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Mortgage math

Principal

Definition

The amount you actually borrowed.

Each payment is split between principal (which reduces your balance) and interest. Early years are mostly interest; late years are mostly principal.

Every mortgage payment does two jobs: pay the interest owed for the period and chip away at the principal. Because interest is charged on the outstanding balance, early payments are mostly interest and later ones are mostly principal — the curve flips over the amortization.

Paying down principal builds equity directly, dollar for dollar. That's why lump-sum prepayments are so powerful early in the term: every extra dollar of principal removes all the future interest that dollar would have generated.

Your remaining principal is what a prepayment penalty (and the balance you renew or refinance) is calculated on — so watching it fall is watching your real ownership grow.

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Amortization

The total length of time it would take to pay your mortgage off completely if the rate and payments stayed the same. In Canada, insured mortgages (under 20% down) are capped at 25 years, or 30 years for first-time buyers and buyers of new builds; with 20% or more down, the lender sets the maximum (commonly 30 years). A longer amortization lowers the payment but raises lifetime interest.

Equity

The difference between your home's current value and your remaining mortgage balance. Equity is what you can borrow against (HELOC, refinance) or what you keep when you sell.

LTV

Loan-to-Value ratio

Loan-to-value ratio: your mortgage balance divided by the property's value (the lower of purchase price or appraised value on a purchase). 80% LTV means 20% equity. Insured purchases can go up to 95% LTV on homes of $500,000 or less; above that, the 10% down-payment tier lowers the maximum.

Monthly payment

Principal + interest payable each month. Canadian fixed-rate mortgages are normally quoted with semi-annual compounding. Most lenders let you switch to accelerated bi-weekly or weekly payments to pay the mortgage off sooner.

Semi-annual compounding

The Canadian convention for fixed-rate mortgages: the quoted annual rate compounds twice a year rather than monthly. At the same quoted rate, semi-annual compounding costs slightly less than monthly compounding, so a Canadian rate isn't directly comparable to a U.S. monthly-compounded one.