VARIABLE RATE OR FIXED RATE?
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Your Mortgage Agent will offer you several choices to help find you the mortgage that best matches your needs. Outlined below are common mortgage definitions that can explain mortgage terminology to assist you in making an educated mortgage choice to suit your specific needs.
INTEREST RATE TYPE
You will have to choose between “fixed” or “variable”. A fixed rate will not change for the term of the mortgage. This type carries a slightly higher rate but provides the peace of mind associated with knowing that interest costs will remain the same.
With a variable rate, the interest rate you pay will fluctuate with the rate of the market. Usually, this will not modify the overall amount of your mortgage payment, but rather change the portion of your monthly payment that goes towards interest costs or paying your mortgage (principal repayment). If interest rates go down, you end up repaying your mortgage faster. If they go up, more of the payment will go towards the interest and less towards repaying the mortgage. This option means you may have to be prepared to accept some risk and uncertainty. In many cases, you can also choose to pay a higher payment (provided your income level will allow), resulting in more principal pay down, and if rates increase, your payment may not have to change (but less money would go towards principal in an increasing rate market).
The term of a mortgage is the length of time for which options are chosen and agreed upon, such as the interest rate. It can be as little as six months or as long as five years or more. When the term is up, you have the ability to renegotiate your mortgage at the interest rate of that time and choose the same or different options.
“OPEN” OR “CLOSED” MORTGAGE
An open mortgage allows you to pay off your mortgage in part or in full at any time without any penalties. You may also choose, at any time, to renegotiate the mortgage. This option provides more flexibility but comes with a higher interest rate. An open mortgage can be a good choice if you plan to sell your home in the near future or to make large additional payments.
A closed mortgage usually carries a lower interest rate but doesn’t offer the flexibility of an open mortgage. However, most lenders allow homeowners to make additional payments of a determined maximum amount without penalty.
Amortization refers to the length of time you choose to pay off your mortgage. Mortgages typically come in 25 amortization periods but they can be as short as 15 years. The longer the amortization, the smaller the monthly payments. However, the longer the amortization, the higher the interest costs. Total interest costs can be reduced by making additional (lump sum) payments when possible.
You have the option of repaying your mortgage every month, twice a month, every two weeks or every week. You can also choose to accelerate your payments. For example, for a $250,000 mortgage (5% interest rate and 25 year amortization) choosing an accelerated bi-weekly payment over a bi-weekly regular payment ($727 vs. $670) allows you to pay down your mortgage more quickly. You could pay off the mortgage in just over 21 years and reduce your interest costs by almost $30,000.
This usually means one extra monthly payment per year.