Mortgages — What to Know from Application to Closing
Navigating the world of mortgages can be complex, especially in a diverse and dynamic real estate market like Canada’s. Whether you’re a first-time homebuyer or you’re looking to switch your mortgage to a more favorable structure and rate, understanding the key elements of this type of loan is crucial. So, to help you get started, this guide will walk you through the essentials of mortgages in Canada, including the different types, the typical application processes, the interest rates, and other key considerations.
Types of Mortgages
Mortgages generally fall into one of five categories, with conventional fixed and variable-rate mortgages supported by hybrid options for greater flexibility. Each comes with its pros and cons, and it’s important that you carefully consider the best option for you when deciding to take out a mortgage on a home. Options include:
1. Fixed-Rate Mortgages
A fixed-rate mortgage keeps your interest rate constant throughout the loan term, offering stability in payments.
Pros:
– Predictable payments
– Protection from interest rate increases
Cons :
– Generally higher initial rates than variable rates.
– Less flexibility if market rates drop
– If you break a fixed-rate mortgage early, you may face a penalty of three months’ worth of interest or the Interest Rate Differential (IRD) amount, whichever is higher.
2. Variable-Rate Mortgages
Variable-rate mortgages have interest rates that fluctuate with the lender’s prime rate, typically offering lower initial rates but payments going toward principal vs. interest may change over time.
Pros:
– Lower initial rates
– Potential savings if rates decrease
Cons:
– Uncertainty in payment amounts
– Risk of higher interest payments if rates rise
3. Adjustable-Rate Mortgages (ARMs)
ARMs are similar to variable-rate mortgages but include payments that may adjust more frequently based on changes to the lender’s prime rate.
Pros:
– Potentially lower initial rates
– Possible savings if rates fall
Cons:
– The actual payment amount may change anytime prime rates shift
– Risk of significant payment increases if rates rise
4. Closed Mortgages
Closed mortgages restrict early repayments without penalties, offering lower rates for committed borrowers.
Pros:
– Lower interest rates
– Predictable payments
Cons:
– Penalties for early repayment
– Less flexibility
5. Open Mortgages
Open mortgages provide flexibility, allowing early repayment without penalties, though at higher rates.
Pros:
– Flexibility to pay off early
– No penalties for extra payments
Cons:
– Higher interest rates compared to closed mortgages
Understanding Interest Rates and Terms
Alongside the type of mortgage, a general understanding of interest rates and the terms of any mortgage is critical.
Interest Rate Types:
- Prime Rate — The benchmark interest rate established by the Bank of Canada (BoC) influences variable and adjustable-rate mortgages. Individual lenders set their own prime rates, typically aligned with the BoC’s prime/overnight lending rate.
- Fixed Rate — An interest rate that remains constant throughout the term of a fixed-rate mortgage.
Variable Rate –– An interest rate that changes over time based on fluctuations in the prime interest rate, affecting loan or mortgage payments.
Terms and Amortization
The term of a mortgage is the length of time you commit to the lender with a specified interest rate and payment conditions. Typical terms range from 1 to 5 years, after which you must renew or renegotiate your mortgage. Terms of 7 years and 10 years are also available, but any term above 5 years is rarely chosen.
Amortization refers to the total length of time over which you will repay the mortgage in full. In Canada, common amortization periods are 25 or 30 years. Longer amortization periods result in lower monthly payments but more interest paid over the life of the loan.
Key Considerations
To ensure you are fully prepared for your home ownership journey, remember to factor in the following considerations:
1. Down Payment
Currently, for Canadian homes priced under $500,000, the minimum down payment for an insured mortgage is 5%, while homes priced between $500,000 and $999,999 require 5% down on the first $500,000 and 10% down on the remaining portion above $500,000. However, this will change as of December 15th, 2024, when the Federal government will raise the cap on insured mortgages from $1 million to $1.5 million. This change aims to allow more people to buy homes with less than a 20% down payment. In addition, come December, first-time homebuyers and those purchasing new builds will be able to take out loans with a 30-year amortization.
2. Mortgage Insurance
If your down payment is less than 20%, you must purchase mortgage insurance through providers like CMHC, which protects the lender if you fail to make your required monthly payments (default on the loan), and adds to your mortgage costs.
3. Prepayment Options
Look for mortgages that offer prepayment options, allowing you to make extra payments or reduce the principal without penalty, helping you pay less interest over time.
4. Mortgage Brokers vs. Financial Institutions
Mortgage brokers can help you find the best rates and terms from various lenders, offering multiple options and assistance with the application process, though they may charge fees or earn commissions.
5. Closing Costs
Besides the down payment, prepare to pay closing costs ranging from 1.5% to 4% of the purchase price, including legal fees, home inspections, title insurance, and property taxes.
6. Interest Rate Changes
Understand how interest rate changes can affect your payments. Variable-rate mortgages fluctuate with the prime rate and impact interest payment amounts, while fixed-rate mortgages offer stable payments regardless of rate changes.
Wrapping Up
Understanding mortgages in Canada requires familiarity with the types of mortgages, the application process, interest rates, and key considerations. By educating yourself about these aspects, you can make informed decisions that align with your financial goals and homeownership aspirations.
