What is a Mortgage Loan?

If you’ve ever daydreamed about owning a home, there’s probably one aspect of homeownership that seems more like a nightmare than a dream: the mortgage loan.

Here’s how it goes—you picture yourself playing in the backyard with your dog and working on crafts in the basement, but suddenly your daydream is interrupted by a flood of panic about money. If this sounds familiar, you’re not alone.

Most Canadians still aspire to be homeowners even though they worry about the cost of homeownership.

Indeed, there’s a lot to consider when purchasing a home, but the prospect of taking on a mortgage shouldn’t deter you from actualizing your dreams of homeownership. In fact, in many instances, homeownership is a smart financial decision.

Of course, there are other factors to consider, including lifestyle, flexibility, and stability. This brings us the next point: a mortgage loan isn’t as scary as it sounds.

Here’s everything you need to know about mortgage loans.

What is a Mortgage Loan?

A mortgage loan is similar to other types of loans in the sense that you are borrowing money to use for a specific purpose.

In the case of mortgage loans, the money is used to purchase a home. The lender holds the title of your property and will continue to hold the title until you’ve paid back the balance of the loan plus interest. 

The lender owns the title until the mortgage is paid because your home serves as a guarantee that you will pay back the loan. This helps to reduce the risk for the lender and serves as an incentive for borrowers to pay in full and on time.

Types of Mortgage Loans

There are two primary types of mortgage loans: open mortgages and closed mortgages. There are a few differences between the two types, but the main difference has to do with prepayment penalty fees for paying down your mortgage early.

Open Mortgages

This mortgage type is best if you plan on paying down your mortgage early or making additional payments along the way. Open mortgages also provide more flexibility and there are a variety of things you can do without having to worry about prepayment penalty fees.

Here are a few examples of the benefits of an open mortgage:

  • You can break your contract in order to change lenders

  • You can pay off your mortgage early

  • You can pay extra towards your mortgage balance each month

Closed Mortgages

With this mortgage type, you may have to pay fees. Yet, the primary benefit of choosing a closed mortgage is securing a lower interest rate. In general, closed mortgage interest rates are lower than open mortgage interest rates.

The Length of Your Loan

Your amortization period, or the length of your loan, is how long it will take you to pay off your mortgage loan. The amortization period varies but some of the most common amortization timeframes are 10, 15, 20 or 25 years.

But here’s the deal—the longer the loan, the more interest you’ll pay. So if you take out a $200,000 mortgage with a 4% interest rate and a 15 year amortization period, you’ll pay a total of $266,288 throughout the life of the loan (including interest).

But if you have the same $200,000 mortgage loan with the same 4% interest rate, and change the amortization to 25 years, the total cost rises to $316,702.

In other words, you’ll end up paying $50,414 more towards interest. 

Of course, there are benefits to having a longer amortization and the primary benefit is lower monthly payments, but it’s important to keep the extra interest in mind.

Just remember: a longer loan typically equals more interest. Also, if your down payment is less than 20% of the home’s purchase price, the longest amortization you can get is 25 years.

Fixed vs. Variable Interest Rates

Another important factor to consider when taking out a mortgage loan is interest rates. Interest rates are the “price” of your loan and will determine a lot about your mortgage, including how much you’ll have to pay towards interest charges throughout the life of your loan.

In the same way you pay for goods or services, you’ll pay interest to your lender for the service of borrowing their money. There are two different types of interest rates to consider: fixed and variable.

Fixed Interest Rates

Like the name suggests, fixed interest rates will stay the same throughout the entire term of the loan.

For example, if you agree to a 3.5% interest rate when you sign for the loan, the interest rate will remain at 3.5% until the end of the term. The primary benefit of this is that you’ll know the exact amount of your mortgage payment each month and there won’t be any surprises.

Fixed interest rates tend to be slightly higher than variable interest rates, but some borrowers enjoy the peace of mind.

Variable Interest Rates

These interest rates increase and decrease during your mortgage loan term and are tied to a variety of factors outside of your control.

Even though variable interest rates tend to be lower, the uncertainty can make some borrowers feel uneasy. For example, between 2005 and 2015, interest rates varied from 0.5% to 4.5%, so it’s important to note that there can be a wide range of rates.

How Your Payments are Calculated

When it comes to calculating your monthly mortgage loan payments, there are four primary factors at play:

Mortgage loan amount: This is the amount of your mortgage loan. If you’re buying a $300,000 apartment with 10% down, then your mortgage loan would be for $270,000.

Down payment: As you can see from the example above, your down payment affects the size of your mortgage loan, and as a result, it also affects your payments.

Interest rate: Whether it’s a fixed interest rate or a variable interest rate, the interest rate on your loan is going to affect your monthly payments.

Amortization: The length of your loan will also affect your payments. Remember, the longer the length of the loan, the more interest you’ll pay.

Bottom Line

Mortgage loans may seem intimidating but they really aren’t that scary. Once you understand the basics, you’ll be able to make an informed decision about the loan type, length, and terms that are best for your unique financial situation.

You May Also Like:

The Best Credit Cards for Beginners

If you’re new to credit or you just moved to Canada, you’ll find yourself looking into credit cards for beginners ... Read more

Read More

Your Source for the Best Bad Credit Car Loan Rates in Canada

Are you in the market to buy a new vehicle, but you have a less-than-stellar credit score? Trying to find ... Read more

Read More

What Factors Determine a Credit Score and Approval for Credit Cards in Canada?

You may have heard of the term credit score, but what exactly does that 3-digit number represent and how does ... Read more

Read More