Amortization

Amortization simply involves paying off debt with equal payments at equal intervals over time. An example of this is a fixed rate mortgage – your monthly payment remains the same throughout the entire life of your loan.

Even though your monthly payments might look the same at face value ($500 a month let’s say), it’s important to understand how to break down each payment into two components – interest and principal. Each time you make a monthly mortgage payment, part goes towards paying off the interest on your loan, while the rest goes towards the principal (or the remaining amount you owe on your loan).

At first, a significant portion of each of your mortgage payments goes towards paying interest, while a small percentage covers the principal. Over time, the amount you pay in interest each month slowly decreases, while the amount that goes towards the principal slowly increases. By the time you reach your last payment, it will be made up of entirely principal – and you’ll have paid off you loan!

Now, you’re probably thinking – “That’s nice, but why does this matter?”

When making decisions about amortized loans (home and car loans are common), many people make the mistake of looking at only the cost of each monthly payment. While this is an important factor, looking at only the total monthly payment means you aren’t able to see how much you’re paying in interest vs. paying down your principal. To uncover this information, it’s smart to create an amortization table that outlines how much you’re spending and where. That way, you can see easily and transparently, the actual cost of your loan. You may, for example, be getting a lower monthly payment, but be paying for your loan over a longer period of time, meaning you are paying more in interest than if you went with a higher monthly payment from day one.

 

Mortgage rate

A mortgage rate indicates the amount of interest a lender charges you when you take out a mortgage. It’s always in your best interest to get the lowest rate possible, because a lower rate means lower monthly mortgage payments. You can either choose a fixed-rate mortgage (interest rate stays the same) or a variable-rate mortgage (interest rate fluctuates), which are both described above.

So, why are different mortgage rates offered?

Lenders prefer working with people who are likely to make their loan payments in full and on time. To determine how likely this is, banks look at your credit score. If you have an excellent credit score, you’re more likely to quality for a lower interest rate. If you have a lower credit score, you will likely get a higher rate or, if you have really poor credit, you may not qualify for a loan at all.

When selecting a mortgage, do your homework! Finding the best deal will likely involve shopping around to several different lenders.

Variable rate mortgage

A variable-rate mortgage is exactly what it sounds like – a mortgage in which the interest rate fluctuates. An increase in the interest rate means that your monthly mortgage payment will go up, while a decrease in the interest rate will make your monthly payment go down.

Typically, variable rate mortgages offer a low introductory interest rate – lower than the rates for a fixed rate mortgage. This can be a better deal initially, but once the introductory offer is over, it’s difficult to predict what your monthly payments will be. This makes financial planning more difficult. If interests rates went up significantly, you could be responsible for a monthly payment you can’t afford!

Even though variable rate mortgages are riskier than fixed rate mortgages due to their unpredictability, there are some scenarios in which it might make sense to choose one. You might, for example, plan to pay off your mortgage before the introductory period is over (so you avoid dealing with fluctuating rates entirely) or you might be confident that interest rates will go down, bringing your monthly payment down with it.

Either way, before selecting a variable or fixed rate mortgage, talk to a financial professional and carefully weigh the pros and cons of each option to determine what’s right for you.

Fixed rate mortgage

A fixed rate mortgage offers the same interest rate for the entire length of your loan. The benefit of a fixed rate mortgage is that you can predict exactly what your monthly mortgage payments will be – a great advantage for financial planning purposes.

Fixed rate mortgages are often compared to variable rate mortgages, which feature fluctuating interest rates. Variable rate mortgages typically offer a low introductory interest rate – lower than the rates for a fixed rate mortgage. This can seem like a really good deal upfront, but it’s possible for the interest rate to rise over the life of your loan, meaning you could end up paying much larger monthly mortgage payments.

Before selecting either a fixed or variable rate mortgage, it’s important to weigh the pros and cons of each option to determine what’s right for you and your financial situation.

 

Interest rate

When you borrow money from a bank, the bank charges interest as payment for letting you use their money. The amount of interest charged is expressed as a percentage of the principal – or the total amount of the loan.

The same works in the opposite way. When you put money in your savings account, you receive interest payments in exchange for letting the bank use your money while it’s sitting in your account.

You’ve probably seen interest rates advertised using the acronym APR. APR stands for annual percentage rate and it takes into account both the interest rate itself as well as lender fees.

When borrowing and lending money, understanding the interest rate and its impact is critical to ensuring you make an informed decision. When selecting a mortgage, for example, interest rates can have a significant impact on how much you pay in your mortgage payments each month.

 

Refinancing

Let’s say you took out a variable rate mortgage and interest rates are climbing. You’re starting to get worried that you won’t be able to keep up with your mortgage payments because higher interest rates mean higher monthly payments. What can you do? Are you stuck with your original loan terms forever?

No, not necessarily thanks to the concept of refinancing. Refinancing simply means replacing an existing loan with a new loan, presumably with better terms. Basically, you take out a second loan, use the new loan to pay off the first, and then pay back the new loan in monthly installments just like before, only with a better deal.

Refinancing can mean lower monthly payments, a lower interest rate or a change in the length of the loan, depending on what you negotiate with your lender. Refinancing is also a time consuming and sometimes expensive process, so it’s important to think through your options carefully before refinancing.

 

Reverse Mortgage

Use your home equity to borrow money, tax-free

A reverse mortgage allows you to take money from your home equity – tax-free-, without having to pay monthly mortgage payments. Unlike a regular mortgage that dwindles away as you pay it off, this type of loan rises over time as interest and loan fees accrue. This can come in handy if you’re reaching a retirement age and are sitting on a pile of home equity but haven’t hit your retirement goals. In order to tap into your home equity without selling and downsizing, a reverse mortgage can come into play. The older you are and more equity you own on your home, the bigger the loan you can secure.

How to qualify

First off, you must be at least 55 years old – as well as your spouse – and a homeowner to be eligible for a reverse mortgage. These loans can come in the form of a lump-sum payment, planned advances, or a combination of the two. Keep in mind, there are restrictions in Canada that limit the maximum amount you can receive. When it comes to paying back the loan, reverse mortgage balances are only due when the homeowner dies, sells the home or moves away permanently.

Deciding if this is a good idea

Before getting a reverse mortgage, make sure to weigh your options. These loans can be costly and eat away at your equity with interest and loan fees. There are also risks of not being able to pass your home down to your family after you die. That’s why it’s always a good idea to get outside advice about how a reverse mortgage could affect your financial plan.

 

BORROWING HAS A LOT OF INS AND OUTS

See how to optimize your debt

 

 

Start now