Your First Home. Kimberley Marr

an investment.

      1.5 Builder’s mortgage

      Occasionally, new home builders offer financing assistance as an incentive (and convenience) for buyers to purchase one of their new homes or condominiums. Builders may have an arrangement with a lender to buy down the prevailing interest rate or offer to lock in the interest rate until the home is built and you close (which could be several months to a few years in the future). For instance, assuming the current market interest rate is 5 percent, and the builder offers you a 3.5 or 2.9 percent rate, the builder would be paying the difference between the current rate and whatever rate is offered for the period of the term — this is what is meant by “buying down” the rate.

      While this may be an attractive and more affordable way to enter into home ownership, read the fine print and get legal advice. Some builders may add this extra amount they paid to buy down the rate to the sale price of the home. Often the term of the mortgage the builder offers is short (e.g., one or two years), after which the mortgage loan becomes due and payable and you will need to arrange your own mortgage elsewhere at current rates. If interest rates have increased, this could create an affordability or qualifying problem for you. Determine if you will qualify for the mortgage at an anticipated higher rate. Consider worst-case scenarios with interest rates and how they may affect you in the future. Understand in advance what your responsibilities will be, and ensure that you get appropriate legal advice before you agree to this type of mortgage.

      1.6 Closed mortgage

      With a closed mortgage, you are “locked in” for a specific amount of time (e.g., three, five, seven, or ten years). This is known as your term. You commit to the lender for a pre-defined period of time. It has the benefit of allowing you to feel comfortable knowing that your mortgage interest rate will not change during the locked-in term — meaning your monthly mortgage payments will stay the same during this time period. This helps for budgeting and cash-flow purposes.

      However, with a closed mortgage, unless you have a prepayment privilege included with your mortgage agreement, you may not have the option to prepay more than the predetermined amount of the principal balance before the expiration of the term without paying a penalty. If you decide to sell your home prior to the expiry of the term, this may cost you a considerable amount of money in penalties. It is imperative that you find out, negotiate, and understand your prepayment and discharge options in advance with the lender to minimize costly penalties in the future.

      Normally, a lower interest rate is associated with a closed mortgage, and it is possible to obtain prepayment privileges and early discharge terms (often limited to three months’ interest penalty) with a closed mortgage. Make sure that you understand in advance what your terms and conditions will be with a closed mortgage. It is very important to know if a prepayment penalty exists (it usually does) and the amount the penalty will be before you agree to the mortgage; otherwise, this could be a very costly surprise. Ask and get the answer in writing! Consult with your lawyer prior to committing to any mortgage.

      1.7 Open mortgage

      Generally, an open mortgage is the opposite of a closed mortgage in that it has no prepayment penalty and is normally more flexible. Usually open mortgages are for shorter terms (e.g., six months, one or two years), and they usually come with higher interest rates because the lender is aware that you may pay back the loan early. Many lenders let you convert an open mortgage to a closed mortgage at some point in the future, although you may have to pay a fee to do so.

      1.8 Fixed rate mortgage

      A fixed rate mortgage has a preset interest rate that remains the same for the entire term. You have the comfort of knowing that each month you will make the same mortgage payment. Usually the amount of your payment goes toward both reducing the outstanding principal debt as well as interest and is decided at the outset of the mortgage. Over time, the allocation of what is attributed towards principal (versus interest) changes as more goes towards principal reduction. Keep in mind that most mortgages are front-loaded with interest at the beginning. (More about this and how to pay off a mortgage sooner in Chapter 3).

      1.9 Variable or adjustable rate mortgage

      The variable or adjustable rate mortgage is a little trickier. The Bank of Canada sets its overnight rate (i.e., the rate it lends to the banks) and the banks then add their spread and that ends up as the prime rate. When the Bank of Canada increases or decreases the rate that it lends, the banks usually follow suit with their prime rate, which in turn impacts variable rate mortgages. It is important to understand that not all banks or lenders use the term “prime rate” for their mortgages; some use terms such as “base rate” or “mortgage prime rate” which could have different definitions. Check the standard charge terms for the lender to determine if they actually use the terms the way you expect. Depending on the terms of the mortgage, this could affect you in a couple of ways:

      1. The monthly amount you pay could change when the interest rate changes, making it more difficult to budget your monthly cash flow should rates increase.

      2. The monthly mortgage amount remains fixed (does not change), but the percentage attributed towards interest and principal repayment changes. For example, if the interest rate increases, this reduces the amount you pay off each month toward the outstanding principal debt as more of your payment is applied to interest and less towards principal. What this also means is that your amortization period changes — it goes up, meaning it will take you longer to pay off the mortgage. However, if interest rates fall, this has a positive effect as the amount attributed to principal reduction is increased and the amortization period is shortened.

      The major difference between fixed and variable or adjustable rate mortgages is the risk factor. You will need to consider whether or not you are more comfortable with a fixed monthly or biweekly payment. Or, whether or not you should take the risk of a variable or adjustable rate that may save you money, but may also cost you more money if rates rise. Normally, the interest rate for a variable rate mortgage is slightly lower.

      Consideration needs to be given to where interest rates are at the time of this book’s printing because they are at affordable, low levels. Will interest rates drop much in the future? Who knows what will occur with rates. Conservative buyers often choose a fixed rate mortgage at these low-rate levels because they want the security and comfort of knowing that their monthly or biweekly mortgage payments will be the same over the term of their mortgage.

      If you choose a variable rate mortgage, consider being qualified or approved for the higher fixed rate, just in case rates increase because you don’t want to be “house poor.” In other words, you don’t want to be in a situation where you are short of cash for discretionary items or have trouble meeting other financial obligations such as vehicle payments or credit card bills due to the fact that too large a portion of your income is being spent on home-related expenses (mortgage, property taxes, maintenance, and utilities).

      Some lenders make it mandatory that you qualify for a higher fixed rate term. Be careful and budget conservatively in anticipation of a potential interest rate increase. Speak with a mortgage professional for the details and qualifying rules related to your situation.

      1.10 Convertible mortgage

      A convertible mortgage is a variable-rate or short-term (e.g., 6 to 12 months) fixed-rate mortgage that can be converted to a longer term fixed-rate mortgage (e.g., three, five, seven, or ten years) at any time during the term. If you would like to take advantage of lower rates on short-term or variable mortgages but feel that interest rates may rise, the convertible mortgage offers you the ability of being able to convert to a longer term fixed-rate mortgage. Usually these are closed mortgages as opposed to open mortgages. Again, be mindful of the difference in the mortgage payment when you convert, and budget accordingly.

      Plan ahead and be prepared. Speak with your mortgage professional and ideally your lawyer to understand the terms, conditions, restrictions,