This is part (2) in the series about mortgages, generally, the biggest investment and debt in the lives of most Canadians. We have reviewed the sources of information available to the homeowner or potential homeowner and now we will cover the main types of mortgage financing in today’s market place.
Before you go looking at options, terms and rates you need to understand something about the type of mortgages available. This is important because there are many forms of mortgages, but how they work, their pros and cons and how they fit to your situation will affect your decision making process.
There are fixed rate mortgages, variable rate mortgages, lines of credit mortgages, open mortgages and closed mortgages. In addition there are specialty mortgages such as cash back mortgages, low frills mortgages, combination mortgages, and so on.
Fixed Rate Mortgages are the long time standard in the mortgage industry and they offer terms from 1-5 years plus some additional terms up to 10 years by most lenders. This type of mortgage fixes your interest rate and payments for the length of the term chosen. At the end of your term you would have the option to renegotiate your existing mortgage balance for a new contract term or chose another mortgage type altogether. Pros: Because the rate and payments are fixed, you do not have to be concerned about any surprises in your mortgage costs during the contract term. Excellent for buyers adapting to this new responsibility and for those who want stability in their mortgage! Cons: These types of mortgage can restrict people who wish to move on before the term is completed as there is potential for higher prepayment penalties.
Variable Rate Mortgages have become very popular over the past 20-25 years. They have floating rates based on the bank’s Prime rate. Depending on what the lenders offer from time to time, the rate is generally Prime + or – an adjustment. This adjustment is stable for the term chosen but your overall rate fluctuates based on the movement in the lender’s Prime. You have fewer terms to choose from, usually 1, 3, & 5 year terms. Pros: The rate offered on this product is often lower than the fixed rates for the same term and in a declining rate environment the benefits increase. This would allow you to reduce your mortgage principal at a much faster pace. Also, the maximum prepayment penalties are usually capped at 3 months interest. Cons: Since the Prime will move over time, there is potential that your rate may increase beyond the rate you could have had with the fixed rate mortgage, thus costing more.
Line of Credit Mortgages are very common today as well. They involve using the equity of your property (maximum 80% of the value) for a personal line of credit that can be accessed whenever you need. This product also has a rate connected to Prime plus a margin the lender offers at the time of the contract. Pros: Convenient access to funds and minimum payment requirements as low as interest only. There are no prepayment penalties. Cons: As with all revolving credit there is a danger to abuse this type of mortgage and if you just make the interest only payments you will not reduce the balance. Also the floating rate situation is a major concern if the prime is climbing.
Open mortgages and Closed mortgage are generally available on fixed or variable rate products and will affect the aspect of prepayment penalties, rates, and terms offered. This is an additional classification on the mortgage you choose. Pros: The Open mortgage does not restrict you with prepayment penalties and gives you the flexibility to make changes throughout the term. The Closed mortgage guarantees your interest rate (generally lower) for the length of the term providing stability. Cons: The open mortgage generally comes with a much higher interest rate. The Closed mortgage has prepayment penalties which can restrict your choices during the term.
Speciality mortgages are variations on those discussed above which offer additional perks that may help you for specific needs. The cash back mortgage could mean access to additional cash added to your mortgage that you may use toward down payments, closing costs, renovations, furniture/appliance purchase and so on. You may use a low frills mortgage in return for special rate options. A combination mortgage would let you have the standard fixed or variable rate product plus a line of credit mortgage under one account. Pros: The cash back allows you to get the added funds you may need included in your mortgage above the standard limits. The no frills will get you a lower interest rate offer on a fixed term. By using the combination mortgage you enjoy the stability of a standard mortgage plus the benefits of the line of credit. Cons: A much higher interest rate accompanies the cash back mortgage. Often reduced prepayment options and higher penalties are associated with the low frills product. The combination product has the same cons as the fixed or variable and line of credit mortgages.
A lot of information to review in order to see how and why any particular item fits (or does not fit) you! Everyone has different circumstances and priorities. Information, analysis, and interpretation are all important and a mortgage professional can help you sort through the details and make the right decisions that will work for you.
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Stay tuned for Number 3 in this series...