Key Mortgage Terms Every First-Time Homebuyer Should Know

Buying a home for the first time is an exciting milestone, but the mortgage process can be overwhelming with so many unfamiliar terms. To help you navigate this journey, we’ve compiled a list of essential mortgage terms that every first-time homebuyer in Canada should understand.

1. Overnight Rate

The overnight rate is the interest rate at which major financial institutions borrow and lend one-day (or overnight) funds among themselves. Set by the Bank of Canada, it influences the interest rates that lenders offer on mortgages and other loans. A change in the overnight rate can affect variable-rate mortgages and lines of credit.

2. Prime Rate

The prime rate is the interest rate that commercial banks charge their most creditworthy customers. It’s influenced by the overnight rate set by the Bank of Canada. When the prime rate changes, it can impact the interest rates on variable-rate mortgages, home equity lines of credit (HELOCs), and other financial products.

3. High-Ratio Mortgage

A high-ratio mortgage is a mortgage where the down payment is less than 20% of the home’s purchase price. If you have a high-ratio mortgage, you’ll be required to purchase mortgage default insurance, which protects the lender in case you default on the loan.

4. Mortgage Stress Test

The mortgage stress test is a qualifying criteria designed to ensure that borrowers can afford their mortgage payments if interest rates rise. In Canada, all borrowers must qualify for their mortgage at a higher interest rate than what they are being offered, which is either the Bank of Canada’s benchmark rate or 2% above the lender’s rate, whichever is higher.

5. Inflation

Inflation is the rate at which the general price level of goods and services increases over time. Rising inflation can lead to higher mortgage interest rates as lenders adjust for the decreasing purchasing power of money. Keeping an eye on inflation trends is important when considering a fixed vs. variable rate mortgage.

6. Amortization Period

The amortization period is the total length of time it will take you to pay off your mortgage in full. Common amortization periods in Canada are 25 years or 30 years. A longer amortization period lowers your monthly payments but increases the total interest paid over time.

7. Return on Investment (ROI)

In the context of homeownership, ROI refers to the profit or loss you realize on the home when you sell it, relative to your original investment (down payment and mortgage). It’s an important factor for those looking to build equity or profit from their property over time.

8. Down Payment

The down payment is the initial payment you make toward the purchase of a home. In Canada, the minimum down payment is 5% for homes priced up to $500,000 and increases for homes priced above that. A larger down payment reduces the amount you need to borrow and can also lower your mortgage insurance costs.

9. Debt-to-Income Ratio (DTI)

Your debt-to-income ratio is the percentage of your monthly income that goes toward paying debt. Lenders use this ratio to assess your ability to manage monthly mortgage payments and other debts. Ideally, your total debt payments, including your mortgage, should not exceed 40-44% of your gross monthly income.

10. Variable vs. Fixed-Rate Mortgages

A variable-rate mortgage has an interest rate that can fluctuate based on changes to the prime rate, meaning your mortgage payments can increase or decrease over time. A fixed-rate mortgage, on the other hand, locks in your interest rate for a set term, providing stability in your payments. First-time buyers need to carefully weigh the pros and cons of both types when choosing their mortgage.

11. Mortgage Term

The mortgage term is the length of time your mortgage agreement is in effect, which typically ranges from 1 to 5 years. At the end of the term, you’ll need to renew your mortgage at a new interest rate. The term should not be confused with the amortization period.

12. Pre-Approval

Getting pre-approved for a mortgage involves a lender assessing your financial situation and determining how much you can afford to borrow. This gives you a clearer idea of your budget and can make the home-buying process smoother. It’s important to note that pre-approval is not a guarantee of final approval.

13. Closing Costs

Closing costs are the fees you need to pay when your home purchase is finalized. They typically range from 1.5% to 4% of the home’s purchase price and can include legal fees, land transfer taxes, and other related costs. First-time buyers should budget for these costs in addition to their down payment.

14. Home Equity

Home equity is the difference between the value of your home and the outstanding balance on your mortgage. As you pay down your mortgage and as your property value increases, your home equity grows. You can borrow against your home equity with products like home equity lines of credit (HELOCs).

Conclusion

Understanding these key mortgage terms can help you make informed decisions as you navigate the home-buying process. Whether you’re deciding between a fixed or variable rate mortgage, calculating your down payment, or considering the impact of the mortgage stress test, knowing the terminology can make all the difference. For more personalized advice, reach out to us at Mortgages for Less—we’re here to help make your homeownership dreams a reality!