Mortgage Payment Options
Decisions, decisions, decisions. After first settling on a lender and term, applying for a mortgage will typically require a borrower to make several important choices at the outset. Among these, amortization, payment frequency, and property tax collection will rank among the most common. Although each is important in its own right, it should be mentioned that nearly all of these decisions can be re-visited and changed after a mortgage is set up and funded, with the notable exception of the registered amortization.
Choosing an Amortization
Amortization is the time in which a mortgage charge is slated to be paid off; in other words, it is the expected date a mortgage principal will be paid off, assuming the current payment and interest rate. This is distinct from the length a mortgage rate is secured for, called the "term". Canadians will typically renew their mortgage terms many times throughout the life of an amortization and in nearly all cases, the payment will go up/down each time.
The maximum registered amortization for most lenders is 30 years (when equity is greater than 20%), and 25 years (when equity is less than 20%), though there are some exceptions to this. Generally, registering amortization for the maximum length of time allows for most payment flexibility because you can reduce your effective amortization from what is registered on title, but you can never increase it. So, an initial payment might be based on a 30 year registered amortization, but increasing your regular payment will make the effective amortization 20 years. But if a mortgage is registered with a 20 year amortization, payments could never be dropped to make the effective amortization greater than this.
The most important thing to remember about amortization is that it can (and should!) be reduced over time. Prepayments (either lump sum, or gradually increasing the regular payment) are the surest way to accomplish this.
Choosing a Mortgage Payment Frequency
The choice of payment frequency is one of the major decisions a borrower must make when setting up a mortgage. While much of this decision boils down to personal preference, there are some obvious factors that should be weighed in the decision. Many borrowers like to align their mortgage payment with their paycheque cycle (often-biweekly) to ensure money will always be available in the account. For first-time homebuyers who are used to a monthly rent payment, a monthly payment often might make the most sense. Finally, there is a small interest savings to be gained by setting up on the most frequent payment cycle, weekly.
"Accelerating" a weekly or bi-weekly payment simply means increasing the regular payment by an extra month's worth of payment to your mortgage (spread out over each year). So, an accelerated bi-weekly payment is exactly half of a monthly payment, while an accelerated weekly payment is exactly one quarter of a monthly payment. Accelerating a payment does indeed reduce interest cost (because the principle is being paid down quicker), but the total payments over the term will be considerably higher.
Here's an example of a payment frequency breakdown by various cycle*:
|Payment||End-of-Term Balance||Payments over term|
*All calculations assume a $400,000 initial principle, 3.00% interest rate, 5 year term and 25 yer amortization
Interest Adjustment Dates/Initial Payments
Once a payment frequency is chosen, it is important to understand how (and when) the first payments are calculated. Mortgage payments are made "in arrears" which means they cover payment for the periods that precede them. This is different than rent payments, which are made "in advance". So, a mortgage payment won't be due until at least one period from the date it funds. Sometimes, a there will be an partial initial payment to bring a mortgage onto schedule. This payment is called an "interest adjustment" and falls on the Interest Adjustment Date (IAD). For example:
- Borrower chooses monthly payments, to be deducted on the 1st day of every month
- Mortgage is advanced on the 19th of July
- 1st deduction will be on August 1st (IAD), but will be a partial payment covering only 12 days of interest (from the 19th-31st)
- 1st regular payment will start on September 1st
Property Tax Payments
Many lenders will offer an option (in fact, some will even require) to collect property tax instalments on their borrower's behalf. This regular property tax payment is put aside into a separate tax account which the lender will use to pay property taxes when they are owing. This payment will be adjusted regularly to account for property tax changes, though situations can arise where the account is in shortfall (requiring the borrower to pay a lump sum). Lenders are generally happy to administer property taxes on behalf of their borrowers since a mortgage charge has less legal priority than overdue taxes owing to a municipality.
Question we haven't answered? Contact us for more information about payment frequencies and options.