of the appraised value of the property. This means that you have to make a down payment of 25 percent or more of the property value. Some financial institutions require a down payment of more than 25 percent of the property value.
With a high-ratio mortgage, you can usually borrow more than 75 percent of the value of the property. This means that you make a down payment of less than 25 percent of the property value. However, the lender makes you pay for mortgage insurance. A high-ratio mortgage is known as a CMHC mortgage.
Also with a high-ratio mortgage you are liable to the bank for the principal sum that you borrowed. You cannot simply gives the keys back to the bank and say the property is yours.
Open or closed mortgage
You can also get an open mortgage or a closed mortgage.
With an open mortgage, you can make additional payments on the principal or pay off the mortgage completely, without notice or penalty. Different types of open mortgages are available, so check with your financial institution.
With a closed mortgage, you may not be able to make extra payments. Rates are usually lower for closed mortgages.
You can negotiate to make additional payments, such as weekly payments, before you sign your mortgage.
Insurance
Mortgage insurance and mortgage life insurance are different.
Mortgage insurance
Mortgage insurance protects the lender if you don't make your payments. (it doesn't protect you, the consumer.)
If you make a down payment of 25 percent or more of the appraised value of the property, mortgage insurance may not be required.
Mortgage insurance is available through the Canada Mortgage and Housing Corporation (CMHC)
CMHC insures high-ratio mortgages up to 95 percent of the value of the home. The application fee is $75.
Mortgage insurance premiums range from about one-half percent to three percent of your mortgage amount.
Mortgage life insurance
If you want to ensure that your mortgage will paid in full if you die, you may want to buy mortgage life insurance. Coverage may cease after the older of the two applicants (if there are two) reaches a specified age. Check with your lender and your insurance company.
Pay down the mortgage
Because you pay so much interest at the beginning of the amortization period, you can see how important it is to pay down the mortgage (reduce the principal) as soon as possible. You can save a lot of money by choosing a mortgage that lets you make extra payments on the principal. Most mortgages these days have some sort of prepayment privileges.
But beware most mortgages also have a penalty if you wish to pay off the mortgage before the end of its term. This penalty is usually equal to three months interest.
Mortgage brokers
A mortgage broker can get a mortgage for you from a financial institution or private lender. Be sure to understand all the conditions of the contract.
Get an annual statement
Your lender should send you an annual statement that shows how much you have paid in principal and interest on your mortgage during the year. If you don't get a statement, ask for one.
Renew your mortgage
You don't have to renew your mortgage with thc same institution. Check around to find the best terms and rates. Ask if you can pay a lump sum to reduce the principal before you renew. Also ask about renewal fees before you sign. If you find a good deal elsewhere, your original lender may be willing to match those terms to keep your business.
Discharge your mortgage
After you have paid your mortgage in full, the lender will either discharge (remove) your mortgage or give you the documents so that you can discharge it. The lender must not charge you for these documents. You discharge the mortgage at the Land Titles Office of the provincial government for $5. You may also want to get a copy of Title for your records. Title shows that the mortgage has been discharged and that you own the property.
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