First time home buyers have several different options when it comes to choosing a mortgage.
Generally speaking, they break-down into four broad categories:
· Conventional or high ratio mortgages
· Term length (convertible mortgage)
· Fixed rate vs. variable rate (Learn more when you compare home loans)
· Closed or open mortgages
A conventional mortgage is a loan for less than 80% of the total purchase price. To qualify for this loan you will need a down payment of at least 20%. If you are unable to bring a 20% down payment to the table then you can still qualify for a high ratio mortgage, but you will be required to pay default insurance – a one-time payment which protects the lender should you default on the loan.
Term length also plays a role in your mortgage choice. You could opt for a 6-month convertible mortgage which will offer you the short-term commitment at fixed payments, with an added advantage that while within the term, the mortgage is fully convertible to a longer term from 1 year to 10 years. At the end of the 6-month period, the mortgage becomes open and you can renew with the existing lender to transfer to another lender. Generally short term mortgages are appropriate if you believe interest rates will drop when it comes time to renew. If you are under the impression that rates will rise then you might be better off choosing a long-term mortgage, as this will give you greater security of knowing what you payments will be for a longer period of time.
A fixed rate mortgage allows you to pay a set rate for a term that is anywhere from six months to 25 years. While a variable rate (or an adjustable rate mortgage – A.R.M.) fluctuates with the market, allowing you to take advantage of lower rates in the event of a drop.
And lastly, a closed mortgage usually offers a lower interest rate and gives borrowers some stability as they are arranged at a set interest rate for a period of time enabling easy forecasting and planning. However, many lenders charge a penalty if the mortgage is repaid early and the penalty can be quite hefty. An open mortgage, on the otherhand, lets you pay off as much as you want, any time, without penalty. But this flexibility usually comes with a higher interest rate.
There are hundreds of different combinations of these types of loans and each lender has their own rules and features.
Your financial situation, short and long-term goals and your appetite for risk will ultimately determine which product is right for you.
Here is a breakdown of the different mortgages, as well as a guide to the advantages and disadvantages of each.
Overview: The term for this type of mortgages is usually three or more years and is best used when current interest rates are practical.
Advantages: This is a good alternative if you value peace of mind or if you are looking for a long-term investment.
Considerations: You may end up paying more over time if interest rates decrease while you are still locked in.
Suitable for: Buyers who would like to budget for the future.
Overview: With a term of two years or less, this mortgage option offers a viable alternative to breaking a long-term mortgage.
Advantages: You are offered lower interest rates so this alternative is ideal if you aren’t planning on holding onto the property for a long period of time.
Considerations: If interest rates increase at the time of renewal, you may end up paying a higher borrowing cost.
Suitable for: Borrowers who feel that the lower interest rate initially far outweighs the risk of rates increasing at time of renewal.
Overview: This is a risk-free way to pay your mortgage since all or a portion of it is set at a fixed interest rate.
Advantages: Currently, this option is a good idea since interest rates are low.
Considerations: Statistically speaking, this choice has been proven to cost you more in the long run (approximately $15,000). In the case that rates drop, you won’t benefit. Also, you can be penalized if you pay off your loan before the due date.
Suitable for: Those who are worried that interest rates may rise and who like to have a set plan for budgeting.
Overview: With this selection, rates will vary and are based on the present interest rate. For a given amount of time your mortgage will be a certain amount, and as soon as that term is over it will change to another amount, whether higher or lower.
Advantages: You are allowed more flexibility. It’s been proven historically that with a typical 25-year mortgage you can save approximately $15,000 with this option. Also, sometimes the rate can be set so that it doesn’t exceed a certain amount.
Considerations: You are expected to pay the current interest rate, even if it increases, which makes it hard to budget.
Suitable for: Borrowers who are comfortable with their mortgage payments being an unstable amount, and who want to make a profit.
No down payment mortgage
Overview: If you don’t have the funds for a down payment, this option allows you to skip it by including the down payment in your mortgage. The main requirement is that you must have money for closing costs and you must have an excellent credit history.
Advantages: You can start building your home equity right away. If you fix your interest rate, you will be protected from market fluctuation.
Considerations: Monthly payments are often higher than you would pay if you had a down payment.
Suitable for: Borrowers who would like to act now and become a homeowner.
High ratio mortgage
Overview: This term is applied to mortgages that are 80 per cent greater than the value of the property.
Advantages: There are various terms and rates offered and it is similar to a regular mortgage.
Considerations: You are required to pay an insurance fee or premium that can be paid upfront, or added to the mortgage. Remember that the greater the loan-to-value ratio, the greater the insurance premium.
Suitable for: People that have the funds for a down payment, and also for those who would like to purchase a second home.
Overview: Potential buyers who might not be able to afford a house can now do so with an extended mortgage that makes your monthly payment cheaper by extending the typical 25 year mortgage to 30 to 40 years.
Advantages: This alternative makes your monthly payments more affordable.
Considerations: You will be in debt longer and there are higher interest rates meaning that over the term of the loan you will pay more.
Suitable for: Buyers who have a job and are expecting a rapid pay increase. This way, you can eventually increase your monthly payments and cut back on interest.
Home Equity Line of Credit (HELOC)
Overview: Similar to a regular line of credit because you can borrow and pay back as needed. The main difference is that it is registered as a mortgage, and your collateral is your property.
Advantages: This option allows you to pay lower fees since you are only expected to make a minimum monthly payment, usually just interest. Also, with a regular mortgage you must discharge the amount once paid, so if you need extra cash one month, you must go through the whole borrowing process again and pay the legal fees. HELOC allows you to skip this entirely.
Considerations: The interest rate is variable, so over the specified ‘draw period’ (the length of the loan which is typically 5 to 25 years) it will be difficult to budget. Since your home is your security, if you are unable to make a payment it could result in foreclosure.
Suitable for: Buyers who are comfortable with a variable interest rate, and who would like the option to borrow and pay back at will.
Cash back option
Overview: This option allows you to receive cash back on the date your mortgage is advanced. It is available on a variety of terms. The cash back amount is contingent on the amount of the mortgage, with average rates at 4, 5 or 7 per cent of your mortgage.
Advantages: The cash that you receive can be used immediately for things like renovations, legal fees, moving costs, etc.
Considerations: You must carry out the entire term of the mortgage, regardless of circumstances.
Suitable for: First time homebuyers, and those that are in need of extra cash at time of purchase.
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