Features You Want to See In Your Mortgage Contract for 2018
In previous articles, we’ve discussed the ways you can save for a down payment, get approved for a mortgage, and remain financially stable in the years that follow. We’ve also brought up the new Canadian mortgage rules and how they’ll affect a lot of potential homeowners’ abilities to get approved in 2018. Well, with all that knowledge under your belt, it’s time to start thinking about the next step, what comes after your approval.
It’s no secret that mortgaging a home is not an easy or inexpensive task. Therefore, it’s essential that your lender provides you with the best, most clear, and concise mortgage contract they can draw up. Being that a mortgage is one of, if not the, priciest endeavour you’ll undertake in your lifetime, reading the fine print has never been more important.
Still trying to successfully shop for a mortgage? Read this.
What is a Mortgage Contract?
Almost all financial transactions come with a contractual obligation that you, as the consumer or borrower, must fulfill. When you apply for a credit card, for instance, you’ll sign a contract wherein you’ll agree to certain terms pertaining to the payment schedule, interest rate, penalties for defaulting, etc. A mortgage contract is not so different, in that you’ll also be agreeing to a list of terms and policies related to the eventual purchase of the home in question. However, being that the situation revolves around hundreds of thousands of dollars, mortgages contracts definitely require a lot more paperwork. It’s extremely important to study your own contract thoroughly and understand every feature involved. The consequences of breaking a mortgage contract could certainly be worse than a slap on the wrist.
So, once you’ve gone through the pre-approval process, completed the OSFI Stress-Test and have been approved for the loan amount and interest rate you’ve negotiated, it’s time to discuss the mortgage contract. Keep in mind here that every lender’s process will vary in the way they go about drawing up their contracts. However, the overall principle of the matter is the same. Together, you and your lender are going to work out a way for you to pay your mortgage in installments, over the course of a predetermined amortization period.
Some notable features in a typical mortgage contract include:
- Mortgage type (open or closed, conventional, or high ratio, etc.)
- Amortization period (total number of months until payment is complete)
- Mortgage term (short-term, long-term, or convertible-term)
- Interest rate (variable or fixed)
- Payment frequency (monthly, semi-monthly, weekly, or bi-weekly)
- Accelerated payment options
- Mortgage security registration
- Portable or assumable mortgage options
- Cash-back option
- Title Insurance (lender or homeowner title)
Any of these features can affect how much you’ll pay throughout your total amortization period. Therefore, it’s best to read each section carefully and discuss it with your lender before you actually sign anything.
Strictly speaking, there are two styles of mortgages when it comes to the down payment:
Means the homeowner is making a downpayment of 20% or more of the home’s value and therefore doesn’t require default mortgage insurance. The down payment is more expensive, but the amortization period will be shorter.
Means the homeowner is making a down payment of less than 20% of the home’s value and therefore needs to purchase default mortgage insurance. The down payment is cheaper, but the amortization ends up being longer.
When it comes to the payment plan, which includes the interest rate and the option for pre-payments (extra payments to pay the total mortgage quicker), there are also two different mortgage types:
This type of mortgage allows the homeowner more flexibility for their payment schedule. While interest rates will generally be higher with an open mortgage, this feature allows the homeowner to make extra payments, in addition to their regular ones.
As a result, the homeowner can:
- Pay off their mortgage before the end of their term.
- Renegotiate their mortgage before the end of their term.
- Break their contract in order to switch lenders before the end of their term.
- Reduce their amortization, potentially saving them money.
- They can do all of this without any prepayment penalty fees.
This is a better option if the homeowner is:
- Planning to sell and change homes in the near future.
- Paying their mortgage sooner using extra money and lump-sum payments.
Limit the amount of extra money the homeowner is permitted to add to their mortgage payments. This is known as the “prepayment privilege”. While most closed mortgages don’t allow extra payments, meaning the amortization period is non-adjustable once the contract is signed, the interest rates are often lower than those of an open mortgage.
As a result, the homeowner is charged a prepayment penalty if they:
- Make extra or lump-sum payments.
- Break their contract.
However, this is a better option if:
- The homeowner remains in their home for the duration of their amortization.
- Their prepayment privileges provide enough flexibility for the prepayments they decide to make.
Want to know how much you should expect to pay for a house in your city? Check out this infographic.
The amortization period is the time you, as the homeowner, have to pay the full mortgage amount. The longer your amortization is, the lower your regular mortgage payments will be. While these smaller payments can be financially beneficial to some, keep in mind that the longer your amortization is, the more you’ll end up paying in interest over time.
In Canada, homeowners have a maximum amortization period of:
- 25-years for a high-ratio mortgage.
- 35-years for a conventional mortgage.
The mortgage term refers to the time when the mortgage contract will officially be in effect, which includes the current interest rate, policies, and outlines. Mortgage term segments generally range from several months to five years, although longer terms are possible, depending on the lender’s specifications. At the end of each term, the homeowner needs to renew their contract or contemplate switching lenders for various reasons (more favorable interest rates, etc.). Depending on the policies of your own mortgage contract, you may have to pay a penalty to switch lenders, renegotiate your contract or pay off your mortgage before your term is over. So, before you decide how long your term should be, it’s best to consider all possibilities, like if you ever plan on moving or negotiating a longer payment period.
Means you’ll be able to renegotiate your contract or switch lenders within a shorter amount of time, without having to pay any extra fees. This is a better choice if you predict a drop in interest rates or if you plan to move/change mortgages soon. The downside here is that, if interest rates go up, you may have to renegotiate at a higher interest rate.
Means that you may be able to lock-in a favorable interest rate for a longer period of time, saving you money and helping you budget according to your strengthened knowledge of your typical housing costs. The downside is that you may be charged a prepayment penalty if you make any changes to your contract before your term is up. However, if your term is longer than five years and you wish to make changes, some lenders charge a lower prepayment penalty after the five-year mark has passed.
Here, homeowners are able to extend their short-term to a longer one. After they’ve converted or extended their term, they’ll qualify at the interest rate that their lender is offering for that longer term, which can end up being lower.
For more differences between a mortgage term and an amortization, read this.
The interest rate refers to how much you’ll pay the lender for their services and the money you’re borrowing, on top of your regular payments. There are two types of rates that you can choose.
Are often higher than variable rates. However, because they’re “fixed”, they don’t fluctuate over the course of the mortgage term. Since you’ll have the same rate throughout your mortgage, you’ll have a better idea of what you’ll pay overall. A fixed-rate can also be better if general interest rates are predicted to rise in the near future.
Fluctuate throughout the mortgage term, according to the market prime rate, which can sometimes be lower than most fixed-rates. If interest rates drop, you could save some money. However, if they rise, the opposite will occur.
Want to know how to deal with rising interest rates in Canada? Click here.
Fixed Payments with a Variable-Rate
Here, if the prime rate goes up, a larger portion of your regular mortgage payments will go towards the interest, rather than the principal. However, if the prime rate drops, a larger portion will go towards the principal, meaning you’ll have a shorter amortization. If the prime rate reaches a certain level, otherwise known as a “trigger point”, your lender might increase your payments, which likely means that you’ll pay off your mortgage within the allotted timeframe.
Adjustable Payments with a Variable-Rate
Here, your payments will fluctuate along with the prime rate, with a set amount going towards the principal and the interest portion varying according to the current rates. This way, you’ll know in advance how much of the principle will be paid off by the end of your term.
There are six mortgage payment frequency options you can choose from, four regular types and two optional, accelerated types. Make sure to consider how each will affect your finances before you choose.
- Monthly – 1 payment per month (usually on the 1st of every month), for a total of 12 payments yearly.
- Semi-Monthly – 2 payments per month, total of 24 payments yearly
- Bi-Weekly – 1 payment every 2-weeks, for a total of 26 payments yearly.
- Weekly – 1 payment per week, for a total of 52 payments yearly.
With semi-monthly, bi-weekly, and weekly payments, you’ll end up paying the same amount in principal as you would with monthly payments.
- Accelerated Bi-Weekly – 1 payment equal to 50% of the monthly payment, made once per two weeks.
- Accelerated Weekly – 1 payment equal to 25% of the monthly payment, made once per week.
With each accelerated payment option, you’ll make one extra month’s worth of payments towards the principal every year.
Security Registration for Your Mortgage
All lenders apply a “charge” for the possibility of their borrowers defaulting. It’s set in place so that the lender can sell the house, if and when the borrower does not honor their payment schedule. There are two types of charge, both of which will be “discharged” once the borrower pays their mortgage in full. Make sure to talk to your lender about their charge policies, as certain lenders use only one of two possible types and some costs may be associated with the discharging process.
The Standard Charge
Is only secured against the mortgage loan detailed within the document and not against any other loans the borrower has with their lender (lines of credit, etc.). The charge is registered for the mortgage amount.
The Collateral Charge
Is used to secure more than one type of loan with a lender, including lines of credit and mortgages. With a collateral charge, it’s possible to register for a higher amount than the mortgage loan itself. In turn, this helps the potential homeowner borrow additional money in the future, on top of their original mortgage, without needing to pay fees for discharging their mortgage or for registering a new one.
Portable or Assumable Mortgages
These types of options are often made available for those who plan on selling their home or moving before their amortization is over.
Allow homeowners the option of transferring their mortgage from their existing home to a new one, if and when they sell. This way, the homeowner can remain with their current lender, transfer their remaining balance and receive the same interest rate, terms, and conditions. This option is also appealing because homeowners won’t have to pay the prepayment penalties normally associated with breaking their mortgage contract early.
Allow homeowners to take possession of or “assume” another homeowner’s existing mortgage, and vice versa. This is a favorable option if current interest rates have risen since the mortgage was initially approved. It’s also a good option for anyone who’s downsizing to a less costly dwelling but wants to avoid the prepayment penalty for breaking their contract before their term ends. While the majority of fixed-rate mortgages have the assumable option, this is not possible when it comes to either variable-rate mortgages or home equity lines of credit.
Another feature in some contracts, the cash-back option grants you a portion of the total mortgage amount, as soon as you’re approved, in cash. With this extra cash, you can buy furniture or deal with any legal fees associated with the mortgage itself. However, if you select this option, you’ll likely pay a higher interest rate, which could cost you more in the long run. Also, if you decide to renegotiate, transfer, renew or terminate your current mortgage contract in any way, the cash-back money will have to be returned in full before the end of your term.
Insurance for the Home’s Title
A home’s “title” is a legal term used to determine who actually possesses the property that the house is built on. Once you purchase a home and the title is re-signed in your name, as part of your mortgage contract, your lender may require you to purchase title insurance, which is a one-time expense or “premium”. You can get title insurance from a lawyer, mortgage broker, insurance agent, or title insurance company. This policy is set up to protect you and your lender from various losses, such as problems with the survey, fraud and other issues involving the property’s title, and provocations toward the property’s ownership.
Currently, there are two kinds of title insurance:
- Lender’s Title Insurance – is established to give the lender some protection until the mortgage is paid in full.
- Homeowner’s Title Insurance – is established to protect you from certain losses for the time that the title is in your name, even if your mortgage is paid in full.
Reviewing Your Contract For Errors
As we said, one of the most important things you can do before signing a mortgage contract is to read it through carefully. Unfortunately, some lenders have been known to make small, but critical errors within their contracts, ones that could cost you hundreds, if not thousands of dollars extra, if not corrected. This is especially true if the lender accidentally lists the wrong interest rate. A simple mistaken rate of 2.99%, instead of 2.49%, could shoot your regular payments through the roof. The problem with a legally binding mortgage contract is, after it’s signed, the homeowner will be charged a penalty fee for every correction that needs to be made, before the contract is up for renewal, that is.
Always make sure to check that all the mortgage rates and terms are accurate. Some of the features that need to be examined properly include, but aren’t limited to your:
- Annual interest rate
- Regular payment amount (blended principal and interest)
- Estimated Property Tax Amount (added to your regular payment)
- Payment date and frequency
- Advance date (the day you first receive your loan money and the payment schedule begins)
Planned renovations are an area where a lot of borrowers fail to realize the consequences of inaccurate information. In this case, however, these inaccuracies are often the fault of the borrower. Many people end up voiding their insurance policies when they don’t inform their insurance provider of the renovations they have planned. Then, once they have no insurance, their lender might even retract their loan.
It’s also very important to make sure your contract discloses all the possible fees and penalties associated with the mortgage itself. Here are some common fees that borrowers fail to take into account:
- Administrative fees (to open and close the mortgage loan)
- Amortization schedule
- Amortization adjustment
- Mortgage statement
- Payment deferral
- Payment change
Many of these fees apply to errors that go uncorrected, requiring the contract to be modified. For example, the “payment change” fee applies after a lender makes an error when calculating the borrower’s regular payments. If the borrower signs their contract and only notices later, they could be charged around $50 to have it corrected. If the mortgage loan arrives, but the borrower doesn’t have a valid home insurance policy, they may be charged a $200 fine each month until said policy arrives. While most contracts feature a customer complaint information section, it’s best to expect that any errors that need to be corrected after the contract is signed will be subject to a charge.
The Features You Want Are The Features You Need
All these mortgage policies and conditions are essential to a proper mortgage contract and you definitely want to see them featured here. In other words, if your mortgage contract isn’t very detailed and doesn’t require a lot of attention, it’s a sign that something is wrong and you may not be getting the deal you were hoping for. So, before you go signing any dotted lines, it’s always a good idea to have the contract inspected by a professional, such as a real estate lawyer. Remember, simpler doesn’t always mean better.