You’ve always heard that 20 percent is the gold standard for a down payment - making home buying feel more like a dream than a reality for many. Yes, 20 percent is still a good number to aim for. But having less than that doesn’t mean you can’t afford to buy a house. In today’s market, you can often put down significantly less to get out of your rented space and into a new home.
Below we’re going over the ins and outs of obtaining a mortgage - and what you should expect your monthly mortgage payments to look like.
What Is a Mortgage?
A mortgage is a secured loan used to buy a house or piece of property. A secured loan is a type of loan that requires collateral from the borrower - such as a house, car or other form of property.
The most common length for a fixed mortgage term is five years with an amortization period of 25 years. But there are certainly other durations for both terms and amortization that can be adjusted depending on what fits best for you.
How Does a Mortgage Work?
If you choose to use a mortgage to purchase your home, the lender (your bank, credit union or other financial institution) will actually own the home outright. You will make regular payments (typically monthly) to the lender for a predetermined length of time. As mentioned before, the most common loan lengths are five-year fixed terms and 25-year amortization periods. These payments will include the principal amount and interest. It may also include other expenses like property taxes, private mortgage insurance and homeowner’s insurance. When determining a mortgage, consider the duration of the terms and amortization period, the type of mortgage (closed or open), and whether the rate is fixed or variable.
Mortgage terms come with different benefits and drawbacks. Short-term mortgages allow you to renegotiate your interest rate sooner, while long-term mortgages will allow you to lock in an interest rate, but prevent any changes for the duration of the term.1
Open vs. Closed Term Mortgages
Open mortgages allow you to put down more money towards your premium, but often come with a higher interest rate. Closed mortgages are the opposite, offering a typically lower interest rate, but there is a fine if you choose to put down more money toward your premium.
Just as it sounds, a fixed-rate mortgage offers an interest rate that will not change over the chosen term of your mortgage. You can expect to pay the same interest rate for the duration of the term until it is renewed. This process repeats for the duration of the amortization period. Using the example above, a fixed rate five-year term would be refreshed with a different interest rate, every 5 years for 25 years.
Unlike a fixed-rate mortgage, variable-rate mortgages are able to adjust interest rates over the term of the loan.
While variable-rate mortgages usually offer a lower initial interest rate than fixed-rate mortgages, the borrower is taking a chance on whether or not that rate will eventually rise. Though variable-rates are typically not encouraged, they could be useful for those who plan to sell the home sooner rather than later or those who know they will be refinancing their mortgage before the rate increases.
How Is a Mortgage Payment Calculated?
Let’s assume you’re taking out a 25-year fixed-rate loan for a $200,000 house. Here’s what your mortgage payment will likely include:
- The principal amount: This is how much you bought the property, minus your down payment. If you bought a $200,000 home and put down $20,000 (10 percent) upfront, your principal amount for the loan would be $180,000. For a 25-year loan, we’d divide that amount into 300 monthly payments - about $600 per month.
- The interest: If you’re obtaining a fixed-rate mortgage, your interest rate will only change between each term of the loan. If your annual interest rate is four percent, you need to divide that amount by 12 to determine how much you’ll pay in interest per month. In this case, you’d be paying 0.33 percent per month.
- CMHC Insurance: If you plan on making a down payment of less than 20 percent when buying a home, you will likely be required to pay an insurance premium. The minimum downpayment will depend on the cost of the home and insurance can only be acquired on homes that are less than $1,000,000.2
- Property taxes: It’s common for your lender to establish an escrow account in which things like property taxes are collected. That’s why they will often be included in your monthly mortgage payments. When it comes time for the government to collect, your lender will pay the amount on your behalf using what you’ve already put in to escrow.
- Homeowners insurance: Most lenders will require a borrower to obtain a homeowners insurance policy, which again will typically be lumped into that monthly mortgage payment.
If you’re considering purchasing a home, it’s important to do your homework first. Speak to your financial professional and begin researching mortgage types and rates before visiting your first open house. This can help eager homebuyers like yourself stay level-headed and realistic about what you’ll be able to afford.
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