Mortgages: Do a little homework to enjoy big savings?

If you’re one of the many Canadians shopping for a mortgage in the hope of becoming a proud homeowner, there are some important things you should consider before signing for what may be the biggest purchase you’ll ever make.

What you should know

Mortgage features can vary a great deal, so it is well worth your while to do some comparison-shopping. As a consumer, you have options, so talk to more than one financial institution or mortgage broker. Don’t feel tied to your own financial institution or your local branch. It can pay to bargain and negotiate. Just as when buying a car, customers who ask can often get a better rate than the one advertised.

The Financial Consumer Agency of Canada offers a lot of useful information, such as an online mortgage calculator on its Web site (www.fcac.gc.ca) and the ABC’s of Mortgages, a booklet you can order free of charge by calling the Agency’s toll-free number, 1-866-461-3222.

The first step is to understand the language of mortgages. Here are a few of the most important concepts that you should be familiar with:

Down payment

This is the amount you pay, as a lump sum, when you sign your mortgage contract. The larger the down payment you make, the smaller your mortgage will be. With a larger down payment, you will pay less interest in the long run – and eliminate your debt faster.

Amortization period

This is the length of time it will take you to pay off the mortgage, assuming that your interest rate remains the same and that you make your payments on time. It is not unusual for homeowners to have an amortization period as long as 25 years. However, the shorter the amortization period, the faster you can pay off your mortgage, and the less interest you will pay.

Term

This is the length of time over which the financial institution commits to lending you the money for the house purchase. It is usually a shorter period of time than the amortization period. A typical term for a mortgage is five years, although the length can vary.

Renewal

At the end of the term, the financial institution will decide whether to continue the loan or ask you to pay it off. If you are a reliable client, the financial institution will offer to renew the loan and you will have to renegotiate your mortgage for the next term.

Renegotiation

At the end of the term of your mortgage, when it is time renew it, you get to renegotiate. Talk to representatives of other financial institutions and a mortgage broker to see if they can offer you a better interest rate and conditions. You can then decide if you want to move your mortgage to another financial institution.

Prepayment penalty

If for any reason you need to end the mortgage by paying back the full amount before the end of the term, you may be required to pay a penalty amount. This extra amount can be large. Before signing, ask if there is a “penalty clause” and have the financial institution explain it.

Interest rate

This is the rate of interest that applies to your mortgage for the duration of the term. The interest rate can either be fixed or variable (see the definitions below). Remember that a small difference in the interest rate can result in thousands of dollars more, or less, that you will have to pay in interest over the years.

Fixed rate

A fixed interest rate means you will have a predictable payment amount over the term of the mortgage. If a stable, predictable payment amount is important for your peace of mind, a fixed rate may be the best option for you.

Variable rate

A variable interest rate, which rises or falls according to changes in the bank’s “prime rate”, will normally be lower than the fixed rate you could get at the same financial institution at that time. During a period of low or falling interest rates, the potential savings can be attractive. However, a variable rate does have an element of risk: If interest rates go up, you can end up with a higher payment.

There are variable-rate mortgages that feature a fixed payment; with this type of mortgage, if the interest rate goes up, the payment amount will not change, but because more of the payment will go toward paying interest, less will be applied to the principal, making the amortization period longer.

Payment options

You usually have some choice in deciding how often you will make payments and in what amounts. Most financial institutions offer several payment options (monthly, weekly, etc.). Some payment methods, such as weekly and bi-weekly payments, can save you a lot, compared with regular monthly payments. A weekly payment means you make the equivalent of one extra monthly payment a year, which means you pay off your mortgage faster and save on interest charges.

Faster means cheaper

In general, the faster you pay off your mortgage, the less you will pay in interest. There are several ways to shorten the time required to pay back your mortgage, which will result in substantial savings. One way is to choose a weekly or bi-weekly payment option. Another way is to keep the same payment amount even if, at the end of your term, you are able to renew your mortgage at a better rate of interest.

You can also ask your financial institution about increasing the amount of your regular payments, or making a lump-sum payment on your regular payment date. Before you sign for a mortgage, it’s important to check what kind of advance payments are allowed.

Keep in mind the long-term effects of interest. By paying attention to the details and following a few of these tips, you can save thousands of dollars and reduce the number of years during which you have to live with mortgage payments.

CNM