There are lots of things we don’t know. That’s ok. Perhaps you are new to Mortgages or a seasoned vet. Either way, there will always be something you may not have known about any subject. With how much information is involved in Mortgages. It’s no wonder people get overwhelmed learning how they work, which is the best one for them and all the different types of Mortgages.
Here Is The 3 Part Series Of The 15 Things You Didn’t Know About Mortgages.
What Is A Mortgage?
A Mortgage is a loan from a Bank or Lender used to purchase a house or property. There are multiple types of Mortgages such as a Conventional/Traditional Mortgage, Fixed Term Mortgage, a Variable Rate Mortgage, and a High-Ratio Mortgage. These types are more common than many others.
A Conventional/Traditional Mortgage is a Mortgage that the buyer is responsible to have at least a 20% down payment toward the property. This type of Mortgage is also not secured by any Government agency such as the
A Conventional Mortgage is offered through Private Lenders, Banks and Credit Unions.
A Couple Benefits Of A Conventional Mortgage Are:
-Often you will not be required to have Mortgage Insurance because you have at least 20% equity
-Paying a minimum of 20% down gives your house immediate equity.
-Stable payments every month
Disadvantage Of A Conventional Mortgage:
-20% may be a large down payment to acquire especially with bigger Mortgages
-Closing costs normally need to be paid upfront and typically can’t be rolled into the mortgage payments
-You don’t benefit if interest rates drop. Your rates are fixed for the term.
A Fixed Term Mortgage
A Fixed Term Mortgage is a Mortgage where you enter an agreement with a lender to pay for your Mortgage with a Fixed Interest Rate for an agreed-upon length of time. These Mortgages can be set up typically from between 1-5 years before renewal. Over 60% of Mortgages in the US are Fixed Rate Mortgages.
The Benefits Of Having A Fixed Term Mortgage Are:
– You are protected from any changes in Interest Rates during the agreed-upon term.
-Your Mortgage payments are the same amount every month. This makes budgeting much easier and leads to fewer problems with defaulting on a payment.
-The minimum down payment is typically 5%.
Some Of The Disadvantages Are:
-A Fixed Rate Mortgage typically has a more expensive payment
-If Interest Rates drop you don’t get the benefit of a lower monthly payment
-You are fixed into your payment for the agreed-upon term or face expensive penalties to refinance partway through
Variable Rate Mortgage
A Variable Rate Mortgage is a mortgage in which the Interest Rate is based on the Index/Prime borrowing rate at the time and will change with the Prime rate. Typically, there is also a margin above Prime added to the interest rate, for example, Prime Rate plus 0.5%.
On average, a Variable Rate Mortgage will be cheaper than a Fixed Rate Mortgage at the time of renewal but also carries more risk to the borrower with a payment that can fluctuate as Prime Rate changes over time. Therefore, your monthly payments can change every month.
Advantage To A Variable Rate Mortgage:
-If Interest Rates go down, so will your monthly mortgage payments
-Typically cheaper to borrow compared to a Fixed Rate
-Normally there is a cap to the amount your Interest Rate can increase per year
Disadvantages Of A Variable Rate Mortgage:
-If Interest Rates increase it affects your rates
-Your monthly payments can increase throughout the year
A High Ratio Mortgage is a Mortgage similar to a Conventional Mortgage except you have a down payment of less than 20%. Having a High-Ratio Mortgage you are required to have Mortgage insurance. The price of Mortgage Insurance can either be paid upfront or can be rolled into the monthly payments for the Mortgage. In Canada using a High-Ratio Mortgage, you can purchase a house with as little as 5% down. This is a great option especially for first time home buyers who may not have a large down payment.
The Advantages Of A High-Ratio Mortgage:
-5% down payment opens up more opportunities especially for first time home buyers
-More leverage from the Bank to purchase the property
-You can still get a Fixed Rate
Disadvantages Of A High Ratio Mortgage:
-Low equity in the home
-Payments may be higher because you Leverage more from the Bank
-Required to have Mortgage Insurance
There are many different types of Mortgages even beyond the few types that I have presented here. Mortgages can be very complex and it is best to get advice from a professional about all of your options before making a decision as a Mortgage can be a long term commitment and isn’t always “easy” to get out of. There can be a lot of fees to pay if you want out of your Mortgage or want to renew a Mortgage prematurely.
Now that we have a basic understanding of a few different types of Mortgages, here are some things you may not have known about Mortgages.
Paying Interest At The Start
When you secure a Mortgage from a Lender to purchase a Property your monthly payments may not be paying down as much of the principal loan as you may think.
At the beginning of the Mortgage, your payments are comprised of most interest and very little principle. As the Mortgage matures through your term, more of the principle is being repaid each month.
For example, if you secure a Mortgage for $100,000 from a Lender with a fixed 5-year rate of 3.99%, having put a down payment of $5000. Your monthly payments will be $499 over a 25-year term. Each payment is comprised of Interest and Principle. The Interest is what you are paying the bank for securing the loan of $100,000 and the Principle is the amount of the payment that is going toward paying down your loan. Your monthly payments for the first 5 months will look like this.
Where are after 10 years, having a monthly payment of $499, your payments will look like this. Note how the amount of Interest paid from each payment after 10 years is much less than the first 5 months. The amount of Interest in the first 5 months is significantly higher than the Principle amount paid. Whereas, after 10 years, the Principle payments are becoming higher than the Interest. The Lender sets the Mortgage payments up so that the total Interest on the Mortgage is being paid down sooner than your Principle.
The bottom line is: the Lender wants their Money before they give you full
This means, you borrowing Money will increase the Lenders’ bottom line, even though you keep control of the house.
Mortgage Rates Change All The Time
Multiple different variables affect the rates that you can get for a Mortgage. Some of these variables are:
-Credit Score Of The Borrower
Your credit score can affect the rate that you are given from a Lender to secure a Mortgage. The Lender will give a Borrower with a Higher Credit Score a better Rate in comparison to someone who may not have the best history for repaying Loans. You can increase your Credit by making sure that you are paying all of your bills on time and not defaulting on any payments. Using a Credit Card can be good for your Credit but be sure to pay down the balance before incurring the Interest Charges for that month. This will allow you the benefit of increasing your Credit and not paying upwards of 20% Interest on some credit cards.
The length of time you want to secure your Mortgage will affect the rates that the Lender will give you. For a Short Term Fixed Rate Mortgage you will normally have a lower Interest rate than if you were to secure a 5 Year Fixed Rate Mortgage.
Securing a Mortgage for a Fixed Term will allow you to have more stable payments for the Amortization Period but, it will also have a higher rate than if you have a Variable Rate Mortgage. The downside is that with a Variable Rate Mortgage you are subject to Rate changes throughout your term based on Prime/Index.
-The Type Of Mortgage
What type of Mortgage you secure will change the Rates you can get from the Lender. There are many different types of Mortgages as well as Lenders. Be sure to speak with your Mortgage Broker about which Mortgages are offering the best rates and how that Mortgage is different from the other types of Mortgages. Find the right fit for you and learn the differences between the different types of Mortgages.
Prime/Index rate is the base borrowing Rate for Lenders. Prime Rate is subject to change all the time as the economy does well the Rate changes and if the economy is doing poorly the Prime Rate changes to Boost the Economy and stimulate growth. Mortgages being Leverage or Borrowed Money are based on Prime/Index set by the Borrower therefore the Rates will change based on how well the economy is doing at that point in time.
-Location Of The Property
The location of your property has a big effect on the Rates you can get for borrowing from a Lender. Many States or Provinces have different Rates even at the same time. Some Cities can have a higher average borrowing Rate than others as well.
The more Equity you have the better rates you can qualify for. Ways of getting more Equity are by having a bigger Down Payment. Using an Accelerated Payment Schedule where you end up paying additional Payments in the year. This will then get your Mortgage paid down faster each year. When the Banks see that you have Equity in your Home your Mortgage becomes less of a risk to the Lender therefore, you can get a better rate for the renewal of your Mortgage.
There are many different variables in the Rates that a Mortgage can be secure for as always check with your Mortgage Broker or other Professional to be sure you are getting the best rate and the best Mortgage for your needs.
There are options to Negotiate Rates for a Mortgage. Just in changing the type of Mortgage you have can affect the rates you get for a Mortgage. You can choose to have a Variable Rate Mortgage which you can have some negotiating power about the margin on top of Prime you may have to pay. Or by extending or shortening your Fixed Term you can adjust the rates you are going to pay.
A broker may be able to negotiate a better rate from one company for a 5 year fixed term in comparison to another company.
The more equity you have in your home the more power you may have to get a better Interest Rate. By having more equity in your home the risk for the lender is lower on your Mortgage. This can give you an advantage in negotiating a better rate from different lenders.
Remember if you don’t try and get a better rate the Banks/Lenders won’t give you a better rate. It is up to you to make sure you are getting the best deal you can, after all, purchasing your home is a long term commitment that no one wants to overspend on.
You Can Still Buy A House With Low Credit
You may not have the best Credit, maybe a Credit Card got out of hand or you missed some payments for insurance. Either way, more and more lenders are getting very competitive with lending to less than perfect credit.
You can talk with a Mortgage lender and see about getting Pre-approved for a Mortgage. Note that, someone with poor credit may end up with a higher rate on their mortgage because the lender is taking more risk in financing someone with poor credit history. You may also qualify for a smaller amount that can be borrowed to go toward your property.
Rather than going with big banks a Private Lender may be a better option for someone with lower credit. The smaller Private Lenders are competing against the larger Corporations and therefore need to be more competitive and normally they will be more willing to take the risk in securing a Mortgage.
Having a higher down payment toward the property can also make it easier to secure a loan. By having a higher down payment you are increasing the equity in the home and lowering the risk to the lender. This combined with showing that you have a stable and steady income will greatly increase your chances of getting approved for a Mortgage through any lender.
Private Mortgage Insurance
Private Mortgage Insurance protects the lender in the event that the borrower defaults on the Mortgage. Most Mortgage companies require that there be Mortgage Insurance on any Mortgage in excess of 80% leverage. As in, the borrower has less than 20% down payment or equity in the property. For example you purchase a $100,000 home with 5% down which is $5000 instead of $20,000 (20%).
It is important to note that the Mortgage Insurance is to protect the lenders’ investment not to protect yours. That being said, you pay for the Mortgage Insurance to protect their Asset but this allows you to have a smaller down payment.
You are required to purchase Mortgage Insurance for the lenders’ benefit in exchange for the lender taking on a higher risk Mortgage. A Mortgage with more than 80% leverage is considered a higher risk because of the low equity.
Not all Mortgages require Private Mortgage Insurance. A Conventional Mortgage which is a Mortgage with a minimum down payment of 20% or more may not require Mortgage Insurance. By saving a higher down payment you will lower your monthly payments by not having to pay for Mortgage Insurance.
There Are Different Types Of Insurance
Borrower Paid Insurance
Borrower Paid Insurance is Mortgage Insurance that the borrower pays through their monthly/ weekly Mortgage payments. These payments toward the insurance premium will continue on your monthly payments until you have at least 22% equity in the property.
This is the most common type of insurance paid by borrowers due to the fact the payments typically get combined into the Mortgage payment every month which helps to make the mortgage more affordable.
The Single-Premium Insurance is still paid by the borrower but the payments are bulked into one bigger payment. The benefits are that your monthly mortgage payment isn’t affected by the increasing cost of insurance but the downside is that if you sell the property none of your insurance premium will be refunded.
Lender Paid Insurance Premium
This Insurance Premium is paid by the lender but because the lender is still taking on more risk with a Mortgage that has less than 20% equity, the interest rates will be higher on the Mortgage. Therefore, in the long run, you are still paying for the insurance premium you just don’t directly pay for it. You pay by an increased interest rate in comparison to the other types of payments.
There are different options that you can take for insurance premiums. If you want to avoid these premiums you can have a higher down payment on the Mortgage or refinance when you are available to eliminate the insurance premium.
Now that we have a start to some of the things you may not have known about mortgages check out Part 2 Of 15 Things You Didn’t Know About Mortgages!