What is a mortgage?

A mortgage is a loan that uses a property as security to  ensure that the debt is repaid. The borrower is referred to as the mortgagor, the lender as the mortgagee.  The actual loan amount is referred to as the principal, and the mortgagor is expected to repay that principal, along with interest, over the repayment period(amortization) of the mortgage.

 A mortgage can be used to finance many different things, including:

• Purchasing a resale home
• Puchasing a home from a builder
• Refinancing to consolidate debts
• Finance a renovation
• Finance the pruchase of other investments
• Finance the puchase of investment properties

Since a mortgage is a fully secured form of financing, the interest you pay is usually less than with most other types of financing.  Many people use the equity in their homes to finance the purchase of other investments, this is called the Smith Maneuver. Using a Secured Line of Credit, or a fixed-rate mortgage, investors can write off their interest cost against their taxable incomes.

Fixed vs. Variable Rate Mortgage

With a fixed-rate mortgage, the interest rate is set for the term of the mortgage so that the monthly payment of the principal and interest remains the same throughout the term. Regardless of whether rates move up or down, you know exactly how much your payments will be and this simplifies your personal budgeting.  In a low rate enviroment, it is a good idea to take a longer term fixed rate to protect you from upward pressure on interest rates.

A variable-rate mortgage(also called adjustable-rate) provides a lot of flexibility, especially when interest rates are on their way down.  The rate is based on prime and can be adjusted when the prime rate changes. Typically, the mortgage payment remains constant, but the ratio between principal and interest fluctuates.  When interest ratesare falling, you pay less interest and more principal.  If rates are rising, you pay more interest and less principal. Any portion not paid is still owed, or you may be asked to increase your monthly payment.  Make sure that your variable-rate mortgage is open or convertible to a fixed rate mortgage at any time, so that when rates begin to rise, you can lock-in rate for a specific term.

Closed and Open Mortgages

An open mortgage allows you the flexibility to repay the mortgage at any time without penalty.  Open mortgages are available in 6 month, 1 year, 3 year, 5 year terms.  Open mortgages are chosen if your thinking of selling your home, or expect to pay off the whole mortgage in a short time frame. Open mortgages are usually  lower that fixed-rate mortgages depending on the interest rate enviroment.

A closed mortgage offers the security of fixed payments for terms 6 months to 10 years.  The interest rates on fixed-rate mortgages are affected by changes in the bond market.  Fixed-rate mortgages offer prepayments of the principal of up to 20% a year based on the orginal principal, this is more than most of us can hope to prepay on a yearly basis. 

Amortization