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How Does House Mortgage Work ?

How Does House Mortgage Work ?


David Doe

Published in

Real Estate

30 Dec 2021

A mortgage will almost certainly be required for anyone purchasing a home. How does a mortgage work in Canada, you might wonder ? Although it's a simple financial product, the various options and interest rates can be perplexing? You'll want to make sure you understand how mortgages work because buying a home is likely to be the most significant investment you'll ever make !

How Does a Mortgage Work ?

How Does a Mortgage Work ?

A mortgage is a loan that is solely to purchase a home. Most people won't pay for a home with cash, so they'll need a mortgage from a bank or a private lender to help pay the balance. You make payments on a set schedule once you've secured a mortgage. Each mortgage is unique, but there are some common elements that you should know and understand !

Interest Rates

When people think of mortgages, the interest rate is usually the first thing that comes to mind. The interest rate represents the cost of borrowing. As an example, suppose the current interest rate is 2%. That means for every $100 borrowed; you'd have to pay $2. Other factors come into play, so this is a simplified answer, but you get the idea. Borrowing, get a bigger loan. If interest rates rise, your monthly payments will increase as well, limiting the number of homes you can afford. The Bank of Canada's prime rate determines Lenders' interest rates !

Mortgages Categories

With mortgages, you have two choices: fixed and variable rates. A fixed-rate mortgage has an interest rate that stays the same throughout the term. You're essentially locking in your rate, ensuring that you'll know exactly how much you'll have to pay !

Variable-rate mortgages provide a discount (prime minus X percent), implying that you will pay less than current fixed rates. If interest rates fall, you'll be able to save even more money. If interest rates rise, however, you may end up paying more than you would with a fixed-rate mortgage. However, some lenders will let you convert a variable-rate mortgage to a fixed-rate mortgage, so you still have options !

Mortgages: Open and Closed

You must choose between closed and open mortgages besides fixed and variable rates. Most homeowners will choose a closed-term mortgage because it allows them to take advantage of lower interest rates. If you want to renegotiate your mortgage or pay off the balance before your term ends, you'll have to pay the penalty. Closed-rate mortgages may include prepayment privileges, allowing you to make extra payments without incurring penalties !

If you think you'll be able to pay off your mortgage soon, open rate mortgages are a good option. You can pay off your mortgage in whole or in part, incurring no fees. Another option is to convert your mortgage to a different term incurring no penalties. This increased flexibility comes at a price: higher interest rates !

Period & Term of Amortization

Because mortgages are typically large, they must be repaid over a long period. The amortization period is what it's called. Most new homeowners will receive a mortgage with a 25-year amortization period, but sometimes, a 30-year amortization period may be available. A longer amortization period lowers your monthly payments but raises the total amount of interest you'll pay over the life of the loan. You will reduce your amortization period for renewing your mortgage because you will have built up some equity !

The length of your mortgage contract with a lender is referred to as your mortgage term. The most common term length is five years, but it can be one to ten years. Longer times are usually more expensive, but the rate you get is guaranteed. The lower rates of a short term are appealing, but when your term is up, you'll have to renew at whatever the rates are !

The Frequency of Payments

You have several payment frequency options when setting up your mortgage which will determine how much and how often you pay;

Mortgage Payment Options:

  • Weekly: You make that pay weekly.
  • Once a month: Payments are made once a month !
  • Bi-weekly: Every other week, you make that payment !
  • Weekly payment acceleration: Your monthly payment is divided by four and paid every week !
  • Bi-weekly sped up payment: Your monthly payment is divided in half and paid every other week !

Many homeowners find that setting up a monthly or bi-weekly payment schedule helps them you'll be making extra payments. That means you'll be able to pay off your mortgage sooner !

Credentials For Mortgage Approval

Lenders are looking for three things when they apply for a mortgage. You should be approved as long as you have:

  • A good credit rating: Lenders want to know if you have a good credit history.
  • A deposit: To qualify for a mortgage, you must have saved at least 5% of the purchase price.
  • A steady source of income: Having a full-time job shows that you have a consistent source of income.

Even if you don't meet all the requirements, you may still apply. Some lenders will work with borrowers with a low credit score, but you have to pay a higher interest rate. Freelancers and low-income people can still get a mortgage, but they may need income proof or co-signer !

Limit on Borrowing For a Mortgage

For determining how much you can borrow, most lenders use two calculations:

  • GDS (Gross Debt Service): Ratio Your GDS comprises housing costs such as your mortgage, heat, condo fees, and property taxes. It shouldn't be over 32 per cent of your pre-tax income !
  • TDS (Total Debt Service): Ratio Your TDS is calculated by adding additional debt payments to your GDS, such as student loans and credit card debt. Lenders don't want you to spend over 40% of your pre-tax income on this loan !

While these ratios are a reasonable estimate, it's important to remember that when determining how much you want to borrow, you must also consider any other goals you may have. Retirement savings, vacations, and even the cost of having children must all be factored into your budget. If you take out a larger mortgage, you may find yourself stretched too thin when other expenses arise later !

Choosing a mortgage is a process that should not be rushed. To know how to do mortgage works, You must examine the various options and determine which lenders provide the best deals. You can seek advice from a mortgage specialist if you have additional questions. Alternatively, you could contact Guglu Homes for the best real estate services !

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