Posted by John Doe
We always advise first-time home buyers explore their mortgage options before they do anything else. It provides you with the information you need to make an informed decision when shopping for your mortgage. You want to apply for a pre-approved mortgage before your house hunt starts to avoid disappointment should you find a home but not receive approval for a mortgage.
This also allows you to set a realistic budget based on the amount the lender is willing to provide for your mortgage. We’ve prepared a basic overview of the types of mortgages available in Canada to make the process easier.
How Many Types of Mortgages Are There?
There are seven types of mortgages available in Canada. That might seem like a lot, but they are necessary to accommodate the many different financial needs of home buyers. Some will work best for first time buyers, others work well for those with less cash for a down payment, while others might appeal to those willing to take a risk with their mortgage payments. Offering flexibility also allows home buyers to find something perfectly suited to their financial needs without a cookie cutter approach to lending.
High Ratio versus Low Ratio
Mortgage ratios are based on the amount of cash you are able to put towards your down payment. A high ratio mortgage is a mortgage with less than 20 percent down and a low ratio mortgage is anything above 20 percent. A high ratio mortgage requires a minimum of 5 percent down for $500,000 and 10 percent for any amounts above $500k.
- Low Ratio Mortgages: When applying for a low ratio mortgage, some lenders might require insurance. In this case, there are rules which include that buyers must have a mortgage amortization of 25 years or less, a home with a price below $1 million, and a credit score of at least 600. You cannot purchase a home with the intent of finding a tenant and instead must live in the home.
- High Ratio Mortgages: High-ratio mortgages pose a higher risk for both you and the lender. For this reason, all high ratio mortgages must be insured. Premiums are based on the loan-to-value ratio of the mortgage which means that the lower your down payment, the higher your rates.
Recent rules have made it harder for people who require insured mortgages to qualify as they must now undergo a stress test. The test is designed to ensure that you would afford the mortgage even if there are future house price or rate increases. That means that not only do you have to qualify for the mortgage loan you are applying for at the current rate, but also at the Bank of Canada’s five-year fixed posted mortgage rate. This can pose a challenge as this rate is usually higher than the rate you are currently being offered.
The Types of Mortgages
Now that we have covered high and low ratio mortgages, let’s take a look at the types of mortgages available:
The conventional mortgage is a traditional mortgage available to home buyers that have at least 20 percent of the house price to use as a down payment. In most cases, mortgage insurance is not required for this mortgage. However, there are some lenders that will still want you to have mortgage insurance even if you have the 20 percent.
An open mortgage allows you to pay off your mortgage without penalties if you choose to pay it in its entirety or in installments. This type of mortgage can have term lengths ranging from six months to one year, with higher interest rates than a closed mortgage although they share similar terms.
Variable Rate Mortgage
As the name implies, a variable rate mortgage is not based on the current rate at the time the mortgage kicks in. Instead, your payments are calculated by the lender to include any interest and principal and this remains consistent throughout the mortgage. However, changes in the market rate will change your mortgage rates.
If you are more flexible with the cash you have available, this can work well, as this means that if interest rates drop, less of your payment is applied to interest and more comes off the principal. However, should the rate rise, you pay more towards interest and less on the principal, which is bad. Therefore, it is not the choice if you have a fixed budget.
Capped Rate Mortgages
Capped mortgages offer a variable rate, but that rate is capped. This works well, as although there are rates fluctuating, the lender has capped the amount it can rise, guaranteeing that you will never pay above that rate. This allows you to benefit when rates are lower, as well as allowing you to see just how high your payments can go. You can make an informed decision based on your budget if the capped rate is something you can afford, which means less risk. However, capped rate mortgages tend to charge a penalty if you want to pay off your mortgage in full.
A closed mortgage provides a fixed rate that allows you to have the same interest rate for the duration of your mortgage. This is ideal for those with a tighter budget, as you will never see a change in the amount you pay, and they often come with a lower rate than you would for an open mortgage. When you are lucky enough to be looking for a mortgage when rates are low or prior to a rumoured increase, this is the time to opt for an extended term on your mortgage, so you can enjoy the lower rates as long as possible.
The convertible mortgage allows you to lock in a rate for extended periods with the caveat you must stick with the same lender. They also use a fixed rate that will range from six months to a year.
This mortgage is only available to those who already have a mortgage and own their home. It allows you to use the equity in your home as a loan while staying in your home. To do so you must be 62 or over and have paid down a large part of your mortgage. The amount of money available varies based on how much equity you have in your home and the older you are the more money you can borrow.
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