Mortgage terms: other considerations

Finally, when considering what is the best mortgage don’t forget to factor in how terms, prepayments and penalties will impact you ability to pay down your largest debt.

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Aside from variable and fixed mortgages there are number of other options, but probably the most common (and favoured in this economic environment) is the convertible mortgage.

The convertible mortgage is a variation on the fixed rate mortgage. These mortgages start off with rates that are lower than fixed but higher than straight – variable mortgages. But you get the option of locking into a fixed rate, for a longer term, without penalty. The drawback is that you may be forced to lock – in at a rate that’s higher than what’s available in the market, at that time. That’s because you’re restricted to keeping the mortgage with the same lender: in essence, you are a captive client.

For more on other specialty mortgages, such as capped – rate mortgages, all – in – one options and hybrids, see: The Solution to Mortgage Confusion.

Consider the term, penalties and prepayment options
Finally, before settling on any mortgage make sure you know how specific conditions and limitations impact how you pay for the single largest investment in your portfolio:

Terms: Mortgages come in varying lengths of time, known as terms. Terms indicate how long you are contractually obligated to repay the debt to your lender. Terms range from 6 months, to 1, 2, 3, 5 and 10 years, etc. Typically the sweet spot for mortgages is usually the 5 – year rate—the same term banks use to pre – approve your mortgage application. The mortgage term is important if your lender requires you to pay a penalty for closing the mortgage before the term ends. Just consider what happened to Mohsen Movahed, the Vancouver man who was charged $25,000 by Scotiabank for prematurely closing his mortgage. (Read full story here.)

Penalties: You will be charged a penalty based on the type of mortgage you select. If you opted for a variable rate, you’ll pay the equivalent of three months of interest (although read the fine print, just to be sure). If you opted for a fixed rate mortgage, you’ll pay a rather hefty penalty known as the interest rate differential (IRD). For more information on breaking your mortgage see: Should You Break Your Mortgage.

Prepayments options: These are predetermined terms that dictate how much in extra payments you can make towards the debt principal. Often people ignore these options, but they can be a very effective way to save thousands of dollars. That’s because if you pay down your principal sooner, then a larger percentage of your mortgage payment can be used to pay down the existing principal, rather than on interest payments. For a strategic approach, you can even use these prepayment options in combination with variable rate mortgages to slash your total debt, even if interest rates rise.

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