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Mortgage 101

A mortgage is a long-term loan for the purchase of a property, usually at interest rates that are much lower than other lending vehicles such as credit cards, lines of credit or automobile loans.

Homes are often the biggest purchases we ever make. And because of historical increases in property value, homes are also often one of our biggest investments. Homes have historically increased in value over time. Of course, this is highly variable from year to year, and is influenced by broader economic conditions such as interest rates, job prospects and wages in your area, and supply and demand of homes.

Mortgage rates—the percent of interest we pay to borrow the money—have been uncharacteristically low for some time as the Bank of Canada tried to encourage financial activity. But even with low interest rates, mortgage rates need to be carefully considered because a change in interest rates can have significant implications on your financial situation.

Let’s say you bought a home for $300,000. You have budgeted $1,500 per month on housing. With an interest rate of 3.5%, it would take you 25 years to pay for your home, and you would spend almost $150,000 in interest.In comparison, if interest rates rose by just 1%, you would need to increase your monthly payment to $1,666, and the amount of interest paid over the 25 years would reach nearly $200,000.

Know Your Mortgage Terminology

Mortgage Term vs Amortization

The term of your mortgage is the amount of years you are committed to the lending institution. Generally speaking, it is three to five years. So even if you pick the worst rates possible, you only have to live with them for the duration of the term. Amortization is the overall time period that is allotted to paying down your mortgage. The average Canadian amortizes their home for 20-25 years.

Fixed vs Variable Mortgage

Mortgage rates come as fixed (meaning they stay the same throughout the duration of your term) or variable (meaning they fluctuate according to the prime lending rates). The upside of fixed rates is that you are locked in at the set rate, even if rates go up. But if rates go down, you are stuck with the rate you locked in at.

On the flip side, people often opt for variable rates when they think rates have a chance of going down. The downside of variable rates is that you could pay more if rates go up during your term.

Mortgage Payment Frequency

There are options for how often you make a mortgage payment. Monthly, weekly and bi-weekly payments are common choices.

The 1% Difference in a Mortgage

Because mortgages are usually for large amounts over long amounts of time, even small increases in interest rates can have a big impact on how much you pay to borrow the money. In this example, increasing the interest rate by just 1% adds $50,000 in interest charges.

  • 3.5%

    PURCHASE PRICE: $300,000
    MONTHLY PAYMENTS: $1,500

    Total Interest Over 25 Years: $150,000
    Total Cost of Purchase: $450,000
    INTEREST SAVED: $50,000

  • 4.5%

    PURCHASE PRICE: $300,000
    MONTHLY PAYMENTS: $1,600

    Total Interest Over 25 Years: $200,000
    Total Cost of Purchase: $500,000

Speed Up. Pay Down.

Increasing the payment frequency from monthly to weekly makes you mortgage-free faster, and reduces the total interest paid.

PURCHASE PRICE: $300,000
INTEREST RATE: 3.5%

  • $375 / Week

    TOTAL INTEREST: $128,373
    TOTAL TIME: 22 YEARS

  • $1500 / Month

    TOTAL INTEREST: $148,956
    TOTAL TIME: 25 YEARS

20 Years Vs. 25 Years

Reducing the amortization period (the time it takes to repay your mortgage) can dramatically decrease the total interest you pay on your home.

PURCHASE PRICE: $300,000
INTEREST RATE: 3.5%

  • 20 Years

    MONTHLY PAYMENT: $1,736
    TOTAL INTEREST: $116,637

  • 25 Years

    MONTHLY PAYMENT: $1,498
    TOTAL INTEREST: $149,381

Your mortgage can be one of your biggest financial transactions. Make sure you know the implications of the one you choose.