When purchasing real estate in the Hamilton area it’s important to consider your mortgage options. Although there are specialty products available in the mortgage market like Interest Only mortgages and Balloon Payment Mortgages, the majority of homeowners opt for one of these four mortgage options: A fixed rate, a variable rate, a conventional or a high-ratio mortgage.
A fixed rate mortgage is one of the most stable mortgage types. The interest is determined and is set for the term of the mortgage, and homeowners pay one fixed amount throughout the term. The borrower’s monthly payments for interest and principal remain the same for the duration of the loan regardless if Canada prime rate increases. These mortgage rates do not fluctuate as long as the borrower is in a term agreement. The three most common durations to lock-in interest rates are the 1, 3 and 5 year terms.
The advantage of fixed rate mortgages is that you know exactly how much your mortgage payments are regardless of whether rates rise or fall. This makes for easier budgeting and is less risky than a variable rate mortgage. Fixed rate mortgages are most desirable when current interest rates are low.
The variable rate, which can also be called an adjustable rate mortgage or ARM, is the opposite of the fixed rate in that the interest rate may change during the term of the mortgage reflecting changes in the current market rates. The variable rate has been shown to save thousands of dollars in interest payments. However, each situation is different and professional advice is needed.
A variable rate mortgage loan also allows the borrower flexibility in times where a fixed rate may not be the best choice. Variable rate mortgages have typically been a better option for the consumer over the last 10 years. The interest rate was previously calculated at an ongoing basis at prime minus a set percentage. In the summer of 2008 the variable rate mortgage changed from a Prime minus offering to a Prime plus offering due to credit markets and the US credit crisis. Availability of funds has become scarce so, to combat the problem of scare credit and to tighten the belt slightly, Prime plus has become the new benchmark. Today, for example, if the prime rate in Canada is at 3 per cent, the holder of a prime plus 0.50 per cent mortgage will pay a 3.5 per cent interest rate, until the prime rate changes. (Prime rate is the “best” rate that the banks use when pricing loans to their most creditworthy customers.) This is still an unbelievable product in terms or savings and options.
This is a loan for no more than 80% of the appraised value or purchase price of the property. To qualify for a conventional mortgage, your down payment, or the cash you provide for the purchase price, must be at least 20% of the purchase price. A mortgage in which more than 80% of the fair market value of the property, also called the lending value, is referred to as a high-ratio mortgage. The “ratio” is the percentage of money borrowed in comparison to the value of the property.
This mortgage loan is based on the credit of the borrower and on the collateral for the mortgage. Since the buyer is making a larger down payment on the property, the buyer has more immediate equity in the property. Because the buyer will have a fair cushion of equity, the risk to the bank isn’t as great as in lower down payment purchases. Thus, repayment terms are generally a little more favorable.
In addition, conventional mortgages do not often require mortgage insurance.
High Ratio Mortgage
When the loan-to-value of a home is 80% or more, meaning a homeowner has less than 20% of the property value as a down payment, then this is considered a high ratio mortgage and it must be insure.
A high ratio mortgage will require mortgage insurance. Mortgage insurance is usually purchased by the lender through one of Canada’s three default insurers, the Canada Mortgage and Housing Corporation (CMHC), Genworth and Canada Gauranty and the cost of the premium is charged to the buyer as a closing cost, or is financed through the mortgage.
High ratio mortgages are considered riskier for banks, because there is less immediate equity in the property, and in the event of default, it may be more difficult to recoup the loss in total. Therefore, the federal requirement of mortgage insurance became law.
Because of mortgage insurance, a high ratio mortgage can still be obtained with a down payment as little as 5% of the purchase price. The ability to use mortgage insurance as a replacement for a higher down payment opens the housing market to more people.