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Residential Mortgages 101

One of Kismet’s key roles as your wealth advisor is to help you make decisions better, and one of the biggest decisions you will make in your life is buying a home.

Buying a home is a big deal for a whole host of reasons. Yes, it means you’re finally the owner of a place that is truly your own, but there’s another very important reason. 

Unless you’re buying your home outright with cash (which is usually not the wisest move), you’ll need to take out a mortgage, which means multiple 6-figured of debt.

So as you begin to build a comprehension of this debt and how it fits into your investment portfolio and risk tolerance, we’re going to walk you through some key mortgage concepts.

The first thing to understand about mortgages is that the interest rate you pay is a reflection of the risk inherent in your loan. 

For example, the higher your loan-to-value (LTV) ratio is, the easier it is for the lender to lose money if real estate prices crash. This is because prices could drop to the point where the loan value is greater than the value of the house, therefore exposing the lender to a loss.

Related to the LTV ratio, if you intend to make a down payment of less than 20% (LTV of more than 80%), then you’ll need mortgage loan insurance. As a service provided by the Canada Mortgage and Home Corporation (CMHC), mortgage insurance protects the lender from nonpayment and makes it possible for you to get a mortgage for up to 95% of the purchase price. 

However, you the lender would need to pay an insurance premium, and if the home costs more than $1,000,000, mortgage loan insurance is not available.

So a higher LTV ratio results in a higher interest rate, but what else is there?

Well a mortgage that is being amortized over a longer period of time would be considered riskier due to the increased length of time for repayment. The amortization period refers to the number of years before the principal of the mortgage is paid back. Periods of 25 or 30 years are considered standard.

The mortgage term, on the other hand, is the length of time your mortgage is in effect. Usually this number is between 2 and 10 years, and upon expiration you need to refinance (either with your original lender or with a new one).

Another large consideration is whether you go with a fixed rate mortgage or variable rate mortgage. With fixed rate mortgages you know exactly what amount you’re going to pay every month, and they generally have a higher interest rate because of the reduced risk they provide.

Variable rate mortgages often start lower, but are tied to an interest rate benchmark that may increase over the term of the mortgage.

It is risky to attempt to time the market and try guessing when interest rates will increase. So if your finances couldn’t handle a significant increase in interest rates while on a variable rate mortgage, then fixed rate may be best for you.

There are many more factors to take into account, but LTV ratio, CMHC insurance, and the choice between variable and fixed rate mortgages will get you the majority of the way. Of course, we at Kismet Wealth Group are always around to help you better make these decisions, but now you at least have the basics and can come to us with a better idea of your needs.