explication finances

How do Mortgages Work in Canada?

When considering the possibility of buying your own home, it is essential to learn how a mortgage in Canada actually works, as it can be quite overwhelming for some.

Few people have the liquid cash available to purchase the full value of a home in cash. This is where a mortgage is essential for the majority of people. A mortgage is essentially a loan more specifically catered to lending on a property.

You will most likely borrow this money from a conventional high-street bank (although other options are available). Unlike most regular loans, a mortgage is normally paid off over a much longer period of time (generally 10-25 years in Canada). It is because of this length and high loan value that it is important to factor in various considerations before you go ahead with applying for a mortgage in Canada.

Mortgage Types in Canada

First of all, you will need to think about what mortgage you actually require, as there are different types:

Type Definition
Conventional Mortgage
This is your typical mortgage where you will make a down payment (typically around 20%), and you will pay off the outstanding balance over time, with the addition of an interest rate.
Open Mortgage
An open mortgage gives you the ability to pay off the balance of your mortgage as quickly as you like, without any penalties or high fees. Due to this ability, these mortgages generally come with higher interest rates. However, these types of mortgages are the best if you know you’re likely to be borrowing for a short period (EG – renovation projects which you will sell in 12-24 months)
Closed Mortgage
A closed mortgage comes with a fixed interest rate attached to it for the period of the loan. Because the interest is fixed and long-term, the lender tends to provide more favourable interest rates here, as their income is more certain.
Variable Rate Mortgage
A variable rate mortgage will track the prime rate. As this increases, so does your mortgage interest rate. This means that your monthly mortgage payments can fluctuate up and down over time. This could potentially be good or bad, depending on how far you may be stretching yourselves to obtain your mortgage.
Reverse Mortgage
A reverse mortgage is probably one of the more complex options available. This essentially allows you to receive a cash value for the equity in your home while you’re still living in it.

To apply for a reverse mortgage in Canada, you need to be 60 years old to qualify. This is essentially an option for senior citizens who require extra money to fund their retirement years.

Down-payment Requirements

The first thing to consider when getting a mortgage in Canada is the down payment and how much you need to save to get the type of property you are looking for.

The down payment on a mortgage must be paid upfront, and therefore there is no point in even looking for properties until this down payment has been set aside. This down payment is conventionally a percentage of the total purchase price of the property.

A good rule of thumb is to aim for 20% of the purchase price of the property. It is important to note it is based on the purchase price, not the valuation. Therefore, if a property is slightly out of your reach, but you can bring the seller’s price down, the mortgage is on the final agreed price.

There are mortgages out there that are available with smaller down payments. However, these are very dependant on personal circumstances, as well as the current economic situation.

Getting Mortgage Pre-approval

Getting your mortgage pre-approved basically allows you to go shopping for properties knowing exactly how much you can spend. This means that you can look at properties you know are definitely within your budget, and the lender will be prepared to provide you with a mortgage to purchase.

When looking to have a mortgage pre-approved, the lender will likely require several pieces of information and identification:

  • Proof of ID (driver’s license etc.)
  • Proof of Address
  • Employer’s Contact Info
  • Employment History
  • Proof of Income
  • List of Debts (Car loans, credit cards etc.)

It is important to stay on top of your debts, as these can have a surprisingly large impact on your mortgage’s affordability in a lender’s eyes. In addition to this, your credit history is important, as this will give the lender a glimpse into how suitable you are as a potential customer. Have you defaulted on loans in the past? Do you generally pay your credit card off quickly? Etc.

Choosing your Type of Mortgage

As broken down before, there are many types of mortgages in Canada to choose from. Generally, the best way to look at it for most people is whether you want an open or closed mortgage. Do you plan on making extra payments and paying the mortgage off early? Then you will want an open mortgage, as this will give you the extra flexibility you’re looking for.

However, if you want to keep your monthly payments as low as possible and have a lower interest rate, but you don’t mind paying the mortgage off over a long period of time, then a closed mortgage is the one for you. This is generally good for people who are buying their “forever home” where it doesn’t matter how long the mortgage period is, as they plan to live in that property forever. Just make sure that is definitely the case before you sign for your mortgage, as a closed mortgage generally has significant penalty fees if you try to make prepayments and break the mortgage agreement.

Mortgage Length

The time horizon of a mortgage is very location dependant. For a mortgage in Canada, the typical timeline is 10 to 25 years. This is the timeline in which it takes for you to pay off the principal mortgage amount, plus the interest that the lender has attached to your loan.

The length of mortgage which you choose can be incredibly important for your affordability in the short and long-term, so this can be one of the most important decisions when concluding on your mortgage. A longer mortgage term means lower monthly payments, but you will pay more in the long term as interest compounds over the longer period. However, a shorter mortgage term means higher monthly payments. It is important to take your personal current and future circumstances into consideration, with the main focus being on your income’s stability. Is it possible you may ever struggle to pay for the loan? Do you have an unpredictable or unstable career? (EG Self Employed) In that case, stretching the mortgage out to reduce the payments as much as possible may be the safest option.

When discussing your mortgage’s length with your lender, they will likely refer to this as the “Amortization Period.”

Interest Rates

Another choice to make is whether you want a fixed or variable interest rate mortgage. The lender needs to profit from lending you the money to purchase your ideal property, which is gained in the form of either fixed or variable interest.

A fixed interest rate is generally going to lead to higher monthly payments; this is the cost of having the stability and knowledge that your mortgage payments will not change over the loan’s life.

Conversely, a variable rate mortgage is likely to be lower on average throughout the loan period; however, this can fluctuate significantly. We’re currently in a period of meager rates at the time of writing, but this could change (and will over time). When considering a variable rate mortgage, you need to consider if the monthly payments suddenly increased significantly, would it drastically impact your ability to continue paying back the loan?

Frequency of payments

Monthly payments have been the default point of discussion throughout, but it isn’t the only option. You can pay semi-monthly, bi-weekly, weekly and more. It is worth noting that the more frequent your mortgage payments are, the more you will save in interest over your mortgage period. However, the more frequent the payments and quicker you pay off the loan, the higher the cash outflow.

A cash flow tip here would be to coincide your mortgage payments with when you get paid. This will allow you to know exactly when your cash is coming out of your bank account and won’t leave you stranded for half a month waiting for pay-day after the mortgage has been paid.

Types of Lender

Your conventional institutional lenders in Canada are the likes of RBC, CIBC, BMO, TD and Scotiabank. These are considered your “A Lenders” and they will generally offer the lowest interest rates, as they have the monopoly of the market. However, with those lower rates will come more terms and requirements to qualify for your mortgage. They generally may be willing to lend you less based on your current financial situation.

Conversely, lending institutions commonly referred to as “B lenders” may be willing to lend you more money, with fewer strings attached. However, their interest rates will be significantly higher than the institutional lenders in order to factor in the increased risk they are taking on. A “B lender” may be suitable for people who don’t have a perfect credit history and may struggle to get a mortgage approved from a conventional institutional lender.

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Jean-Maximilien is an expert in Canada and France about Loyalty programs, Credit cards and Travel. He is the Founding President of Milesopedia.

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