Mortgages can seem very overwhelming. It is important to have a good understanding of the mortgage basics and the impact they have on the mortgage itself. Let’s look at the basic pieces to a typical mortgage.
Mortgage principal amount
The mortgage principal amount is the actual amount of money that is being borrowed. This is the amount of money that interest is paid on and the amount that needs to pay back over the set amortization period. The amortization period is the amount of time it will take to pay the mortgage in full based on the current interest rate and the current conditions of the mortgage, assuming no prepayments.
This period consists of a number of small time periods within which payment is made. Each of these time periods are referred to as a term. The term of the mortgage is the period of time you would commit to a particular interest rate, and to the particular mortgage conditions.
Let’s take a look at the actual interest rate. There are many factors that affect the interest rate and just a small change in the interest rate can have a very big impact on the mortgage and the monthly payments. When it comes to selecting the interest rate, there are two main options, fixed or variable rate.
Fixed rate means the interest rate is guaranteed to stay the same for the entire term of the mortgage. This is a popular option for people who like to know what their mortgage payment is going to be and like the security that comes along with that. Variable rate means the mortgage interest, and therefore the mortgage payments can change throughout the term of the mortgage. The variable rate is affected by the prime interest rate, which as of March 15, 2014 is set at 3 per cent.
A variable rate mortgage is typically structured as a fixed percentage added or subtracted to the prime rate. For example, a variable rate mortgage may be prime minus 0.5 per cent, which means that the variable mortgage rate is 2.5 per cent. However, as prime fluctuates, which it does from time to time, so does the mortgage rate and therefore the mortgage payment.
If you were to choose a five-year variable rate mortgage of prime minus 0.5 per cent, you’d be paying 0.5 per cent below prime for your entire term. Once your mortgage term is up, you can decide once again the term length you want to commit to moving forward, and whether you want a fixed or variable rate for the duration of that term.
These are just some of the basics of a typical mortgage. A good mortgage professional should ensure you have a good understanding of the mortgage you are committing to, and take into account not only the interest rate, but how that mortgage and the conditions associated with that mortgage match with your lifestyle and future goals.