Before, going deep into the types of mortgage, first let’s understand what is a mortgage? A mortgage can be defined as –
The pledging of Real Property to a Creditor/Lender as security for a debt.
It is a financial agreement that helps people buy real property by borrowing large sum of money (debt) in exchange of a security.
There are two main parties involved in a mortgage agreement. They are:
- Lender (Mortgagee) – Who lends the money or mortgage
- Borrower (Mortgagor) – Who borrows the money or mortgage
Our previous video on what to expect in the mortgage brokerage exam helped many of our viewers understand the expectations of the mortgage brokerage exam. We also summarized Exam Weightings for Fundamentals of Mortgage Brokerage Course that helped people know the breakdown of marks based on the various units.
Passing a Mortgage Brokerage Exam is very tough for people as it includes a thorough understanding of the mortgage types and its processes. For e.g., there are more than 14 types of Mortgage in Canada that are available. Each borrower is different and has their own set of needs and requirements.
Now, we want you to focus on the concepts. To give you a brief idea, we have come up with the 5 Most Important Mortgage Types. If you are planning to become a Mortgage Broker, then you should know these 5 Mortgage Types and what they mean.
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5 Important Types of Mortgage
1. Fixed Rate Mortgage (FRM)
A Fixed Rate Mortgage (FRM) is a loan where the interest rate is fixed for the full term of the mortgage. With this type of mortgage, The mortgage payments stay the same over the entire term of the mortgage. This information provides the borrower with the security of precisely knowing the amount of each mortgage payment allocated to paying the interest portion and outstanding principal balance.
In the initial years of the mortgage, more of the payments go towards paying the interest than the principal balance remaining. Therefore, the length of time to pay off the mortgage takes longer. In order to compensate the lender for any rise in market interest rates during the term of the mortgage, the interest rate is higher on a fixed rate mortgage than the rate on a comparable variable rate mortgage.
Plus, this means that the longer the term of the fixed rate mortgage, the longer is the security borrower gets from unexpected market changes. This enables higher interest rates for fixed rate mortgages with longer terms.
2. Variable Rate Mortgage (VRM)
A Variable Rate Mortgage (VRM) is the exact opposite of the Fixed Rate Mortgage. It is a loan with an interest rate that may change (float) periodically during the term of the mortgage. The interest rate of the mortgage fluctuates with changes in market interest rates, which is typically the lender’s prime rate.
Most people hesitate to take this type of mortgage as the rate of interest can keep fluctuating which gives a level of uncertainty and risk in their financial plan.
People with loose cash in hand after monthly expenses i.e., tight monthly budgets, unstable or temporary jobs, as well as those who like security and certainty of mortgage payments prefer fixed mortgages over variable mortgages.
Because it involves uncertainty and change in the interest rates with this type of mortgage, the rates are comparatively lower as opposed to that of the fixed mortgage rates.
People with higher financial credibility and job security prefer the variable type of mortgage.
3. Open Mortgage
An Open Mortgage allows the borrower to repay all or part of the principal amount at any time of the mortgage term without notice, penalty, or extra charges.
The faster and bigger the mortgage payments are made, the earlier the loan can be repaid. It can thus prove as a disadvantage for the lender. Thus, to make things even for the lender and the borrower, open mortgages typically have shorter terms and carry higher interest rates to compensate for their increased payment flexibility.
People with higher income inflow typically prefer this, to pay out the mortgage as soon as possible.
4. Closed Mortgage
A Closed Mortgage is the opposite of the Open Mortgages. They lock the borrower in to the interest rate and features of that mortgage for the entire term. Options for payout may be limited and typically incur penalties.
While there is less prepayment flexibility with a closed mortgage, most lenders offer some form of prepayment privileges as well as lower interest rates as the mortgage term is typically higher than that of the open mortgage types.
5. Assumable Mortgage
We can have properties on sale that still have their mortgage to be paid off. If a buyer purchases a property with an existing mortgage (ongoing with the seller) on it as part of his or her purchase agreement, he or she may assume that mortgage. This means the buyer takes possession of the property and assumes the obligations and payments under the existing mortgage.
There may be advantages for the buyer in such a practice. It might be that the interest rate on the existing mortgage can be lower than that of the current rates.
These are some of the basic types of mortgage that are used in general practice. There are many other different types of mortgage that will be covered in the later videos.
Learn about the Most Important Topic in Real Estate Studies – DOWER ACT
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