Unless you're able to pay for a new home in cash, we all know that a mortgage will be required. What you may not know is the types of mortgages available to you, here in Canada. This is something you'll want to know as you prepare for your mortgage application.
Especially with the recent changes in mortgage laws, it's important to fully understand what any given type of mortgage entails, and whether or not it's right for you.
Here's a brief overview of your possible mortgage options.
A Traditional Mortgage
Similar to the mortgages your parents or grandparents might have once had, a traditional or conventional mortgage is now only available for buyers who are able to put down 20% or more of the purchase price.
A traditional mortgage simply involves borrowing money from a bank or other financial institution and paying it back in regular instalments that include interest. What makes a mortgage different than other kinds of loans is that your house will be forfeited to the bank if you fail to make your repayments.
As per the 2016 mortgage rules, home buyers who can only put down between 5-19% of the purchase price are required to undergo a mortgage stress test, and it's now required that they also obtain mortgage insurance. This is available from the Canada Mortgage and Housing Corporation and a handful of approved companies. Buying a house with a down payment of less than 5% is now prohibited.
Additionally, starting in January of 2018, all homebuyers (including those with a down payment of 20% or more) will be required to undergo this mortgage stress test. Even though a 20%+ down payment allows you to avoid paying for mortgage insurance, borrowers will now need to qualify at the bank's contractual rate plus 200 basis points under the new mortgage rules.
Open Mortgage
The term "open" refers to a lack of restrictions on when and how you can make early payments on your mortgage. For instance, you can make additional payments every month or even pay off the entire loan early with an open mortgage.
Most open mortgages come with a term of six months to one year. Once the term expires, you must refinance your mortgage or a new mortgage must be obtained from a different lender.
Because banks don't make any money on early repayment fees with an open mortgage, most open mortgages carry a higher interest rate than a closed mortgage.
Closed Mortgage
The opposite of an open mortgage, a "closed" mortgage comes with stiff penalties and fees if you want to make extra payments or pay off the entire loan early. Closed mortgages generally have better interest rates than open mortgages.
Variable Rate Mortgage
The rate that "varies" in a variable rate mortgage is the interest or the amount of money you'll have to pay back the bank on top of the amount you've borrowed.
Sometimes known as "adjustable rate" mortgages, variable rate mortgages include clauses that peg the interest rate to the posted lending rate by the Bank of Canada. If the lending rate goes up, so too will your mortgage's interest rate. Likewise, if the lending rate goes down, your mortgage's interest rate will fall.
Variable rate mortgages often carry the lowest interest rate of available mortgages, but the unpredictability of future payments carries a substantial risk.
Capped Rate Mortgages
Sometimes known as "fixed rate" mortgage, these are the opposite of a variable rate mortgage. When you sign on the dotted line, you'll be agreeing to an interest rate that won't change throughout the term of the loan.
Because each repayment will be exactly the same, a fixed rate or capped mortgage is a lot easier to budget. The downside is that, in the future, lending rates might drop, but you'll still be stuck with your agreed-upon interest rate.
Convertible Mortgage
Convertible mortgages are a hybrid mix of fixed-rate and variable-rate mortgages. Convertible mortgages are rare in Canada, but they do exist.
Effectively, a convertible mortgage starts off as a variable rate mortgage but gives you the opportunity to "convert" the mortgage into a capped or fixed-rate mortgage in the future. Convertible mortgages are more popular when interest rates are high as it gives borrowers the chance to lock in a lower, fixed interest rate in the future if interest rates drop.
Convertible mortgages generally come with longer terms, meaning you'll be committed to the same bank or lending institution for a longer period of time without being able to swap to a different lender.
Reverse Mortgage
Technically speaking, a reverse mortgage isn't really a mortgage. A reverse mortgage allows people age 55 and older to convert their built-up equity into a special kind of loan.
A reverse mortgage does NOT involve selling or moving out of your home. Instead, a portion of your home equity is converted into cash, but you don't need to pay this back until you either move to another home or sell your current home. You can use the cash to pay for anything you like, including paying off your standard mortgage.
Home equity refers to the amount of money you've repaid the bank, minus the amount of money you've paid in interest.
Canadian law requires you to be at least 55 years old in order to be eligible for a reverse mortgage. If you're married, your spouse must also be at least 55 years old.
Reverse mortgages often come with a much higher interest rate than a standard mortgage. There are often substantial penalties if you sell the home within a short period of time (usually around three years) after getting the reverse mortgage.
The only institution able to offer reverse mortgages in Canada is CHIP (Canadian Home Income Plan Corporation). They offer a convenient reverse mortgage calculator which can help you determine if this kind of mortgage is right for you.
Mortgages are complex, legally binding financial documents, so be sure to ask lots of questions. You want to be confident in what you're agreeing to before you sign on the dotted line. Take your time, and carefully evaluate all of your options before choosing the right mortgage for you.
