Homewise is changing the way Canadians shop for and choose their mortgages by making the application process more approachable.
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How Our Mortgage Calculator Can Help You Plan For The Future
When you apply for a mortgage, your mortgage payments will be based on a lot more than just your loan amount and the interest rate. There are so many factors involved in coming up with exact mortgage payment amounts that it can be extremely challenging to figure it out manually.
That’s exactly why we’ve created this mortgage calculator, to help you determine exactly how much you can expect to pay in monthly mortgage payments, overall interest throughout the life of the loan, and the total loan amount owed when all is said and done. Just plug in a couple of numbers to get the answer you need to help make sure you’re ready to become a homeowner.
But in addition to our mortgage calculator, let’s go over important factors that affect your mortgage.
How To Determine Mortgage Affordability
In order to determine how much you can afford in terms of a mortgage, you’ll need to factor in a number of components, including the following:
- Annual household income (before taxes)
- Down payment amount
- Mortgage interest rate
- Current monthly expenses
Your income obviously plays a key role in how much house you can afford, but there are so many other factors that can determine whether or not you can afford a certain house at a certain price. Your debt load will take away from your income, for example, while a large down payment can allow you to potentially take out a larger loan.
Of course, the interest rate will also factor into the equation and will determine how affordable your mortgage will be. Even a fraction of a point can mean the difference between thousands of dollars over the life of the mortgage.
If you’re in the process of applying for a mortgage, avoid these common application mistakes.
Mortgage Term vs. Amortization Period
It’s common for homebuyers to confuse the mortgage ‘term’ and ‘amortization’. But in fact, they’re completely different.
Term – The mortgage term is the amount of time that you are committed to your current mortgage contract with your lender. You’re also committed to the current interest rate and terms of the mortgage during that time period until the term ends. Typical mortgage term lengths are usually five years, though they can be shorter or longer depending on the deal you strike with your lender when you first take out your mortgage.
Once the mortgage term expires, you will either need to have paid off your entire loan amount in full, refinance your mortgage, or renew your mortgage, either with your current lender or a new one. Usually, your new term will have a different interest rate and conditions.
Amortization – The mortgage amortization period is the entire length of time that you have to pay off your mortgage amount in full. In Canada, the maximum amortization period allowed is 25 years, though uninsured mortgages may go as long as 30 years. An uninsured mortgage simply means that at least a 20% down payment was put forth, allowing the borrower to avoid having to pay mortgage default insurance, which we’ll discuss later.
That said, there are also shorter amortization periods given, such as 15 or 20 years. A shorter amortization period means that the entire loan amount must be fully repaid within a shorter time frame. This can be advantageous because it means the borrower will be mortgage-free sooner rather than later.
It also means the total amount paid for the loan will be much less because less interest will have to be paid over the life of the loan. However, the monthly mortgage payments will be higher in order to pay off the loan faster.
A longer amortization period is usually more common among Canadian buyers because they’re more affordable in terms of monthly mortgage payments that are easier to budget for. However, the downfall here is that more interest will be paid over the life of the mortgage. Further, the mortgage will take longer to pay off, which means mortgage payments will be part of the borrower’s debt for longer.
For a more detailed looked at the difference between a term and an amortization period, click here.
How Do Mortgage Lenders Determine Their Interest Rates?
Mortgage lenders obviously are out to make money on mortgages. It’s why they’re in the business and it’s how they make their money. In order to make a profit, they charge interest on the loan amount. But how exactly do they come up with the rates they charge?
It usually comes down to two things: the prime rate/bond market, and your level of risk as perceived by the lender.
Bond market – Chartered banks use the bond market to determine their mortgage rates. Government of Canada bonds and mortgages are two investments that lenders use to make a profit. Essentially, lenders calculate the interest rates on the money they loan out through mortgages based on the interest rates that they are getting on the capital they have invested.
They then use any anticipated profits from bond investments in order to make sure they’re able to cover the costs or any losses they experience through loaning money through mortgages. If the bond market is more profitable, the mortgage interest rates will be lower, and vice versa.
It should be noted, however, that the bond market affects fixed-rate mortgages. Variable-rate mortgages, on the other hand, are affected by fluctuations in the Bank Rate and overnight rate, which the Bank of Canada sets. Mortgage lenders use the overnight rate to calculate their own prime rate (for more information about prime rate, click here). There’s a direct correlation between the overnight rate and the mortgage interest rate on variable-rate mortgages since the majority of these types of mortgages change along with a lender’s prime rate.
Your risk level – Your lender will assess your risk level before they even agree to loan you funds to buy a home. If you are approved, your risk level will play a key role in the interest rate you’re offered. If you’re low-risk, your rate will likely be lower. But your rate will be higher if you’re considered higher risk.
So, how does your lender determine what risk level you’re at? There are a couple of things:
Your credit score – Your payment history and financial background play a role in your credit score. A higher score paints the picture of a responsible borrower who is diligent with their money, while a lower score says the opposite. The higher your score is, the lower your interest rate will likely be, and vice versa.
Loan-to-value ratio (LTV) – Your LTV is a measure of the loan amount relative to the value of the home you plan to buy. So, if you’re buying a home for $500,000 and you require a loan of $400,000 (after putting down $100,000), your LTV would be 80% ($400,000 divided by $500,000).
A lower LTV will give you more equity in the home and would make you a lower risk for the lender, thereby helping to lower the interest rate you’re offered.
For even more information about loan-to-value ratios, check out this article.
Mortgage Default Insurance 101
There are plenty of things in life that require insurance, and that includes mortgages in many cases. So, how do you know when and if you will need to contribute to a mortgage default insurance policy?
As mentioned earlier, borrowers who are unable to come up with a 20% down payment will be required to pay mortgage default insurance. Also referred to CMHC insurance, this type of policy is paid for by the borrower but is designed to protect the lender in case the borrower ever defaults.
With a smaller down payment comes a higher loan amount, or LTV. That means there’s less equity in the home which also means that the borrower – and the mortgage itself – is riskier. To offset this risk, lenders charge mortgage default insurance premiums to cover them in the event of mortgage default.
In Canada, there are three major mortgage default insurers: CMHC (Canada Mortgage and Housing Corporation, Genworth Financial, and Canada Guaranty. The insurance provider involved will calculate the premium based as a percentage of the loan amount. This percentage is based on the LTV ratio of the mortgage and the premium is either paid upfront in one lump sum or rolled into the mortgage.
Interested in Applying For a Loan?
Mortgages are typically a required part of the buying process, but it’s important to choose the right mortgage product and lender wisely, as it is a huge financial commitment. To help you navigate mortgages, call Loans Canada today!
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