CHOOSING a MORTGAGE
That Is Right For You
Open and closed mortgages, choose an amortization period and term, decide on fixed or variable interest rates and etc.
A mortgage is a loan to help you buy a home or other property. Mortgages have different features to meet different needs. Make sure you understand the options and features lenders offer you when you shop for a mortgage. This will help you choose a mortgage that best suits your needs.
Open and closed mortgages:
The main difference between open and closed mortgages is the amount of flexibility you have in making extra payments or paying off your mortgage completely. Putting extra money toward your mortgage is called a prepayment. Prepayments allow you to pay down your mortgage faster.
Open Mortgages
Open term mortgages allow you to do the following at any time during your term without paying a penalty:
- Put extra money toward your mortgage on top of your regular payments at any time
- Pay off your mortgage completely before the end of the term
- Renegotiate your mortgage before the end of your term
- Break your contract to change lenders before the end of your term
Closed Mortgages
The interest rate on a closed mortgage is usually lower than on an open mortgage with a comparable term length. Closed term mortgages usually limit the amount of extra money you can put toward your mortgage each year on top of your regular payment without paying a penalty. Your mortgage contract includes a limit to the amount of extra money you may put toward your mortgage. Your lender calls this a prepayment privilege. Not all closed mortgages allow prepayment privileges. They vary from lender to lender. You may have to pay a penalty if you break your mortgage contract or change lenders.
You’ll generally be required to pay a prepayment penalty if:
- You make a prepayment that is more than what your lender allows
- You decide to break your mortgage contract
Good Choice
Choose an amortization period:
The amortization period is the length of time it takes to pay off a mortgage in full. The longer the amortization period, the lower your payments will be. Keep in mind that the longer you take to pay off your mortgage, the more you’ll pay in interest.
If your down payment is less than 20% of the purchase price of your home, the longest amortization you’re allowed is 25 years.
How amortization affects the amount of principal paid back and interest paid after five years:
| Mortgage amount | Amortization | Monthly payment | Total interest paid (Assume a constant interest rate of 4%) |
Amount of principal paid back after five years | Percentage of your mortgage paid back after five years |
|---|---|---|---|---|---|
| $300,000 | 25 years | $ 1,578 | $173,418 | $38,838 | 12% |
| $300,000 | 20 years | $ 1,813 | $135,057 | $54,384 | 18% |
| $300,000 | 15 years | $ 2,214 | $98,541 | $80,973 | 27% |
| $300,000 | 10 years | $ 3,033 | $63,919 | $135,196 | 45% |
Choose a term:
The mortgage term is the length of time your mortgage contract will be in effect. This includes everything your mortgage contract outlines, including the interest rate. Terms can range from just a few months to five years or longer.
At the end of each term, you’ll need to renew your mortgage. You’ll most likely require multiple terms to repay your mortgage in full. If you’re able to pay off your mortgage in full at the end of your term, you don’t need to renew your mortgage.
If you want to renegotiate your mortgage contract or pay off your mortgage before the end of the term, you may have to pay a prepayment penalty. The amount you’ll pay will depend on the type of mortgage you have and the terms and conditions of your mortgage contract.
When choosing the length of your term, you may want to consider:
If you choose a short-term mortgage, you won’t have to wait as long if you want to renegotiate your mortgage for a lower interest rate or change lenders without paying any fees.
This may be a good choice if you expect interest rates to go down or if you may need to change your mortgage within the next couple of years. For example, if you think you’ll be moving to a new home.
However, if interest rates go up, you may need to renegotiate your mortgage at a higher interest rate.
If you choose a longer-term mortgage, you can lock in an interest rate for a longer period of time. This may help you with budgeting since you’ll know for certain what your housing costs will be for a longer period of time. However, you may not be able to make any changes to your mortgage contract for several years without having to pay a prepayment penalty.
For terms longer than five years, you may pay a lower prepayment penalty after five years have passed. After five years, you’ll only be charged three months’ interest on the remaining mortgage balance if you want to make changes to your mortgage contract.
A convertible mortgage means that some short-term mortgages can be extended to a longer term. Once the mortgage is converted or extended, the interest rate will change to the rate the lender is offering for the longer term.
Decide on fixed or variable interest rates:
Interest is the amount of money you’ll pay to a lender for borrowing money. When you apply for a mortgage, your lender may offer different options to calculate the interest you’ll pay on your loan.
Fixed interest rates will stay the same for the entire term. Fixed interest rates are usually higher than variable interest rates.
A fixed interest rate mortgage may be better for you if you want to:
A variable interest rate can increase and decrease during the term. If you choose a variable interest rate, you may be offered a lower interest rate than the one you’d get if you selected a fixed interest rate.
Keep in mind that the rise and fall of interest rates are difficult to predict. Consider how much of an increase in mortgage payments you’d be able to afford if interest rates rise. Note that between 2005 and 2015, interest rates varied from 0.5% to 4.75%.
Get information on current interest rates from the Bank of Canada or your lender’s website.
If the interest rate goes up, more of your payment will apply to interest, and less to the principal.
If the interest rate goes down, more of your payment will apply to the principal. You’ll pay off your mortgage faster.
If the market interest rates increase to a certain percentage or trigger point, your lender may increase your payments. This payment increase will make sure that you pay off your mortgage in the timeframe, that is, amortization period, you originally agreed upon with your lender. Your mortgage contract lists the trigger point.
With adjustable payments, the amount of your payment will change if the interest rate changes. A set amount of each payment will apply to the principal. The interest portion will change as the interest rates change. You’ll know in advance how much of the principal will be paid at the end of the term.
If the interest rate rises, your payments will increase. Make sure that you’ll be able to adjust your budget in case your payments increase.
If the interest rate goes down, your payments will decrease.
Example: Choosing between variable and fixed interest rates
Suppose you’re buying a home and need a mortgage for $200,000.
You’re looking for a mortgage with the following:
- a 25-year amortization period
- a five-year term
Your lender offers you the following interest rates:
- 3.5% for a variable interest rate, with adjustable payments, or
- 4.0% for a fixed interest rate
To decide which interest rate you’ll choose, consider the different scenarios in Table below.
Over the life of the five-year term:
| Scenario 1 | Scenario 2 | Scenario 3 | Scenario 4 | |||||
|---|---|---|---|---|---|---|---|---|
| Interest rate | Monthly payment | Interest rate | Monthly payment | Interest rate | Monthly payment | Interest rate | Monthly payment | |
| Year 1: | 4.0% | $1,052 | 3.5% | $999 | 3.5% | $999 | 3.5% | $999 |
| Year 2: | 4.0% | $1,052 | 4.0% | $1,050 | 4.5% | $1,103 | 3.5% | $999 |
| Year 3: | 4.0% | $1,052 | 4.5% | $1,101 | 5.5% | $1,209 | 3.5% | $999 |
| Year 4: | 4.0% | $1,052 | 5.0% | $1,152 | 6.5% | $1,316 | 3.5% | $999 |
| Year 5: | 4.0% | $1,052 | 5.5% | $1,202 | 7.5% | $1,423 | 3.5% | $999 |
| Total payment over 5 year term | $63,122 | $66,044 | $72,607 | $59,912 | ||||
| Interest paid over 5 year term | $37,230 | $41,620 | $50,830 | $32,472 | ||||
| Mortgage Balance in 5 years | $174,108 | $175,576 | $178,223 | $172,560 | ||||
Consider if you’re comfortable with the possibility of interest rates increasing. Decide if your budget could handle higher payments. If not, a fixed rate mortgage may be better for you.
A variable interest rate mortgage may be better for you if you’re comfortable with:
Decide how often you’ll make payments:
When you make a mortgage payment, the money is split between interest and principal. Money is first put toward the interest, and then toward the principal. The principal is the amount you borrowed from the lender.
At the beginning of your mortgage term, most of your payments will go toward interest. The amount that you owe will only go down a little. As your mortgage balance decreases, more of your payment will go to the principal.
Payment frequency
Payment frequency refers to how often you make your mortgage payments. Your payment frequency is set when you and your lender first arrange your mortgage, but you may be able to change it.
One payment per month for a total of 12 per year.
- Two payments per month for a total of 24 payments per year
- Take your monthly payment and divide it by two (monthly payment ÷ 2)
- The total amount you pay over the year is the same as with the monthly payment option
- One payment every two weeks, for a total of 26 payments per year
- Take your monthly payment, multiply it by 12 and then divide by 26 (monthly payment x 12 ÷ 26)
- The total amount you pay over the year is the same as with the monthly payment option
- One payment per week, for a total of 52 payments per year
- Take your monthly payment, multiply it by 12 and then divide by 52 (monthly payment x 12 ÷ 52)
- The total amount you pay over the year is the same as with the monthly payment option
