If you’re buying a new construction home, congratulations! Purchasing a home is one of the most crucial milestones in your life, but it’s also one of the most complicated — and costly — purchases you’ll ever make. By understanding the following five mortgage terms, you’ll be prepared to make smarter decisions in the home buying process and ease some of the stress! So read on and get savvy.
High-Ratio vs Low-Ratio Mortgage
This term is directly correlated to how much you’ve saved for your down payment. A high-ratio mortgage is where the homebuyer makes a down payment of less than 20% of the home’s total cost. If you have a high-ratio mortgage, it must be covered by mortgage loan insurance (also known as “mortgage insurance”).
However, if you’ve saved 20% or more for your down payment, then you will have a low-ratio mortgage (also referred to as a “conventional mortgage”). If you have a low-ratio mortgage, it is not mandatory to purchase mortgage insurance, which will lower the cost of your payments.
Mortgage Loan Insurance
So what is mortgage loan insurance? This term is also referred to as “mortgage default insurance” or simply “mortgage insurance.” It is a financial product that’s mandatory on all high-ratio mortgages, as we discussed above. Your mortgage lender pays the insurance premium but then the cost is passed on to you; you can pay it in full or work it into your mortgage payments and pay it monthly or bi-weekly.
Amortization means the total time it will take you to pay off your mortgage. Typically, this is 25 or 30 years. However, the mortgage term refers to the period covered by your mortgage agreement. This often ranges from one to five years. Once the term expires, the balance of the mortgage principal (the remaining loan amount) can be paid off, or a new mortgage can be renegotiated with current interest rates.
Variable Rate vs Fixed Rate Mortgage
When negotiating your mortgage, you have two options. You can pick a variable rate mortgage, also known as a floating rate mortgage or an adjustable-rate mortgage, or select a fixed-rate mortgage. A variable rate mortgage has an interest rate that fluctuates with the prime lending rate. The main advantage of a variable rate mortgage is lower interest rates, but in return, you will take on more risk. For example, you could start with a variable interest rate of 2.5%, but if the prime rate goes up to 3.5%, your mortgage interest rate has gone up 1%. If the prime rate goes up, a more substantial portion of your mortgage payment will go toward the interest, instead of paying down your principal. The result? Your mortgage might take longer to pay off and you could pay more in interest.
If you opt for a fixed mortgage rate, then your rate is locked in for as long as your mortgage term. For example, if you lock in a fixed rate of 3% for five years, no matter what the prime rate is, you only pay 3%. This makes it less risky, but if the prime rate falls, you don’t get to take advantage of the lower interest rate until your mortgage term is over, and you renegotiate with the bank.
Total Debt Service (TDS) Ratio
TDS means the percentage of your household’s gross monthly income that goes toward the cost of your new construction home (ex: mortgage, property taxes, heating, etc.) plus your other debts and financing (ex: car payments, credit cards, etc.). Banks use this calculation, along with your gross debt service ratio, when assessing your mortgage application. Genworth Canada programs require a TDS of no more than 44% for you to be eligible for a mortgage.
We understand that the mortgage industry can be very confusing for most people. We hope the terminology discussed above has helped clear up some of the confusion so you can be on your way to becoming a new homeowner with ease! For more information about new construction homes, don’t forget to read the Falconcrest Homes’ blog!Tags: High-Ratio vs Low-Ratio Mortgage, Mortgage Loan Insurance, Mortgage Term, mortgage terms, Total Debt Service (TDS) Ratio, Variable Rate vs Fixed Rate Mortgage