What is a mortgage;
Most people in the market to buy a home do not have the financial ability to pay for the property outright. Therefore, more often than not buyers or purchasers of homes in Canada rely on taking out a loan to finance the acquisition of a home. Although done so mistakenly, the loan itself is not what is referred to as a mortgage; a correct understanding of a ‘mortgage’ is that the term is used to refer to a charge the lender (usually a bank) places on the home as a security if the mortgagee defaults on the repayment of the loan. This allows for the lender to take legal possession of the home and sell it they so wish in the instance that the borrower fails to repay the mortgage loan.
The mortgage loan, hereby referred to as a mortgage, can be constructed in different ways depending on the particular circumstances and/or preferences of the borrower. Different lenders offer a variety of different types of mortgages with varying features.
Firstly, let us discuss the basic features of an open mortgage as opposed to a closed mortgage. An open mortgage is generally subject to higher interest rates than a closed mortgage and are generally for a shorter term than a closed mortgage. It is referred to as an open mortgage due to the fact that in an open mortgage the borrower is allowed to make extra payments and therefore pay off the mortgage earlier or at any time without being subject to a penalty. For instance, a tax return payment can be used to make an additional payment towards the mortgage, or an inheritance amount may also be used depending on the circumstances.
As opposed to an open mortgage a closed mortgage is generally subject to lower interest rates but are set for a longer period of time. Additionally, unlike an open mortgage the borrower can only make his/her/or their regular set payments and are not allowed to make extra payments or pay off the mortgage loan before the set period of time without a penalty. It is not a recommended loan for those who expect to receive a promotion (with higher pay) or if the interest rates are expected to be lowered in the near future. Some borrowers, despite the slightly higher interest rates of an open mortgage may nevertheless still prefer it over a closed mortgage.
Fixed or variable interest rates:
Another varying feature, dependant upon the circumstances and/or preference of the borrower is whether a mortgage loan should have a fixed or variable interest rate. With a fixed interest rate the interest rate on the mortgage loan is locked in at a certain rate for the set term, whereas in a variable interest rate the interest rate may fluctuate based on the fluctuating market conditions. A fixed interest rate may be preferred by some borrowers who do not like risks and would rather rely on certainty. However, despite the reduction in risk a fixed rate is typically set at a higher amount than the variable interest rate. It can be advantageous nevertheless if interest rates are expected to rise in the near future. In contrast a variable interest rate may be advantageous if the interest rate is expected to drop in the near future.
SHORT, OR LONG-TERM MORTGAGE LOANS:
A mortgage loan may also be set for a short or long-term period. The term is the length of time in months or years in which the agreement with the lender to pay the interest rate exists. Typically, the term of repayment may vary anywhere depending on the amount from 6 months to 5 years. Within this term the borrower agrees to pay on a set schedule (flexible in open mortgages) a certain interest rate. In situations where the interest rate is high short-term mortgages have a higher interest rate than long-term mortgages whereas in situations where the interest rate is low short-term mortgages have lower interest rates than long term ones. If the borrower expects that the interest rates are about to rise it is recommended that they lock in a long
The Amortization Period of a mortgage loan is different from the term of a mortgage. The Amortization period refers to the length or amount of time the borrower will be required to make payments to pay off the loan. This is more flexible in an open mortgage and set in a closed mortgage unless a penalty is paid. The length of the amortization period dictates the amount of total interest paid on the loan as well as the monthly payments on the loan. Typically, the amortization period is 25 years but may be shorter or longer as well. However, it is important to note that under the law for home purchasers with less than a twenty percent down payment the maximum amortization period allowed is 25 years. Additionally, the Canadian Mortgage & Housing Corporation refuses to insure an amortization period longer than 25 years.
As one may logically conclude, in a shorter amortization period the borrower is required to make higher monthly payments, nevertheless overall there are advantages if such an arrangement is affordable due to the borrower being able to save more due to paying less interest. In longer amortization periods the amount of monthly payments is lowered but
there is a detriment in relation to savings as more interest is paid over time. In cases, as typically is the case, where the mortgage term and Amortization period differ, and the mortgage term comes to an end before the amortization period has been concluded the borrower will either must pay back the bank loan or secure further financing.
For more information please contact one of our experienced Real Estate Lawyers at MEHDI AU LLP.
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