Mortgages : understanding them better for a real estate purchase- Key Information
The acquisition of property constitutes a pivotal moment in an individual’s life. However, most people engaged in this process do not have adequate financial resources to cover the entire purchase cost through their personal savings. To overcome this financial disparity, resorting to a loan becomes essential. A mortgage then serves as a means to seek funds from a banking institution, thereby facilitating the acquisition of real estate.
But what exactly is the mechanism behind mortgages? Eric Tomassini-Miron, an experienced mortgage broker at RBC Royal Bank, addresses all your questions.
What is a mortgage?
A mortgage, commonly referred to as a home loan, is a financing solution that enables obtaining funds from a bank, thereby facilitating the process of acquiring a property. This form of financing encompasses the difference between the total cost of the property and the amount of the down payment.
Before approving the mortgage, the bank conducts a thorough assessment of your repayment capacity. This step ensures that the granted amount aligns with your financial resources, ensuring the successful realization of your real estate acquisition.
In the context of purchasing a first property, it is also possible to take advantage of a FHSA (Tax-Free First Home Savings Account). This option provides an opportunity to save specifically to build the necessary down payment for the purchase of a first property
How does a mortgage work?
A mortgage, similar to a car loan, for example, represents a loan where predetermined payment amounts must be repaid each month. The notable advantage of a mortgage is that financial institutions offer much more attractive interest rates than other more common credit products such as lines of credit or credit cards.
Unlike a car loan, a mortgage comes with several repayment rules that must be adhered to. When acquiring a property, you will face several crucial choices regarding your mortgage, including amortization, mortgage term, and the type of interest rate. At this stage, your financial advisor will be able to guide you towards options better suited to your situation.
What is an amortization period?
The amortization of your mortgage refers to the number of years you plan to dedicate to the full repayment of your loan. By spreading your loan over a longer period, you effectively reduce the amount of your monthly payments. In Canada, the maximum amortization period for a mortgage depends on the amount of your down payment. If your down payment is less than 20% of the purchase price, the maximum amortization period is 25 years. On the other hand, if you can make a down payment equal to or greater than 20%, you have the option to choose a 30-year amortization. Additionally, your bank may offer accelerated repayment options for your mortgage in case your financial situation changes along the way.
What is a mortgage term?
Once you have determined the optimal amortization period for your loan, it is then essential to choose the term of your initial contract. In Canada, you will not maintain the same interest rate throughout the duration of your loan. Instead, shorter contracts allow you to renegotiate new terms with your bank at the end of each term. You have the option to choose terms ranging from 1 year to 10 years.
This flexible approach gives you the opportunity to react to fluctuations in interest rates. For instance, if interest rates are high at the time of your purchase, you can opt for a shorter term. Then, you can renegotiate a new interest rate in a few years when rates may potentially be lower. This strategy allows you to adjust your contract based on changing economic conditions
What are the different types of interest rates?
Once you have determined the amortization and term that suit you, you will be faced with the choice between two types of interest rates: fixed rate and variable rate.
The fixed rate is relatively straightforward; it remains constant throughout the duration of your term, regardless of subsequent fluctuations in interest rates after the contract is signed. Opting for a fixed rate ensures predictability with consistent monthly payments throughout your term.
In contrast, the variable rate is not fixed; it is subject to change multiple times during the period of your term. By choosing a variable rate, you accept the possibility that your interest rate may increase or decrease based on economic trends in Canada, impacting the amount of your payments throughout the term.
What is the frequency of mortgage payments?
Most banks offer similar options regarding the frequency of mortgage payments. Among the most common choices are monthly, bi-weekly, or weekly payments. Regardless of the option you choose, the total amount paid in a year remains the same. However, it is relevant to note that if you opt for bi-weekly or weekly payments, you will repay your loan slightly faster compared to a monthly payment.
Can you provide an example calculation to illustrate potential mortgage payments on a property valued at $600,000?
If you purchase a property for $600,000 with a down payment of 20%, that is $120,000 (20% of $600,000), resulting in a loan of $480,000. With an amortization period of 25 years and a fixed 3-year rate at 6.25%, this translates to a monthly payment of $3,142, a bi-weekly payment of $1,450, and a weekly payment of $725.
This article was written in collaboration with Eric Tomassini-Mirion, a mortgage specialist at RBC Royal Bank.
In conclusion, the purchase of a property represents a significant milestone in everyone’s life, often marked by the need to resort to a mortgage to overcome the lack of immediate financial resources. Eric Tomassini-Miron, an experienced mortgage specialist at RBC Royal Bank, sheds light on the complexities of this process.
The mortgage, as a borrowing instrument, provides the opportunity to acquire a property by seeking funds from a banking institution. Determining the appropriate amortization period and mortgage term are crucial steps in this process. Amortization, dictating the number of years required for total repayment, may vary based on the down payment, while the mortgage term, offering renegotiation flexibility at the end of each contract, allows for loan adjustments based on interest rate fluctuations.
The types of interest rates, fixed or variable, add another layer of choices to consider. The fixed rate provides stability with constant payments throughout the term, while the variable rate exposes borrowers to fluctuations based on economic trends, thus influencing the payment amounts.
Finally, the frequency of payments, whether monthly, bi-weekly, or weekly, offers flexibility without impacting the total amount paid annually. Opting for more frequent payments, however, can accelerate the loan repayment.
In summary, choosing a mortgage requires a thorough understanding of its various aspects, and the expertise of a financial advisor can greatly assist in navigating this complex and important process of real estate acquisition.
