Navigating mortgages in Canada can be overwhelming. There are many different options that may cost you thousands of dollars. This guide will help you understand the difference between mortgages. Additionally, it will help you find the best type of mortgage for your goals.
|Amortization||The total amount of years it will take to pay off your mortgage. Typically 25 years in Canada.|
|Term||Every few years, you can change the characteristics of your mortgage. This is known as a term and typically lasts five years in Canada.|
|Down Payment||The amount that you must pay upfront to receive a mortgage. The minimum down payment ranges between 5%-20% of the home purchase value.|
|Loan-to-Value||The opposite of down payment percentage. It is the percentage of the total purchase value your bank lends to you.|
|Mortgage Default Insurance||Protects your lender if you default on your mortgage. You need mortgage default insurance if you have a down payment below 20%.|
|Fixed or Variable Rate||Fixed rates don’t change with the prime rate, whereas variable rates do.|
|Open or Closed Mortgage||Open allows you to make prepayments, while closed has penalties for overpaying.|
|Reverse Mortgage||Allows you to receive tax-free income from your home equity in retirement. Must be repaid when you move.|
|Home Equity Line of Credit (HELOC)||Allows you to use your home like a credit card. Must make at least interest payments on the amount you use each month. There are no payments if you don’t use the HELOC.|
|Mortgage Refinance||Required if you make significant changes to your mortgage agreement.|
|Mortgage Renewal||A renewal happens when your term ends, and you need to renegotiate a new term.|
There are many types of mortgage options available in Canada. These include: LTV ratios, fixed rates, closed payments and more. We'll explore all these options below.
Currently, you will get the best mortgage rate if your mortgage has the following characteristics:
When you buy real estate in Canada, you are required to pay a down payment ranging as low as 5% to 20% of the purchase value. Loan to Value (LTV) is the opposite of your down payment percentage. It is the percentage of the property value your mortgage lender is providing. For example, a 5% down payment would have a 95% LTV, a 20% down payment has an 80% LTV, and so forth.
When your LTV ratio is above 80%, meaning below a 20% down payment, your mortgage is considered to have a high ratio. Your down payment provides a safety cushion to your mortgage lender in the event they need to sell your property due to default. As a result, a high ratio mortgage is riskier to your lender because the lower down payment provides less safety cushion. If your LTV exceeds 80% (less than 20% down payment), you will need mortgage default insurance, explained in the next section.
If your LTV is below 80% (above 20% down payment), your lender has more safety cushion, so you will not need mortgage default insurance. You will have a low ratio mortgage, which doesn't need mortgage default insurance. This is also known as a conventional mortgage. To clarify, a low ratio mortgage is the same as a conventional mortgage because the down payment is greater than 20% (below 80% LTV).
As mentioned previously, if you have a high ratio mortgage (below 20% down payment, above 80% LTV), you will need CMHC mortgage default insurance. The purpose of this insurance is to protect your lender if you default on your mortgage. The Canadian government enforces this insurance to ensure the financial system is stable.
There is less risk for your lender with this insurance because it guarantees payment if you stop making monthly mortgage payments. Due to the lower risk, you'll receive the lowest mortgage rates with mortgage default insurance (and a lower down payment requirement).
However, there are rules to qualify for mortgage default insurance in Canada. For example, the property purchase value can't exceed $1 million, there's a maximum amortization of 25 years, and you must meet minimum credit score requirements. If you do not meet these requirements, you won't be able to make a down payment of less than 20%. This means you will need a conventional mortgage if you don't qualify for CMHC insurance.
As with any insurance, there is an added cost. In Canada, mortgage default insurance costs vary depending on your down payment percentage. However, the lower mortgage rates you receive often negate these added costs.
While amortization is the total amount of years you are set to pay off your mortgage balance, you must renegotiate characteristics every few years. The re-negotiation is a mortgage term that typically lasts for five years. This means throughout a 25 year amortized mortgage, you will have five terms and four re-negotiations. However, you may also change your term to your liking.
For example, you can have a ten-year term that locks in your fixed rate for a decade. Additionally, you can have a three-year term meaning you'll have to renegotiate more frequently. A three-year term could be beneficial if you expect your financial situation to improve soon.
Mortgages in Canada can be fixed or variable. This is a source of confusion for many first-time home buyers in Canada. Here's a quick explanation:
Variable-rate mortgages tend to have better interest rates during periods of prolonged low rates. This is because you expose yourself to the risk of your payments increasing with rising rates. This risk is also known as interest rate risk.
In general, it's best to choose a fixed-rate mortgage when you expect interest rates to rise over the next few years. This is because when the interest rates rise, your variable rate mortgage payments will also increase. Additionally, you may consider extending your term to lock in the low interest rates for a longer duration. For example, if you expect interest rates to rise over the next ten years, you should seek a fixed-rate ten-year term to lock in today's low rates for the next ten years.
The opposite is true when you expect interest rates to decrease. Decreasing interest rates are best for variable-rate mortgages because your payments are lower, whereas fixed-rate payments stay the same.
An open mortgage means you can make prepayments toward your mortgage balance without penalty. You can think of the name as the mortgage is open to prepayment. The other option is a closed mortgage, meaning there are prepayment penalties. Typically, you can only pre-pay 10-20% of the principal each year with a closed mortgage. Any additional payments on a closed mortgage will need to pay penalties.
If you plan to pay off your mortgage more aggressively, then an open mortgage is best for you. This is because you will not need to pay extra fines for overpaying your balance. Although open mortgage interest rates are higher than closed, the difference won't matter if you pay it off quickly. Additionally, if you can predict when you’ll have extra money to pay off your mortgage, then you can switch to an open mortgage for a term and then back to closed after. This way, you’ll avoid prepayment fees and higher interest rates.
Open mortgages allow you to pre-pay your mortgage and save money. They are beneficial for those who want to sell their home soon or pay off their mortgage quickly. In contrast, closed mortgages benefit those with lower interest rates that they don't want to lose by paying off their balance early.
|Who it’s designed for||Comparative interest rates|
|New Mortgage||First time home buyers||Lower|
|Renewal||Existing homeowners when their term ends||Changes with market interest rates|
|Refinance||Making major mortgage changes such as financing an investment property||Higher|
Another important aspect of Canadian mortgages is whether you want a new, renewal or refinance mortgage.
Almost everyone in Canada has a traditional mortgage. All of the mortgages mentioned above can be considered traditional mortgages. As you make mortgage payments, you gradually build equity in your home. After your amortization is over and you have fully paid off your balance, you own all of your home equity.
You can think of home equity as the portion of your home that you own. It is calculated as the market value of your home minus any debt owed on your property. When you first buy a home, your down payment is the amount of home equity you have. As you make mortgage payments, your debt decreases to build more home equity. Additionally, as your property value appreciates, you receive home equity. There are many different mortgage products in Canada that allow you to tap into your home equity for loans.
However, a reverse mortgage is the opposite - your mortgage lender pays you to build equity in your home. They are great for retired individuals who want tax-free income. Eventually, you must pay back the lender with some interest when you move or sell the home. To qualify for a reverse mortgage, you must have sufficient equity in your home. Typically, you can borrow up to a 55% LTV, must also be older than 55, and meet other eligibility criteria mentioned in our reverse mortgage article. There are three ways to receive tax-free payments from your reverse mortgage:
Again, it's worth understanding that these payments are tax-free and do not need to be repaid until you move from the house. Additionally, any appreciation to your home still belongs to you. This means when you eventually sell your home, any increase in value can help pay off the reverse mortgage loan.
A higher-tier lender will generally provide you with better interest rates, but they are harder to qualify for a mortgage. The stricter application process is due to more government regulations that the lenders face to become A-level. For example, Canada’s chartered banks and credit unions can be considered A-lenders. These financial institutions are federally and provincially regulated and have the most selective qualification criteria. To qualify for an A lender mortgage, you must have income stability and meet minimum credit score requirements.
When mortgage lenders assess your mortgage application, they review your ability to make mortgage payments. In particular, they look at your debt service ratios which show the percentage of your income that goes towards housing and debt payments. Additionally, they will also perform a stress test calculation to see if you can handle an increase in interest rates. The stress test increases your mortgage rate to the higher of 5.25% or your current rate plus 2% to see if the increased payment size still meets debt service requirements.
If you are denied a mortgage from an A-lender, then a B-lender is your second best option. Canadian B-lenders are somewhat regulated by the government, but not to the same extent as A lenders. B-lenders have more flexibility and offer innovative mortgage products, such as an interest-only term. You may even receive a better interest rate from a B-lender than a Big 6 bank in Canada, however, not always. Although these lenders have benefits, only about 12% of Canadian mortgages originate from B-lenders.
A C-lender, otherwise known as a private mortgage lender in Canada, has the easiest approval process. However, private mortgage interest rates tend to be higher. These institutions pool money from various investors and are not regulated by the government. You may require a private mortgage lender if your credit score is below 600. In general, private mortgage lenders should be used as a stepping stone while improving your financial situation. At the end of your C-lender term, your goal should be to qualify for a B or A-lender.
If your goal is to buy a home for the first time in Canada, two mortgages are designed to meet your needs; a Conventional/ Low-ratio or a high-ratio mortgage. You can receive a conventional mortgage if you have enough of a down payment saved up. Otherwise, high ratio mortgages allow you to buy a home with a down payment as low as 5%-10%. There are other variations depending on your financial situation:
If you already own a primary residence and want to purchase an investment property, there are multiple ways to leverage your current home. In most cases, you can use the home equity of your primary residence to fund the down payment of your secondary residence. The best tools to do this include a HELOC or Cash-out refinance.
If you do not own a primary residence and want to buy an investment property directly, you can use a high ratio mortgage with CMHC insurance as long as you live in one unit. You must also follow the CMHC rules.
There are construction loans if you want to finance renovations or build a new property. For more significant investment properties, such as commercial real estate, you can receive a commercial mortgage to fund the purchase. Finally, there are even mortgages to buy land in Canada, which you can then use a construction loan to develop.
Retired individuals typically have lots of home equity and want income. The two main options for this are reverse mortgages and a home equity line of credit. The difference between these two choices is that you must make monthly payments on HELOC draws whereas you only need to pay back a reverse mortgage when you move. However, the interest rates for reverse mortgages are higher than HELOC rates.
Mortgages have been around in Canada for centuries, where land was used as collateral for loans. There were no banks or other lending institutions at that time - the only way to get a loan was to go directly to a wealthy individual or merchant.
The first mortgages were very informal, and there was no standard contract. Lenders would often take possession of the property if the borrower failed to repay the loan. Borrowers would also often default on their loans, leading to many properties being seized by lenders.
In the 1870s, the Canadian government began to get involved in the mortgage market. They created the first land registry system, making it easier to track mortgages and find people who had defaulted. This helped establish trust between lenders and borrowers, leading to the creation of banks, which would become the primary source of secured loans in Canada.
These days, almost all lending is done through banks or other financial institutions. People borrow money from these companies to purchase houses or other properties. Mortgages are the most popular financial product to buy real estate worldwide.
Mortgages are a huge part of the Canadian real estate market, and there are many different types to choose from. Whether you're looking to buy a home for the first time or want to invest in property, there's a mortgage that will fit your needs. We've outlined the most common mortgages in Canada and explained how they work. However, almost all Canadian mortgage lenders require you to get home insurance. So, whether you're a first-time home buyer or an experienced investor, be sure to read this guide before you start shopping for homes.