Whether your client is a first-time buyer or a current owner who is renewing their mortgage, their commitment to the right (or wrong) mortgage loan can last for years and years and will have a serious impact on their finances – and by extension, on their ability to meet all of their other financial obligations.

Here are the key factors your clients must consider:

• The type of mortgage (closed, fully open or partially open);
• The interest rate being offered; and if it is fixed or variable;
• The term of the mortgage;
• The amortization period (which is the time it would take to pay off the mortgage based on a certain payment amount for a certain number of years); and
• Whether the mortgage can be transferred to a new property they may purchase without any penalty;
• The cost of paying off the mortgage early (before the end of the term).

Term versus amortization

As a quick aside, it should be noted that the distinction between the mortgage’s term and its amortization period can be difficult for many people to grasp.

Simply put: the mortgage term is the period of time that you, as the borrower, are committed to a specific lender, under the particular provisions of the mortgage that you have agreed to. This document sets out the agreed interest rate and terms for that period. The term of a typical residential mortgage is somewhere between one and five years.

In contrast, the mortgage amortization period is the length of time it will take you as borrower to pay off the mortgage entirely, calculated using the entire amount you borrowed, applying a fixed interest rate, and based upon only making the minimum required payments. For example, a 25-year amortization means that if you pay the mortgage-stipulated payment amount of principal and interest, if it is governed by a 25-year fixed interest rate, and you make no extra payments, then you will have paid off your mortgage at the end of 25 years.

(Note that to be eligible for mortgage insurance, the mortgage amortization period must not exceed the current maximum of 25 years. If no mortgage insurance is required, then the amortization might be as long as 40 years).

Pre-payment penalties

One of the other factors to consider when your client is mortgage shopping relates to penalties. As the borrower, you will very likely be subjected to a penalty for paying off the mortgage earlier than at the end of the original term (unless the mortgage is fully open). This means that you will need to ask yourself the simple question: “How much will it cost me to pay off the mortgage before the maturity date?”

The standard penalty is usually based on the greater of:

• A sum equivalent to three months’ interest on the balance being paid out before maturity, or

• The interest rate differential.

The interest rate differential is calculated on the difference between the interest rate that you are paying for your existing mortgage versus the then-current rate being charged by your mortgage lender for this type of mortgage product at the time you wish to make either a partial pre-payment or else discharge the mortgage completely.

Ideally, your mortgage will include a provision allowing for some pre-payment that does not incur a penalty; this type of mortgage clause allows you to pre-pay a certain percentage of the original principal owed of the mortgage annually. This pre-payment provision is always non-cumulative; in other words, “use it or lose it”. The mortgage may also be assumable or portable, which gives the most flexibility.

I personally do not recommend that you allow your mortgage to be assumed by a purchaser of your home. Generally, most mortgage lenders will not release you from your obligations under the mortgage; in other words, you remain liable if your purchaser defaults in making any payments or other obligations contained in your mortgage.

Renewal or renegotiation

Another key consideration relates to the nature of the terms and conditions that you may be offered by the lender when you renew your mortgage, or when you re-negotiate it during its current term (for example, if after some period of living in the home you need to increase the principal amount borrowed).

As the borrower, you should re-evaluate your needs and financial capacities before talking to your mortgage lender, including:

• The ease or difficulty with which you have been making the existing mortgage payments, in the context of your overall household budget and other financial obligations;
• Whether you have other, higher-interest debts to ideally consolidate into the mortgage at a lower rate than you are paying on other debts/loans;
• Whether you would prefer to change the payment amount or frequency on any new/renewed mortgage; and
• Whether you would like the flexibility of increasing the number of pre-payments that can be made each year, and the amount of each payment.

Upon renewal or renegotiation, you should also ask the lender whether, as an existing client, you might qualify for any special or discounted rates.

And remember: Mortgage renewal is only an option; you are never obliged to stick with the same lender after the initial mortgage term ends. You can always shop around for a better rate or better terms and other options with a different lender.

Mortgage shopping has its complexities. Needless to say, it’s important that your client gets the proper information – ideally from an independent professional advisor – because the decision to commit to a mortgage is financially profound and long-lasting.

Martin Rumack

Toronto lawyer Martin Rumack’s practice areas include real estate law, corporate and commercial law, wills, estates, powers of attorney, family law and civil litigation. He is co-author of Legal Responsibilities of Real Estate Agents, 4th Edition, available at the TREB bookstore and at LexisNexis. Visit Martin Rumack’s website.