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What is a mortgage?

7 min read

Barry Choi
#mortgage#home#loan#buying home
What is a mortgage?

Rounding it up

  • To qualify for a mortgage, aim to secure the following items: a good credit score, a down payment, and a steady job.

  • Get pre-approved to find out how much you can borrow for your mortgage.

  • When looking at mortgage rates, pay attention to the current interest rate, mortgage breaking fees, and mortgage brokers options.

  • Never rush the process of getting a mortgage. Educate yourself and use tools like an online mortgage calculator to see how various rates, terms, and payment options can affect your budget.

If you’re thinking about buying a home, there’s a good chance you want to learn more about mortgages. For most people, a mortgage will be the biggest loan they get in their lives, and it’ll take decades to repay. Since it’s a significant commitment, you need to ensure you understand how mortgages work, and what you’re getting yourself into.

So, what is a mortgage?

Simply put, a mortgage is a loan from a mortgage lender or a bank to help you buy a house or any other piece of real estate. It’s a written commitment in which the property you’re buying acts as your collateral—which means if you fail to repay your loan amount in the stipulated period of time, you can forfeit your property to the lender.

How do mortgages work?

Generally speaking, there are three factors that are essential to getting a mortgage:

  • A good credit score

  • A down payment

  • A steady job

How much mortgage you qualify for is dependent on all of the above, which is why you want to have all three in good standing.

How your credit score impacts your mortgage

Your credit score is a number that ranges between 300 and 900. The higher your credit score, the more creditworthy you are – aka your chances of being qualified for the best mortgage rates are higher. When applying for a mortgage, lenders will see where you stand. If you’re in the “good” to “excellent” range, you likely won’t have a problem getting approved for the best interest rates. However, if your score is lower, you may find it tough to qualify, or you may only be approved for a mortgage with a higher interest rate.

How much down payment you need to qualify for a mortgage

Down payment is the amount you pay to the buyer upfront when purchasing your home. To purchase a home in Canada, you need a down payment of at least 5%. For example, if you’re looking to buy a home that costs $500,000, you should have at least $25,000 saved to qualify for a mortgage.

Why a stable income is important when getting a mortgage

Mortgage providers look at your income and stability of employment as key factors when determining how much mortgage you qualify for. There are a number of things that go into the evaluation of your income—including your total household income, the duration of your current job, and whether you are a full-time, permanent employee, or a contractor.

How much mortgage can I qualify for?

Every situation is unique, but you can quickly figure out how much you can afford to borrow by looking at an online mortgage calculator or getting pre-approved. As a general reference, most experts advise borrowing no more than 5x your annual income.

What’s the difference between mortgage term and amortization?

Two major aspects of your mortgage are the mortgage term and amortization. If you’re new to mortgages, these phrases can be confusing as they both deal with time but have different meanings.

Mortgage term is the amount of time that you’re committing to your current mortgage rate selection. A mortgage term can typically be anywhere between 1 to 10 years, but the most common term is five years. It’s unlikely you’d be able to pay off the total balance during your mortgage term—that’s where your mortgage amortization period comes in. The mortgage amortization period refers to the length of time during which you will pay your entire mortgage. Most new homeowners get a mortgage amortization of 25 years. To simply put it, your mortgage amortization period is made up of multiple mortgage terms.

How do mortgage rates work?

When you talk about mortgage and mortgage rates, you’re referring to the rate of interest that you’ll pay on top of your principal amount. While rates do differ lender to lender, there are two types of mortgage rates when securing a mortgage:

  • Fixed mortgage

  • Variable mortgage

Playing it safe with fixed rates

In fixed-rate mortgages, your rate of interest stays the same throughout the term of your loan. This is an attractive option for many people since they’ll know exactly how much their mortgage will cost them each month. The downside of fixed mortgages though, is they are costlier to get out of—if the Bank of Canada lowers their prime rate and you want to explore other lender options, breaking out of your fixed-rate mortgage will be harder.

Potentially save more with a variable rate

Variable mortgages are quoted as Prime +/- a specific number, like “Prime - 0.25%.” As the prime rate set by Bank of Canada changes, so do the payments towards your mortgage. What makes this appealing is that at any given time, variable-rate mortgages are cheaper than fixed mortgages. In a stable or falling interest rate environment, variable rates will save you more money. However, if rates go up, so do your payments towards interest.

What else should I consider when getting a mortgage?

Going for the lowest rate possible is a good strategy, but it shouldn’t be your only concern. There are two other things you’ll want to consider when looking at your mortgage options.

Prepayments

Some lenders will allow you to make additional prepayments. For example, they may allow you to increase your payment options by up to another 25% or make a lump sum payment once a year of up to 25% of the total balance.

Fees if you break your mortgage

Many people don’t think they’ll ever need to break their mortgage, but a lot can happen during your five-year term. You might need to upsize or downsize due to a life event, you could relocate for work, or interest rates may have fallen. Since your mortgage is a contract, there are going to be fees that you need to pay for breaking it.

Mortgages with the lowest rates often have limited prepayment options and higher fees, and are often referred to as closed mortgages. In contrast, open mortgages give you a bit more flexibility.

How to choose the right mortgage

There’s no need to rush things. Take the time to educate yourself. If you’re actively on the hunt for a new home, start by getting pre-approved, so you know for what amount you’ll qualify for.

Low rates are always appealing, but be smart about your purchase price and don’t stretch out your budget. Use an online mortgage calculator so you can see how different rates, terms, and payment options will affect your monthly budget. By doing this, you can keep your options open!

Note: KOHO product information and/or features may have been updated since this blog post was published. Please refer to our Subscription Plans page for our most up to date account information!

Barry Choi

Barry Choi is a personal finance expert based in Toronto who makes frequent media appearances. His website Money We Have is one of Canada's most trusted sources for all things related to money and travel.

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