Suppose you want to purchase a property or rather a piece of real estate such as a house or a condominium. If you have enough money then you can purchase the property from your own pocket or rather bank account. If you don’t then you refer to a bank or a financial institution such as a credit union to borrow money. Since the amount that you borrow for the property is usually large the financial institution requests for a conditional pledge of your property as security against the borrowed money (i.e. the loan). This is called mortgage. The loan that you get with this method is called “mortgage loan”. For the purpose of this article I will use the terms “mortgage” and “mortgage loan” interchangeably.
Mortgage contract outlines your obligations and options in paying the debt. It also explains the consequences of breeching the contract. I will explain some of the terms used in Canadian mortgage contracts also known as mortgage agreements and also some of the terms that you may see on your mortgage loan statement.
Mortgage amount: This is the money that you owe to the bank
Original balance: The mortgage amount that you have borrowed originally.
Outstanding principal: The mortgage amount that you haven’t paid yet. Outstanding principal is initially the same as the original balance but as you continue paying the installments it becomes less than the original balance.
Interest rate: Interest is the cost of borrowing money from a financial institution. Interest rate is a percentage or ratio that relates the interest to the amount of money that you have borrowed. Click here for more information about “Interest rate”.
Accrued interest: The interest that you owe the bank but have not paid it back yet.
Amortization: It is the duration in which you will pay off the mortgage in full. For example if amortization is 25 years then you will pay off the mortgage in 25 years.
Rate type: This could be “fixed” or “variable”. Click here for more information.
Interest term: The interest term refers to the duration that you and bank have agreed on certain conditions for the interest rate and payment installments. The “interest term” is usually less than “amortization”. For example the amortization could be 25 years but you fix the interest rate for 5 years only. Thus the Interest Term is 5 years.
Payment frequency: You may pay the installments on a monthly, semi-monthly, weekly, bi-weekly, or any other intervals agreed between you and the bank.
Regular payment: The amount that you pay according to your contract on predefined intervals. For example if “regular payment” is $500.00 and payment frequency is monthly then you pay $500.00 every month. Part of the regular payment pays the accrued interest and the rest of it pays down the principal or rather the amount that you owe. In the previous example if the accrued interest amount is $200.00 then you are paying down $300.00 (i.e. $500-$200) of the amount you owe to the bank.
Payment due date: The upcoming date to pay the regular payment.
Maturity date: The date that “mortgage term” ends. This refers to the time that you need to renew your contract with the bank or seek another lender.
In Canada mortgages could be “open” or “closed”. An open mortgage gives you the flexibility in terms of how much you pay. While this type of mortgage defines regular payments it also gives you the ability to pay down or even pay off your mortgage when you have more money in hand. On the other hand a closed mortgage does not allow you to pay as much as you want. The interest rate on open mortgages are usually higher. They are good fit if you expect to pay off the mortgage loan very soon (e.g. you expect to sell another property in the near future and pay off the loan then).
Mortgage loan could also be “fixed” or “variable”. This actually refers to the way interest rate is calculated. Click here for more information.
When you want to apply for mortgage loan it is better to know how much you can afford based on your income. Mortgage calculators can definitely help you with budgeting. Click here to access a mortgage payment calculator by Royal Bank of Canada.