Understanding Your Mortgage
Whether this is a good or a bad thing depends upon which side of the table you happen to occupy. If you are the investor, you want the funds that you have lent out to attract interest on a semi-annual basis. However, if you are the borrower, you would prefer annual compounding.
Of course, most mortgagors do not want to be repaid in semi-annual or annual instalments. They want payments more frequently, usually monthly. So they take the effective interest rate as calculated above, and translate it into monthly portions that maintain the contracted cost of borrowing.
Besides the interest rate and its frequency of calculation there are several additional factors that go into the mortgage document. These are (a) an open or closed mortgage: an open mortgage allows the consumer the right to pay off the debt at any time within the contracted period provided that he pay a penalty to the lender at the time that it is exercised. In most cases the penalty is an increase to the interest rate of the mortgage of one-half of one percent. A closed mortgage, on the other hand, is a binding agreement that the debt will not be extinguished before the term of the contract has expired; (b) term and amortization period: the term of a mortgage is the amount of time over which the contract will extend. It is the time from the date that the funds are advanced to the borrower until the last payment is made and the contract completed. Today, most mortgages run for a period of between six months and five years, and, as a rule of thumb, the shorter the term, the lower the interest rate. The amortization period is the amount of time over which the debt will be paid off if the contract is renewed at the same rate of interest. Historically, the period of amortization for residential mortgages has generally been between twenty and thirty years. Today, however, with many families having two incomes, it is not uncommon to see much shorter amortization periods. A longer amortization period results in a lower monthly payment but a higher total interest cost over the term of the contract (please see the accompanying table); (c) variable rate mortgage: up to now we have assumed that the interest rate of the mortgage had to be maintained throughout the term of the mortgage. This is not the case. Since most mortgage payments are made up of an interest component and a principal repayment component, when the interest rate fluctuates, the balance between them shifts. With a variable rate mortgage, the interest varies with the current market rate. Typically, the monthly payments remain constant for the term of the mortgage but the amount of each payment that is applied to the principal repayment will either increase or decrease according to a drop or rise in interest rates; and (d) optional clauses: when negotiating a home mortgage, it is possible to include a clause that will allow the mortgagee to significantly pay down the mortgage prior to the end of its term. One such clause, for example, may provide for a payment, without penalty, of say ten percent of the debts outstanding balance on each anniversary of the mortgage. Other important clauses will allow the borrower to renegotiate the terms of the mortgage, almost always with the payment of a penalty, should interest rates drop considerably during the term of the mortgage as well as the right to transfer the mortgage to a third party should the property be sold.
How much will my mortgage cost me each month?
Spring 1999: Prenuptial Agreements | Understanding Your Mortgage | The Limited Liability Partnership | Automobile Expense Worksheet
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