Navigating the world of interest rates, payment options, and mortgage terms can be challenging. But knowing some basic mortgage terminology can help clear up any confusion and ensure you are set up with an effective mortgage strategy as you pursue your dreams of home ownership!

Below, we cover three key mortgage topics:

1. The length of time you have to pay off your mortgage.

2. How to choose between fixed or variable interest rates, and;

3. Deciding your payment schedule

Amortization vs mortgage term

The words "amortization" and "term" are often used interchangeably, but when it comes to mortgages, they mean different things. If you are in the market to buy a house, it’s important to understand the difference between these words because they determine how long you will have a specific interest rate and how long you will have to pay off your entire loan.

Amortization

A mortgage amortization is the total length of time you’ll take to pay off your mortgage loan. This is important because it affects how much you pay each month, as well as the total amount of interest you pay over the full length of your loan.

In Canada, the standard amortization length is 25 years, but shorter or longer lengths are available, depending on your financial goals and lender's offerings.

A longer amortization generally results in lower monthly payments, appealing to those trying to reduce the amount of money they have to pay each month. However, it’s important to know that this could mean you will pay more interest over the life of the loan. Choosing a shorter amortization can lead to higher monthly payments, but you’ll save on interest and build equity in your home much faster.

For example, with a $500,000 mortgage at a 3% interest rate over a 25-year amortization, your monthly payment would be approximately $2,366. By the end of this term, you will have paid a total of $709,813 (of which $209,813 is interest). However, reducing the amortization to 15 years increases your monthly payment to $3,326, while the total amount paid over the life of the mortgage is reduced to $598,262. This translates to a savings of $111,551 in interest! For illustration purposes only

Mortgage term

The mortgage term refers to how long the interest rate and other terms of the mortgage contract stay the same.

It's a shorter length of time than the amortization and typically lasts from 1 to 10 years, with five years being a common choice for most Canadians. In this period, your interest rate and monthly installments stay constant.

The mortgage term is how long you agree to a specific interest rate with the lender. After this time, you will renegotiate new terms with your existing lender, or can look at switching lenders. This lets you adjust your mortgage to fit your finances or get a better rate.

It’s important to differentiate between the mortgage term and amortization. When the term ends, you will not have paid off your mortgage in full. Instead, the money left owing will carry into the next term, so plan carefully.

As your mortgage term ends, and before you enter into a new mortgage term agreement, it is wise to revisit your finances to make sure you are still on track to reach your long-term goals.

Fixed vs variable rate

Deciding if you want a fixed or variable interest rate is a particularly important choice when getting a mortgage. Each option has its advantages and considerations, and your decision should reflect your financial situation (now and in future), risk tolerance, and future market predictions.

Fixed rate

Opting for a fixed-rate mortgage means your interest rate stays constant throughout your mortgage term. This predictability is comforting for many homeowners, as it protects you from fluctuations in the market, making it easier to plan and manage your money.

Having a fixed rate can be helpful if interest rates go up, because your mortgage payments will not change.

On the flip side, if interest rates fall, you could find yourself locked into a higher rate, resulting in higher interest costs compared to a variable rate. Changing a fixed-rate mortgage early can lead to big fees, which can make people hesitant to do so if they want flexibility or plan to sell their home before the mortgage ends.

Variable rate

A variable-rate mortgage adjusts in response to market interest rate changes. Even though your monthly installments stay constant, the proportion going toward paying interest and the principal balance might fluctuate.

However, variable-rate mortgages often offer lower interest rates compared to fixed-rate mortgages and may allow for more flexibility. Should interest rates drop, the amount that goes towards your interest will decrease, potentially saving you money over the term of your mortgage. However, if interest rates go up, the amount that goes towards interest would increase.

Payment schedules

The frequency of your mortgage payments is another important decision that can affect how quickly you pay off your mortgage and the total amount of interest you will pay. Most Canadian mortgages offer monthly, bi-weekly, or accelerated bi-weekly payment options.

Monthly payments

Most borrowers typically choose monthly payments, as they coincide with the usual monthly billing cycle of several other costs. With monthly payments, you’ll make one payment each month, usually on the same date, which simplifies budgeting and matches the monthly income cycle of most homeowners.

While monthly payments offer convenience, they may not be the most cost-effective choice in the long run. The total interest paid over the amortization period can be higher with monthly payments compared to more frequent payment schedules, as you have fewer opportunities to reduce the principal balance.

Bi-weekly payments

Bi-weekly payments split your monthly payment in half and require a payment every two weeks. This results in 26 payments per year, allowing you to make one additional monthly payment annually.

The bi-weekly schedule is a popular choice for those who are paid on a similar frequency, as it can make budgeting easier. By making more frequent payments, you’re continuously chipping away at the principal, which can lead to significant savings and a quicker path to mortgage freedom.

Accelerated bi-weekly payments

Accelerated bi-weekly payments take the concept of bi-weekly payments one step further. With this choice, you make the equivalent of one extra monthly payment each year, divided across the 26 bi-weekly payments. This means each payment is slightly higher than a regular bi-weekly payment, but the accelerated schedule can significantly reduce your interest costs and pay off your mortgage years earlier.

Choosing an accelerated payment schedule is a strategic move for homeowners looking to maximize their interest savings and build equity faster. It’s a powerful tool for those who can manage the slightly higher payment amount, as the long-term financial benefits can be large.

Pay off your mortgage faster

The goal for most homeowners is to become mortgage-free as quickly as possible. One way to do this is by looking at shorter amortizations and more frequent payments. By making more frequent payments and applying more money toward the principal, you can save a significant amount in interest charges.

For example, consider a $500,000 mortgage with a 25-year amortization period at a 3% interest rate. With standard monthly payments, you would pay a total of $709,813 over the life of the mortgage (with $209,813 going toward interest). Switching to an accelerated bi-weekly payment schedule can reduce your amortization by several years, saving you as much as $25,858 in interest and allowing you to own your home outright much sooner. For illustration purposes only.

It’s best to speak to a mortgage expert to understand what options are available to you as everyone’s situation is unique.

Mortgage terminology

Mortgage jargon can be overwhelming, but familiarizing yourself with key terms will empower you to navigate the home-buying process confidently. Here’s a glossary of essential mortgage terminology that every homebuyer should know:

• Amortization schedule: A detailed chart that breaks down each mortgage payment by the amount distributed to the principal versus interest, highlighting how the balance decreases over time.

• Variable rate: An interest rate that can fluctuate with market conditions, affecting your mortgage payments accordingly.

• Fixed rate: An interest rate that stays the same throughout your mortgage term, offering consistent monthly payments.

• Open mortgage: A flexible mortgage choice that allows you to repay any portion of the principal at any time without incurring penalties.

• Closed mortgage: A more restrictive mortgage that typically offers lower rates but charges penalties for any prepayment above the agreed-upon limits.

• Prepayment penalty: A fee charged by the lender if you pay off your mortgage or make significant extra payments beyond the allowed limits before the end of your term.

• Mortgage term: The period during which your mortgage rate and terms are established. When this term ends, you’ll need to renew or renegotiate your mortgage term conditions.

• Amortization: The total length of time it will take to pay off your mortgage.

  
  

Conclusion

As you can see, choosing a mortgage is more than just a financial transaction, it’s a commitment that shapes your future. Take the time to educate yourself, consult with a mortgage expert, and consider your long-term goals. With the right knowledge and a clear strategy, you will be well on your way to making the best mortgage choice for you and your family!