What is a Mortgage?

What is a Mortgage?

A mortgage is a legal document you sign when you buy or refinance a home or other type of property. The term ‘mortgage’ also refers to the home loan itself, which is secured against the property. A mortgage is typically a large loan that’s paid off over several years. And if it’s not paid on time, the mortgage agreement allows the lender to take possession of the property.

Key Takeaways:

  • A mortgage is a legal document you sign when you buy or refinance a property
  • Each mortgage payment can include up to four components known as PITI – Principal Interest Taxes Insurance
  • Mortgage principal is the outstanding balance of your mortgage
  • Interest is paid on top of mortgage loan payments as the cost of doing business with a lender
  • Lenders may also collect property taxes along with mortgage payments, particularly for first-time homebuyers
  • Lenders often require homeowners’ insurance be in place to cover property damage
  • Mortgage default insurance is mandatory when buying a property and making less than a 20% down payment
  • Second mortgage refers to an additional loan secured on a property that already has a first mortgage

 

What’s included in a mortgage payment?

Every mortgage payment includes at least two parts: 1) A portion of the amount owing on the outstanding principal balance; and 2) Interest on the outstanding amount of the home loan. Additionally, if you made less than a 20% down payment on your property, you’ll also be charged mortgage default insurance. And, finally, some mortgages – especially first mortgages – also include a collection of property taxes, which are then automatically paid on your behalf.

 

Principal

Mortgage principal is the outstanding balance of your mortgage – calculated as the amount borrowed from the lender minus the amount repaid to the lender. As mortgage payments are made, the mortgage principal is reduced.

 

Interest

Interest is paid on top of your mortgage loan payments as the cost of doing business with your lender. Your interest rate indicates the annual cost to borrow money from your lender. The rate is expressed as a percentage of your total loan balance and is paid on at least a monthly basis, along with your principal payment, until your loan is paid off. Because your mortgage balance decreases over time, you’ll pay more in interest at the beginning of your home loan.

Important: Because your mortgage balance decreases over time, you’ll pay more in interest at the beginning of your home loan.

 

Taxes

Your lender may collect property taxes along with your mortgage payments, particularly if you’re a first-time homebuyer to ensure your taxes are paid on time. You can also choose to have your lender collect these taxes for you. The tax funds are then kept in a special ‘escrow account’ by your lender until your property tax bill is due, at which point they’re paid on your behalf.

Tip: Even if your lender doesn’t insist on collecting property taxes with your mortgage payments, this can be a great way to ensure your taxes remain up to date.

 

Homeowners’ insurance

Lenders often require homeowners’ insurance be in place to cover damage from fires, storms, accidents and other catastrophes. You can choose to insure your home and belongings for either their replacement cost or actual cash value. Replacement cost is the amount it would take to replace or rebuild your home or repair damages with materials of similar kind and quality, without deducting for depreciation. Actual cash value is the amount it would take to repair or replace damage to your home after depreciation. 

 

Mortgage insurance

Also known as ‘mortgage default insurance’, this is mandatory insurance you must have when buying a property and making less than a 20% down payment. This insurance protects your lender in the event you stop making payments and default on your mortgage loan. This insurance empowers Canadians, who may otherwise not be able to purchase homes, to be part of the real estate market. Without it, mortgage rates would be higher, as the risk of default would increase.

Tip: You can avoid paying mortgage default insurance by making a down payment of at least 20% of the property’s value.

 

What’s a second mortgage?

A second mortgage is a secondary loan on a home that already has a first mortgage in place. While a second mortgage also uses the home as collateral – and is, therefore, still much cheaper than unsecured loans or credit – interest rates are higher to reflect added risk since the first mortgage holds priority over the second if the home loan goes into default. Home equity loans and home equity lines of credit (HELOCs) are considered second mortgages.

Important: Home equity loans and home equity lines of credit (HELOCs) are considered second mortgages.

 

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