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Mortgage-related terms you should know

03 November 2018 by National Bank
mortgage explained

The jargon related to the purchase of a property can sometimes be confusing for a new buyer. Here are a few terms explained to help you familiarize yourself with the language.

It’s happening: you’re buying your first home. But before it’s all finalized, you’ll have to go through a number of steps and will discover – doubtless for the first time –a whole new vocabulary. Here are a few of the terms and concepts you’ll come up against.

Mortgage loan

Also known simply as a mortgage, a mortgage loan is generally issued to allow individuals or companies to buy property.

Unless they’re paying for a new home in cash, most buyers need to take out a mortgage loan. This consists of a loan from a financial institution for the purchase of a property. The borrower is required to repay the loan according to a predetermined schedule.

Loan guarantee

The property purchased with help from a mortgage becomes the loan guarantee. In the case of residential mortgages, the bank grants a mortgage in exchange for a guarantee that it will be able to take possession of the house if you aren’t able to respect your commitments. If a homeowner fails to make their mortgage payments, the bank can evict them from the house and resell it to pay off the debt.

Down payment

The down payment constitutes a percentage of the sale price that the buyer pays, out of their savings, to secure their new property. The amount must be at least 5% of the purchase price. That’s more or less the amount of money you’ll need to save before you start planning a housewarming party.

Mortgage insurance

This is a type of insurance that the financial institution issuing the mortgage is required to take out if the borrower has a down payment of less than 20% of the price of the property. According to the Bank Act, credit establishments and financial institutions are required to subscribe to this insurance, which is issued by the Canada Mortgage and Housing Corporation (CMHC) as well as a few private lenders to secure the loan.

Amortization period

A mortgage can generally be repaid over a period of several years. In the case of a residential property, this period usually spans between 15 and 25 years.

The type of mortgage you have access to depends on several factors, including your credit history, the amount of your down payment and certain personal preferences. Other factors must also be taken into consideration, including the size of the loan requested, its term and the method of repayment.

In concrete terms, the longer the amortization period, the less daunting your monthly payments will be, but the longer you’ll be paying down your house.

Mortgage interest rate

This is the percentage that determines the amount of interest you will be charged. This is calculated based on the amount borrowed and is added to your mortgage payments. The interest rate may also vary depending on the type of mortgage you’ve taken, the duration of the term and the Bank of Canada prime rate. There are many types of mortgages, but the main ones are fixed rate and variable rate.

Fixed-rate mortgage

In the case of a fixed-rate mortgage, the interest rate is fixed for the entire term of the loan and doesn’t fluctuate with the economy. In other words, the borrower pays the same interest rate for the duration of the term, without any change in the amounts that go to repay the principal and the interest. It’s a guarantee of stability every month.

Variable-rate mortgage

On the other end of the spectrum, a variable-rate mortgage generally starts off with a low interest rate, often lower than the fixed-rates on the market. Lower interest can represent significant savings for borrowers at the outset of the loan term. However, after a brief initial period where the rate is fixed, the interest rate of a variable-rate mortgage will rise or fall based on market rates. This can make it more difficult to make payments even though these rates initially allowed you to save money.

Open or closed mortgages

An open mortgage allows the holder to repay their mortgage faster, to add lump-sum amounts to their repayment, to renegotiate their mortgage or to terminate their mortgage contract before the end of the agreed term without penalty. However, the interest rates on open mortgages are usually higher.

As for closed mortgages, they usually offer better interest rates than open mortgages. However, terminating the mortgage contract before the end of the agreed term can carry penalties for the borrower. Additionally, even though it’s possible to make advance payments, these are limited by a ceiling set by the institution that issued the loan.

Pre-approved mortgage certificate

Once their offer to purchase has been accepted, the buyer generally needs to meet a number of conditions. This sets into motion a race against the clock that lasts several days, and generally includes a home inspection plus pulling together the various conditions of the offer.

Among these, you’ll have to provide proof to the seller that you have the funds or necessary borrowing power to buy the property (obtaining financing), which is where the pre-approved mortgage certificate comes in. Moreover, this document contains the requirements the buyer must satisfy to get final approval on their mortgage. The certificate is issued by the financial institution that will issue the loan.

Life insurance for a mortgage

This is a type of insurance that covers the mortgage in case of the borrower’s death. This way, beneficiaries inherit a property with a mortgage that has already been paid. Several financial institutions as well as various private companies offer this type of insurance. When financial institutions issue life insurance for mortgages, they generally add the premiums to the regular mortgage payments.

This is a good time to look at the different insurance solutions you might want to take advantage of, and evaluate your level of risk.

Disability or critical illness insurance for a mortgage

Just like with life insurance for mortgages, disability insurance for mortgages is designed to protect the borrower. In case of an accident or illness that leads to disability, mortgage payments would be covered by your insurance, once the waiting period is over. Depending on the insurer, the duration of the waiting period can be predetermined, or set by the insured person at the time they take out the policy. This type of insurance is also offered by financial institutions and private companies.

As for critical illness insurance for mortgages, it covers three severe medical conditions: heart attack, stroke and most cancers once are considered life-threatening, in other words when they are not at an early stage (for example stage I). This type of insurance allows you to concentrate on healing without worrying about racking up more debt.

In summary, disability insurance for mortgages has the effect of replacing part of your income while you aren’t working, while critical illness insurance guarantees the payment of a significant sum of money when you need it most.

Now that you’ve mastered the vocabulary, you can embark on your project of buying a home with confidence.

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