Mortgage Financing and the Cost of Borrowing
Mortgage fundamentals
A mortgage is a charge on land securing repayment of a debt. Know the parties (mortgagor/borrower, mortgagee/lender), the difference between a conventional and high-ratio mortgage, and the role of mortgage default insurance. Understand first and second mortgages, the priority of registration, and the remedies of a lender on default, including foreclosure and power of sale where applicable.
Cost of borrowing
Candidates must compute and interpret interest, the annual percentage rate (APR), and the effect of compounding. In Canada, mortgage interest is compounded semi-annually, not in advance for many fixed-rate mortgages, and the posted rate differs from the contract rate. Know the difference between the nominal rate and the effective annual rate, and how a blended payment splits between principal and interest over time. Understand prepayment privileges, penalties (three months' interest or interest rate differential), and the stress test qualifying rate.
Traps
A classic trap is confusing the interest rate with the APR, which includes fees. Another is assuming that a lower monthly payment always costs less overall; longer amortization increases total interest. Questions also test whether a buyer can assume a vendor's mortgage - assumption requires lender consent and does not release the original borrower unless the lender agrees.
Worked example
A $500,000 mortgage at 5% compounded semi-annually has a periodic rate per half-year of 2.5%. The effective annual rate is (1.025)^2 − 1 = 5.0625%. A borrower comparing a 5% loan with a 5.0625% effective cost against a loan quoted at 5.1% annually should prefer the first on rate alone, before fees.