Sep 10, 2020
Mortgages 101 – (Almost) Everything you've ever wanted to know about mortgages
For most Canadians, buying a home is the single biggest purchase they will ever make.
And while the excitement and anticipation of finding your dream home can be exhilarating, those feelings can sometimes give way to stress and confusion when it comes time to apply for a mortgage.
Whether you're a first-time homebuyer or are looking for a new place to call home, it's important to understand the terms of a mortgage agreement and how the mortgage process works.
To help you get started, here's a breakdown of the process along with some of the key terms you should know.
Let's start with the basics
No matter where you are in the homeowners' journey, there are important terms you should know during the mortgage financing process.
Let's start with a few common terms: mortgage, down payment, amortization period, and term.
A mortgage loan is a loan from a lender (e.g. a bank), secured by real estate. Home owners pay back the money borrowed over a set period of time, plus interest.
A down payment is the initial up-front payment you put towards the price of your home. The remainder of what you don’t put "down" is the amount you are borrowing from a lender (i.e., your mortgage). For more information, check out this story on the TD Newsroom.
Once you have a sense of what your mortgage and down payment amounts will be, it's important to know the difference between the amortization period and the term, as these are related but distinct.
The amortization period is the number of years it will take to pay off your mortgage loan completely, assuming the interest rate and payment amount stays the same. This period is agreed upon between you and your lender.
At TD, if your down payment is less than 20%, your maximum amortization period is 25 years. If your down payment is greater than 20%, you could have an amortization period of up to 30 years.
The amortization period you select also impacts the amount of your mortgage payment, and the total amount of interest you will pay. Generally, the shorter your amortization period, the higher your payments will be. However, because you are making fewer payments overall, you wind up paying lower total interest.
Some mortgages also enable you to speed up or slow down your payment frequency. More frequent principal and interest payments will mean you are paying your mortgage off faster. At TD, you can also increase your principal and interest payments once per calendar year by up to 100% of your regular principal and interest payment.
The mortgage term is the length of time you're committed to your mortgage interest rate, lender, and associated conditions. At TD, mortgage terms range from six months to 10 years, with five years being the most common option. Once your term is up, you may be able to renew your mortgage loan with a new term and rate or pay off the remaining balance.
What are the differences between fixed and variable interest rates?
Another important step in the homeowners' journey is deciding what type of interest rate works best for you.
One of the key decisions you'll need to make is whether to go with a fixed rate or variable rate. When deciding between a fixed or variable rate, you'll need to decide which one works for your lifestyle and how comfortable you are with the fact that your interest rate could change during the term of your mortgage.
A fixed interest rate means the interest rate is "fixed" for the mortgage term. Your rate won't change during the term, and neither will the amount of your principal and interest payments. If you're a first-time homebuyer and are looking to know exactly how much to budget for your mortgage payment for the duration of your mortgage term, a fixed rate mortgage could be a good option.
With a variable interest rate, the interest rate can fluctuate. At TD, your principal and interest payments will stay the same for the term, but if the TD Mortgage Prime Rate goes down, more of your payment will go towards the principal. If the TD Mortgage Prime Rate goes up, more will go towards interest.
When interest rates increase, the principal and interest amount may no longer cover the interest charged on the mortgage. The interest rate this occurs at is called the Trigger Rate.
Variable interest rate mortgages can exceed their trigger rate until they reach what is known as a balance called the Trigger Point. When this happens, you will be required to adjust your payments, make a prepayment, or pay off the balance of the mortgage.
What are the different types of prepayment options?
Another important decision is whether to go with an open or closed to prepayment term. TD offers both, which offer different benefits that meet different customer needs.
The major difference between open and closed terms is the ability to make extra mortgage payments or payout your mortgage, which can reduce your amortization and can result in you paying less interest over the course of your mortgage term.
Open to prepayment mortgages are typically best suited to customers who want the flexibility of being able to prepay any amount of their outstanding balance at any time without worrying about prepayment charges. However, open mortgages may have a higher interest rate because of the added prepayment flexibility.
On the flip side, closed to prepayment mortgages can give you the option to make a maximum lump sum payment each year. At TD, that number can be up to 15% of the original principal amount each calendar year. If you want to prepay more than 15%, a prepayment charge may apply. A closed mortgage typically has a lower rate than an open mortgage for the same term.
If you decide to pay out or "break" your mortgage early, you may be subject to a prepayment charge. A prepayment charge for a closed to prepayment mortgage with a variable interest rate is calculated as three months of interest. We calculate the interest you would owe over 90 days on the amount being prepaid, using your annual interest rate. The result is the three months of interest amount that you will have to pay.
The prepayment charge for a closed mortgage with a fixed interest rate is the higher of two amounts:
- Three months interest, OR
- The Interest Rate Differential, aka the IRD, which is the difference between the principal amount you owe at the time of the prepayment and the principal amount you would owe using a similar mortgage rate. The similar mortgage rate is the posted interest rate for a similar mortgage, minus any rate discount you received. To calculate your estimated IRD, please consult the TD Mortgage Prepayment Calculator.
To learn more about fixed vs. variable interest rates and open vs. closed to prepayment terms, visit td.com.
When should I apply for a mortgage, and how do I get started?
Once you know the mortgage basics, have saved for your down payment, and found out how much you can afford, you may be ready to proceed to the next step of your homeowners' journey – getting a mortgage pre-approval.
Some lenders offer both mortgage pre-qualifications and pre-approvals, and it's important to understand that the two terms are not the same. You can learn more about the differences between a pre-qualification and pre-approval here.
Most often, homebuyers will seek mortgage pre-approval with their preferred lender during the homeowners' journey when they are about to begin house hunting. TD conveniently offers a mortgage pre-approval application online which can be completed in as little as five minutes, and once approved, can offer a bit of peace of mind while you search for your new home.
At TD, a mortgage pre-approval:
- Allows you to lock in the term and interest rate for 120 days (subject to conditions). This means your rate is protected if rates increase while you're shopping for a home. On the flip side, if interest rates go down, you can ask for an adjustment to the lower rate and restart your 120-day hold without completing a new application.
- Is free of charge and with no obligation to apply for the full pre-approved amount or for a mortgage with TD.
- Can help you shop for a home with more confidence knowing that you're making an informed financial decision.
If I get pre-approved for a mortgage, then what?
Once you've applied and had your pre-approval application approved, you'll receive a certificate, which can help you and your real estate agent find a suitable home that fits within your budget and estimated mortgage loan. You should still make it a condition on your offer to purchase that you need to confirm financing. The mortgage pre-approval has conditions on it that need to be met, which will be completed through a full application.
Already have a mortgage with TD but looking to renew or refinance? Book a meeting with your TD Mortgage Specialist to determine what the best approach is for you.