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If you own your home, chances are you took out a mortgage to finance the purchase. Now, like most homeowners, you make payments several times a year to pay it off. But do you know how those payments are actually calculated?
Regardless of the amount borrowed, every mortgage payment has two components:
In some cases, your monthly payments may also include the following:
The principal represents the amount you originally borrowed from your financial institution to purchase your property. For example, if your bank lent you $320,000 to buy a $400,000 condo, the principal is equal to the first amount.
Interest makes up the second part of your mortgage payment. This is the fee charged by your financial institution for your loan.
The interest rate directly affects the amount of your payments: the higher the rate, the higher your monthly payments. For example, a $300,000 mortgage amortized over 25 years at 2% interest will cost you $1,270.35 per month. The same mortgage at 3% interest will cost you $1,419.74 per month, or almost $150 more.
At the beginning of the amortization period, the portion allocated to interest payments will be higher than the portion allocated to principal payments. However, over time, the principal component will gradually increase.
If your down payment is less than 20%, you’ll likely have to include the CMHC insurance premium (or the premium of another mortgage insurance company) in your payments. Mortgage loan insurance protects your bank in the event you’re no longer able to make your payments.
You can pay the premium at the time of the transaction or add it to your payments. Since premiums can amount to several thousand dollars, many buyers prefer to include them in their monthly payments. The premium rate varies depending on the loan-to-value ratio, or the loan amount as a percentage of the price or value of your home. In other words, the lower your down payment, the higher the insurance premium. Currently, the rate can be up to 4%.
For example, if you purchase a $200,000 condo with a down payment of $10,000 (5% of the purchase price) and a mortgage with a 2% interest rate amortized over 25 years, the premium will cost you $7,600.
Note that non-CMHC-insured mortgages usually have slightly higher interest rates.
Life, disability, and critical illness insurance protects your family in the event of death, accident, or illness. However, it increases the price of your mortgage payments.
You have the option of purchasing insurance directly from your financial institution or from an insurance company.
The cost will vary depending on your age and medical history, among other things.
Some lenders prefer to manage municipal and school taxes themselves. If this is the case for your lender, your bank will deduct an amount from each of your payments to ensure that you’re able to pay your property taxes on time.
The amortization period—which can span 25, 20, or 15 years—is the time it will take you to pay off your mortgage in full.
A longer amortization means lower monthly payments, which can be a good option for young buyers. However, you’ll pay more interest than you would on a mortgage with a shorter amortization period.
Even if you plan to pay off your mortgage in 25 years, you’ll have to renew the clauses of your contract several times before then. That’s because every mortgage has a lifespan, known as the mortgage term.
Terms generally span seven years or less. Shorter-term mortgages tend to have better interest rates. However, if rates go up, you could end up with a much higher interest rate at the end of your term.
When you renew your mortgage, you can either stay with your bank or change financial institutions (to take advantage of a better rate, for example).
You can also change the frequency and amount of your payments.
Lastly, you must choose one of the following options:
How often do you want to make mortgage payments? You can typically opt for monthly, bimonthly, biweekly, or weekly payments. A higher payment frequency (e.g., weekly) means making smaller payments and paying less interest at the end of the term. On the other hand, frequent paymentsaren’t very practical if you’re self-employed and get paid only once a month.
If you want to pay off your mortgage even faster, you might consider an accelerated payment option. This will allow you to pay the equivalent of one additional monthly payment each year. Keep in mind that your payments will be slightly higher than with the traditional options.
In addition to your regular payments, your lender will likely allow you to make additional payments. These prepayments allow you to pay off your mortgage faster.
If you have a closed mortgage, your prepayments cannot exceed a certain amount. Otherwise, you have to pay a penalty to your financial institution. Open mortgages allow you to pay off all or part of your loan at any time. That said, they carry a higher interest rate. Open mortgages are ideal for individuals who expect to receive large cash inflows (e.g., investments, inheritances) or who want more flexibility.
If you’re having trouble understanding all the factors that determine the size of your mortgage payments, don’t hesitate to consult your Multi-Prêts broker. Our mortgage specialists are equipped to answer all your questions!