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How to choose a mortgage

With interest rates at their lowest point in 50 years, more and more Canadians are forsaking their renting ways and choosing to pay their own mortgage instead of someone else's.

Figuring out what type of mortgage is best for you can be tricky. But once you understand the basics and the lingo, you'll be well on your way to owning your home.

Establish good credit
Before you start shopping for a mortgage, make sure your credit is in good shape. The better your credit, the more options you'll have when applying for mortgage.

According to Maggie Edgar, a mortgage consultant with Mortgage Intelligence in Simcoe, Ont., the two things mortgage brokers look for are job stability (which, in today's economic climate, is considered two years or more at the same job, or a similar job) and established good credit.

That means at least two years of paying your bills on time and not over-extending yourself financially.

"If you don't have good credit, I have lenders who will work with you, but you'll pay a higher interest rate and a fee on top of that," says Edgar. "Having good credit means better interest rates, and over 25 years, even a 1 percent difference can save you a lot of money."

To check your credit report, contact one of the country's two major credit bureaus, Equifax Canada or TransUnion Canada.

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Choose a down payment
There are two main types of mortgages: conventional and high ratio. A conventional mortgage is for 75 percent or less of the purchase price of the property. You pay the balance as your down payment.

If you can afford to make a down payment of 25 percent or more, it's a good idea, as your proclivity for saving will be rewarded with a low interest rate. And the larger your down payment, the quicker you'll be able to pay off your mortgage.

But for many people today -- especially young, first-time home buyers -- a 25 percent down payment is beyond their means. In that case, you can make a down payment of between 5 percent and 24 percent of the purchase price and get a high-ratio mortgage for the balance.

The only catch with high-ratio mortgages is you must buy mortgage insurance to protect your lender in case you default on your loan. But because the insurance premium can be rolled into your mortgage, allowing you pay it off as part of your monthly mortgage payment, most home buyers accept it as a necessary evil.

In Canada, mortgage insurance is offered through the Canadian Mortgage and Housing Corporation and GE Capital Mortgage Insurance Company.

Rates vary depending on the size of your loan, ranging between 1 percent and 3.25 percent of the principal amount of your mortgage.

There is a third option when it comes to choosing the size of your down payment -- not to make one at all. You can actually get a mortgage with no money down whatsoever.

Mortgage Intelligence's Edgar says some lenders will approve you for a 107 percent mortgage that will cover the full purchase price of your property plus all the related closing fees and still leave you $3,000 for moving and renovation costs. To qualify, you need a golden credit rating.

But just because you can buy a house for nothing doesn't mean you should. "They'll charge an additional 4 percent in fees as well as steep interest rates," says Edgar. So often, it's better to hold off until you've saved a down payment of at least 5 percent to take advantage of lower rates.

Choose a rate
Although the economic climate and the state of the stock market will largely determine what interest rate you'll pay on your mortgage, you have some say in the matter. You may choose either a fixed-rate or a variable-rate mortgage.

With a fixed-rated mortgage, your interest rate is locked in and won't change for the duration of the term. With a variable-rate mortgage, the interest rate will fluctuate according to the market and the Bank of Canada's interest rate.

The benefit of a fixed rate is your monthly payments remain the same for the entire term of your mortgage. So, it's easy to budget for and there'll be no surprises.

The disadvantage is fixed-rate products have higher interest rates, as lenders hedge themselves against the possibility of climbing interest rates.

Historically, variable-rate mortgages have delivered more cost savings in the long run than their fixed-rate counterparts when interest rates are stable. But that doesn't mean they're right for everyone.

"It's a lot like the stock market," says Cara MacKillop, mortgage development manager at VanCity, Canada's largest credit union, in Vancouver, B.C. "You have to believe in the philosophy that you'll be better off over the long term and can handle the short-term fluctuations."

The best-case scenario with a variable-rate product is interest rates decrease over the term, and a greater proportion of your monthly payment goes toward paying down the principal, and you end up paying down your mortgage ahead of schedule.

The worst-case scenario, on the other hand, requires a high risk tolerance and good cash flow, says MacKillop. If interest rates increase such that your monthly payment is paying off only the interest on your mortgage, your payment will be increased because it must also pay off the principal.

If you have the cash flow to ride out a period of rising interest rates before being able to renegotiate your rate at the end of the term, you'll be fine. But if you don't, you could be stuck with increased monthly payments you can't afford, so it's better to stick with a fixed rate.

Choose a term
The term is the length of time your contract for repaying your mortgage -- which establishes all fees, interest rates and prepayment options -- remains in place. A term lasts anywhere from six months to 10 years.

Once your term is up, you may either pay the entire outstanding balance of your mortgage or negotiate the conditions of a new term.

First-time buyers who plan on staying in their house for more than a couple of years generally favor long terms (considered three years or more) for the same reason they favor fixed rates because locking in rates over the long term gives them stability.

The downside to longer terms are higher interest rates. Generally, the shorter the term, the lower the interest rate.

According to Janice Church, manager of Scotiabank's Horizon Square branch in Calgary, short terms -- usually less than two years -- are for people who believe interest rates will fall by the time they renew their mortgages or expect big life changes.

"If you are anticipating changes to you income, try a shorter term so you have the option to shorten your amortization and increase your payments or make lump-sum payments to change the look of your debt," says Church.

If you're plugged into the world of business and like speculating which way interest rates are headed, shorter terms can save you money. But you run the risk of interest rates being higher at renewal time. So if your budget is tight, stick with a long term.

Choose prepayment options
Most mortgages are amortized over 25 years, which means it takes that long to pay them off completely.

If you want to pay your loan off within a few years, however, choose an open mortgage. Open mortgages have a built-in opportunity for you to pay the balance of your loan ahead of schedule without penalty charges.

It's an option you pay for, though. Since the lender has no guarantee of how long you'll be making interest payments, they'll charge you higher interest rates. But open mortgages are helpful for people who plan on selling their property in the near future or expect to come into a bit of money.

Most first-time buyers don't have the extra cash to pay off their entire mortgage even if they wanted to, which is why closed mortgages are their best option.

Closed mortgages do not allow prepayment without a hefty penalty. But they do have lower interest rates because lenders feel comfortable knowing they have years of interest payments from you to look forward to.

Bruce Gillespie is a freelance writer and editor in Simcoe, Ont.

-- Posted: Sept. 20, 2004
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