MORTGAGE 101: Understanding Different Mortgage Options

To new buyers, the real estate market can appear intimidating with jargon like amortization, mortgage insurance, fixed vs variable and so on.

Here are some of the key terms and mortgage types you’ll encounter when shopping for your home loan.

What is a Mortgage?

A mortgage is a loan offered by financial institutions to make the process of owning a real estate property feasible. Interest is charged on the Principal amount and each mortgage payment consists of repayment of the principal, plus some of the interest.

In Canada, potential home buyers pay at least five percent of the total cost of the house upfront.

1. High Ratio Mortgage: Refers to the loan to value ratio of the loan. If you pay less than 20 percent of the property cost as a down payment the loan has a high LVR. In this instance, it is mandatory to attain Mortgage Insurance, also referred to as CMHC (Canadian Mortgage and Housing Corporation) Insurance. Its premium is added to the mortgage payment.
2. Conventional Mortgage: This is when 20 percent or more of the property cost is provided by the buyer upfront and the remaining 80 percent or less is extended by the lender. It does not require mortgage insurance as the ratio of the loan is low relative to the property value.
3. Closed Mortgages: Have restrictions when it comes to pre-payment of the loan amount. Some closed mortgages levy a large penalty if the payment is made before the term completion. Others have a prepayment amount limit, with the borrower incurring penalties if any payment goes over the limit.
4. Open Mortgages: Are flexible in terms of prepayments. You can make an accelerated or a lump sum prepayment with no added penalty. These often have a higher interest rate.
5. Fixed Rate Mortgage: The interest rate for this mortgage is locked for either the entire term of the loan or for a period of one to five years. It is stable in nature and is easier to manage as payments don’t change during the fixed term. It is also one of the most popular mortgage options in Canada.
6. Adjustable Rate Mortgage (ARM): This is when the monthly payment amount fluctuates during the entire course of the mortgage term, based on current prime rate of the bank. It is reviewed on a regular interval, and the interest rate combined with the monthly payment is adjusted accordingly. These adjustments are advantageous for buyers when rates shoot down.
7. Variable Rate Mortgages: Are when the monthly payments remain unchanged even though the interest rate fluctuates based on the current prime rate. The differentiating factor between an Adjustable and Variable Rate Mortgage is the percentage of payment that goes against the interest and the principal. For example, if the interest rate spikes up and your monthly mortgage payment is $200, $140 might be applied against the interest and $60 against the principal. However, if the interest rate shoots down then $100 might be applied against interest and $100 against the principal. It allows the buyer to gain the advantage of lower interest rates while having a consistent payment amount.
8. Hybrid/Combination Mortgage: These mortgages combine the best of both worlds, as one part of the loan is financed at a fixed rate and the other part at a variable rate. The terms for both parts might be different but it allows the buyer to reap the benefits of a stable payment plan and potentially low interest rates.
9. Convertible Mortgage: This is an agreement that allows the buyer to move the mortgage plan from shorter to a longer term, or from variable to fixed rate without penalty. The interest rate is adjusted in accordance to the chosen mortgage type.
10. Home Equity Line of Credit (HELOC): A HELOC is a revolving line of credit, where the buyer can borrow money up to the credit limit, which is often assessed up to 65 percent of the property value. Its interest is tied to the prime rate and can change at any time. It provides the flexibility of making lump-sum prepayments or interest-only payments.
11. Reverse Mortgages: These mortgages also give homeowners access to cash against the equity in their home. They are different from HELOCs as there is no monthly repayment. They allow buyers to transform their home equity into a lump-sum payment or monthly cash payments, paid to the homeowner by the bank. It is an effective option for homeowners looking to support their retirement income. Reverse mortgages are paid back to the bank by the mortgage holder’s estate, or when the house is sold.
12. Collateral Mortgage: This is an agreement in which homeowners register their homes with a collateral charge that allows banks to register the approved loan amount for up to 125 percent of the property value. It gives buyers access to extra money at a later date, without going through the refinancing process. For example, if you pay down $50,000, you are able to redraw that amount without submitting a new finance application. It is useful for big asset purchases, or renovations.
13. Portable Mortgages: Can be applied to another property, if the buyer decides to move. The interest rate for the current mortgage can be continued without going through the application process again. It is beneficial during a second purchase when the interest rate of the attained loan is lower than the current market rate.

Now let’s explore the different types of mortgages that the Canadian market holds: Now that we know about the different types of mortgages, it should also be noted that financial institutions in Canada often combine and tailor these mortgage options to build a product that caters to buyer’s specific needs.

Finding out what sort of mortgage suits you is one thing. Find out how much you can afford to borrow at RATESDOTCA