JASON KILBORNE
Professional Mortgage Specialist
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JASON KILBORNE
How Do Mortgages Work In Canada?
What Is A Mortgage?A mortgage is a loan used to purchase real estate.
The loan is secured by the property itself which means that the property acts as collateral for the loan. The Lender you get your mortgage through will register a lien (a.k.a. charge) on the title of the property. They do this so that if you decide not to make your mortgage payments, they can repossess the property and sell it to recover their money. Mortgages are made up of many different components which all play a role in the overall cost of the mortgage. What is the best type of mortgage? The answer is different for everyone. Below, I'll outline the different components so that you have a better understanding of how a mortgage works. |
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Down Payment
Unfortunately, when you purchase a property, you don't just get to sign a piece of paper and take ownership of that property. You need to pay some money first. The amount of money that you contribute to the purchase price of the property is known as your down payment.
Depending on what type of property you're buying and what you'll use it for, there will be a minimum amount that you'll need to pay as a down payment in order to qualify for the mortgage.
For example, currently in Canada, if you are purchasing a single family home to live in, as opposed to renting it out, you may be able to purchase the home with a down payment of as little as 5% of the purchase price as long as your qualify. If you are purchasing a home priced higher than $500,000, then the minimum down payment is 5% on the first $500,000 and then 10% of any amount about $500,000.
If you are purchase a second home or a vacation property, you may also be able to do so with a minimum down payment of 5%.
However, if you are purchasing a property to rent out, your minimum down payment must be 20% of the purchase price.
There are some variations to these rules. If your credit is bruised, or the property you'd like to buy is odd, or if the way you earn income is unordinary, you may need a larger down payment even if you are planning on living in the property.
The funds you use for your down payment can't come from just anywhere.
The 3 main acceptable sources for down payment funds are:
Sometimes it can work out that you could use a gift from a non-immediate family member or borrow funds from a line of credit or credit card, but this is difficult to get approved.
Due to Anti-Money-Laundering regulations, Lenders require a paper trail of the money you'll use to purchase your property. This is to try and prevent people from using illegal funds to purchase real estate in Canada.
When you are using your savings for your down payment, Lenders require a 90 day transaction history for all bank/investment accounts that you'll be with drawing funds from. If there are any large deposits going into the account(s) within the 90 day period, the Lender will require a paper trail showing where the deposited money came from. This is their way of screening for money laundering practices.
When you're using a gift from a family member, the Lender will require a gift letter signed by the person giving you the gift as well as a transaction record from your bank account showing the gifted money being deposited.
If you'll be withdrawing funds from your RRSP's to use towards your down payment, Lenders will require proof that the funds were actually withdrawn from your RRSP account and deposited into your bank account.
The moral of the story here is that you need to have money or access to money in order to get a mortgage.
Depending on what type of property you're buying and what you'll use it for, there will be a minimum amount that you'll need to pay as a down payment in order to qualify for the mortgage.
For example, currently in Canada, if you are purchasing a single family home to live in, as opposed to renting it out, you may be able to purchase the home with a down payment of as little as 5% of the purchase price as long as your qualify. If you are purchasing a home priced higher than $500,000, then the minimum down payment is 5% on the first $500,000 and then 10% of any amount about $500,000.
If you are purchase a second home or a vacation property, you may also be able to do so with a minimum down payment of 5%.
However, if you are purchasing a property to rent out, your minimum down payment must be 20% of the purchase price.
There are some variations to these rules. If your credit is bruised, or the property you'd like to buy is odd, or if the way you earn income is unordinary, you may need a larger down payment even if you are planning on living in the property.
The funds you use for your down payment can't come from just anywhere.
The 3 main acceptable sources for down payment funds are:
- Savings/proceeds from the sale of another home
- RRSP's (which can be used tax free if you're considered a first time home buyer)
- Gift from an immediate family member
Sometimes it can work out that you could use a gift from a non-immediate family member or borrow funds from a line of credit or credit card, but this is difficult to get approved.
Due to Anti-Money-Laundering regulations, Lenders require a paper trail of the money you'll use to purchase your property. This is to try and prevent people from using illegal funds to purchase real estate in Canada.
When you are using your savings for your down payment, Lenders require a 90 day transaction history for all bank/investment accounts that you'll be with drawing funds from. If there are any large deposits going into the account(s) within the 90 day period, the Lender will require a paper trail showing where the deposited money came from. This is their way of screening for money laundering practices.
When you're using a gift from a family member, the Lender will require a gift letter signed by the person giving you the gift as well as a transaction record from your bank account showing the gifted money being deposited.
If you'll be withdrawing funds from your RRSP's to use towards your down payment, Lenders will require proof that the funds were actually withdrawn from your RRSP account and deposited into your bank account.
The moral of the story here is that you need to have money or access to money in order to get a mortgage.
Closing Costs
In addition to your down payment, you'll also need funds available for something called Closing Costs.
Closing costs include things such as legal fees, land transfer tax, property tax adjustments, registration fees, title insurance, interest adjustments and possible some other fees/costs.
A general guideline, when purchasing a home in Manitoba, is to expect your closing costs to equal approximately 2.5% of the purchase price of the property you're buying.
The lawyer you choose to work with to complete your purchase will be the one to determine the total closing cost amount.
Closing costs, as well as the balance of your down payment, are to be paid to the lawyer just prior to the day you take possession of the property you've purchased.
Closing costs include things such as legal fees, land transfer tax, property tax adjustments, registration fees, title insurance, interest adjustments and possible some other fees/costs.
A general guideline, when purchasing a home in Manitoba, is to expect your closing costs to equal approximately 2.5% of the purchase price of the property you're buying.
The lawyer you choose to work with to complete your purchase will be the one to determine the total closing cost amount.
Closing costs, as well as the balance of your down payment, are to be paid to the lawyer just prior to the day you take possession of the property you've purchased.
Mortgage Default Insurance
Mortgage Default Insurance is commonly and incorrectly referred to as CMHC Insurance. CMHC is just one of three providers of Mortgage Default Insurance.
Mortgage Default Insurance is an insurance policy that must be purchased by all Home Buyers if their down payment is less than 20% of the purchase price of the property. If your down payment is 20% or more, then you aren't required to purchase this insurance.
This insurance provides coverage to the mortgage Lender in case the home buyers default (don't make payments) on their mortgage.
The cost of this insurance is calculated as a percentage of the mortgage amount (purchase price less down payment).
The higher your down payment, the cheaper the cost of the insurance.
The cost of the insurance gets added to the principal balance of your mortgage and does not have to be paid upfront as part of your closing costs. Therefore, your starting mortgage balance will be the purchase price of the property, less your down payment amount plus the mortgage default insurance premium.
Mortgage Default Insurance is an insurance policy that must be purchased by all Home Buyers if their down payment is less than 20% of the purchase price of the property. If your down payment is 20% or more, then you aren't required to purchase this insurance.
This insurance provides coverage to the mortgage Lender in case the home buyers default (don't make payments) on their mortgage.
The cost of this insurance is calculated as a percentage of the mortgage amount (purchase price less down payment).
The higher your down payment, the cheaper the cost of the insurance.
The cost of the insurance gets added to the principal balance of your mortgage and does not have to be paid upfront as part of your closing costs. Therefore, your starting mortgage balance will be the purchase price of the property, less your down payment amount plus the mortgage default insurance premium.
Amortization Period
The Amortization Period refers to a predetermined amount of time that it will take the buyer to pay off the mortgage in full.
The length of the amortization period is one of the factors in determining the mortgage payment. The longer the amortization period, the lower the mortgage payments.
Currently in Canada, if your down payment amount is less than 20% of the purchase price, then the longest amortization period available is 25 years.
If the down payment is 20% or more, then the amortization can be stretched out to 30 years.
The length of the amortization period is one of the factors in determining the mortgage payment. The longer the amortization period, the lower the mortgage payments.
Currently in Canada, if your down payment amount is less than 20% of the purchase price, then the longest amortization period available is 25 years.
If the down payment is 20% or more, then the amortization can be stretched out to 30 years.
Mortgage Term
In Canada, the amortization period refers to the total amount of time allotted to pay the mortgage off in full. However, that mortgage is further broken down into smaller chunks of time referred to as "terms".
A Term is a specific amount of time that the home buyer commits to the Lender they are getting the mortgage from.
Terms can range from 6 months up to 10 years.
The most common term length is 5 years. This means that the borrower is committing to making payments to a specific Lender for 5 years. At the end of the 5 years they can choose to move the mortgage to a different Lender, renew the mortgage with the same Lender for another term, or pay off the mortgage completely.
The borrower can choose to end the term early by breaking the mortgage contract but depending on what type of mortgage they have, the borrower may be subject to a financial penalty for doing so.
A Term is a specific amount of time that the home buyer commits to the Lender they are getting the mortgage from.
Terms can range from 6 months up to 10 years.
The most common term length is 5 years. This means that the borrower is committing to making payments to a specific Lender for 5 years. At the end of the 5 years they can choose to move the mortgage to a different Lender, renew the mortgage with the same Lender for another term, or pay off the mortgage completely.
The borrower can choose to end the term early by breaking the mortgage contract but depending on what type of mortgage they have, the borrower may be subject to a financial penalty for doing so.
Types Of Mortgages
In Canada, there are generally two main types of mortgages; open mortgages and closed mortgages.
An open mortgage is one that can be paid off in full at any time without penalty.
A closed mortgage cannot be paid off prior to the maturity date (the expiry date on the chosen term) without having to pay a penalty to do so.
Most mortgages in Canada are closed mortgages because the interest rates are usually significantly lower than the rates on open mortgages.
An open mortgage is one that can be paid off in full at any time without penalty.
A closed mortgage cannot be paid off prior to the maturity date (the expiry date on the chosen term) without having to pay a penalty to do so.
Most mortgages in Canada are closed mortgages because the interest rates are usually significantly lower than the rates on open mortgages.
Types Of Interest Rates
When you get a mortgage, you have the choice of either a fixed rate mortgage or a variable/adjustable rate mortgage.
Visit my fixed vs. variable rate page for all the information you need on this topic.
Visit my fixed vs. variable rate page for all the information you need on this topic.
Payment Frequencies
When you get a mortgage, you can choose how often you would like to make your mortgage payments.
You can choose to make your payments monthly (12 payments per year), bi-weekly (every 2 weeks, 26 payments per year), or weekly (52 payments per year). Some Lenders allow semi-monthly (twice per month, 24 payments per year) but not all do.
If your preference is bi-weekly or weekly, most Lenders will offer an "accelerated" option.
Accelerated bi-weekly and accelerated weekly payments allow you to pay down your mortgage more quickly.
Here's how it works:
Let's say you monthly mortgage payment worked out to exactly $1000 per month...so $12,000 per year.
If you were to choose non-accelerated bi-weekly payments, your mortgage payment every 2 week would be roughly $462 ($12,000/26)
Accelerated bi-weekly payments are calculated by taking your monthly payment and cutting it in half. So your accelerated bi-weekly payment would be $500 in this scenario...so $13,000 per year ($500 x 26 payments).
If your amortization period is 25 years but you chose accelerated bi-weekly payments the whole time and didn't make any other extra payments, you would pay off your mortgage in approximately 22.5 years instead of 25...just to give you some perspective of the advantages of accelerated payment frequencies.
Accelerated weekly payments would have the same effect. The monthly payment is divided by 4 and then you make 52 payments per year.
You can choose to make your payments monthly (12 payments per year), bi-weekly (every 2 weeks, 26 payments per year), or weekly (52 payments per year). Some Lenders allow semi-monthly (twice per month, 24 payments per year) but not all do.
If your preference is bi-weekly or weekly, most Lenders will offer an "accelerated" option.
Accelerated bi-weekly and accelerated weekly payments allow you to pay down your mortgage more quickly.
Here's how it works:
Let's say you monthly mortgage payment worked out to exactly $1000 per month...so $12,000 per year.
If you were to choose non-accelerated bi-weekly payments, your mortgage payment every 2 week would be roughly $462 ($12,000/26)
Accelerated bi-weekly payments are calculated by taking your monthly payment and cutting it in half. So your accelerated bi-weekly payment would be $500 in this scenario...so $13,000 per year ($500 x 26 payments).
If your amortization period is 25 years but you chose accelerated bi-weekly payments the whole time and didn't make any other extra payments, you would pay off your mortgage in approximately 22.5 years instead of 25...just to give you some perspective of the advantages of accelerated payment frequencies.
Accelerated weekly payments would have the same effect. The monthly payment is divided by 4 and then you make 52 payments per year.
Pre-Payment Privileges
Most mortgages allow you to make extra payments, over and above your required mortgage payments, without penalty in order to pay your mortgage off faster.
The amount you can pay and the frequency you can do so will depend on which Lender you get your mortgage through.
The amount you are allowed to pre-pay is usually based on the initial mortgage balance and it's usually on a "per-year" basis. For example, if your mortgage allows pre-payments of 15% per year, this means that the total of the extra payments you make each year cannot exceed 15% of the initial mortgage balance. The initial mortgage balance is calculated by taking the purchase price of the property, less the down payment, plus the mortgage default insurance premium (if applicable). So if your initial mortgage balance was $300,000, you would be able to pay an extra $45,000 against your mortgage principal each year.
When it comes to frequency, some Lenders have restrictions that only allow you to make an extra payment once per year on your anniversary date. Other Lenders will allow you to make extra payments anytime throughout the year.
Pre-payments can be made in a few different ways.
One way is lump sum payments. This is where you would pay chunks of money against the mortgage.
Another way is by increasing your mortgage payment. The higher mortgage payment pays down the mortgage balance more quickly by applying the amount of money being paid, over and above the required mortgage payment, directly to the principal balance.
A third way is something called a double-up. This just means that you would make a double payment. The extra payment amount is applied directly to the mortgage balance.
Most Lenders will allow you to use a combination of these pre-payment methods as long as the sum of all of the extra money paid doesn't exceed the annual pre-payment limit.
The amount you can pay and the frequency you can do so will depend on which Lender you get your mortgage through.
The amount you are allowed to pre-pay is usually based on the initial mortgage balance and it's usually on a "per-year" basis. For example, if your mortgage allows pre-payments of 15% per year, this means that the total of the extra payments you make each year cannot exceed 15% of the initial mortgage balance. The initial mortgage balance is calculated by taking the purchase price of the property, less the down payment, plus the mortgage default insurance premium (if applicable). So if your initial mortgage balance was $300,000, you would be able to pay an extra $45,000 against your mortgage principal each year.
When it comes to frequency, some Lenders have restrictions that only allow you to make an extra payment once per year on your anniversary date. Other Lenders will allow you to make extra payments anytime throughout the year.
Pre-payments can be made in a few different ways.
One way is lump sum payments. This is where you would pay chunks of money against the mortgage.
Another way is by increasing your mortgage payment. The higher mortgage payment pays down the mortgage balance more quickly by applying the amount of money being paid, over and above the required mortgage payment, directly to the principal balance.
A third way is something called a double-up. This just means that you would make a double payment. The extra payment amount is applied directly to the mortgage balance.
Most Lenders will allow you to use a combination of these pre-payment methods as long as the sum of all of the extra money paid doesn't exceed the annual pre-payment limit.
Pre-Payment Penalties
If you sign a mortgage contract on a closed mortgage, and need to break that mortgage contract early for some reason, you'll be charged a penalty.
The amount of that penalty depends on several factors such as: the Lender you have the mortgage with, the type of interest rate you have, the remaining time left on the term, the interest rates at the time of breaking the mortgage compared to the interest rate you're paying, and the remaining mortgage balance.
Visit my Mortgage Penalties page to learn the different ways penalties are calculated.
The amount of that penalty depends on several factors such as: the Lender you have the mortgage with, the type of interest rate you have, the remaining time left on the term, the interest rates at the time of breaking the mortgage compared to the interest rate you're paying, and the remaining mortgage balance.
Visit my Mortgage Penalties page to learn the different ways penalties are calculated.
Mortgage Features
Mortgages can come with additional features that may be a huge advantage depending on your situation.
Here's a list of some of the more common features:
Portability - this is where the mortgage is able to be ported (transferred) from one property to another. This feature comes in handy if you decide to change homes before your mortgage term expires. If your mortgage has this feature, you would be able to take your existing mortgage at it's current balance and interest rate, over to the new home and avoid having to pay a penalty to break the mortgage contract.
Assumability/Transferability - this is where you have the option to transfer the mortgage to someone else or have someone assume it from you. This would come in handy if you wanted to get out of the property, and therefore the mortgage, but not purchase another home. You could essentially have someone step in and take over your mortgage payments and therefore avoid paying a penalty to break the mortgage contract.
Skip-A-Payment - this is there the Lender will allow you to miss a mortgage payment once per year if you run into financial hardship. You don't get to avoid that payment altogether. The payment gets tacked on to the end of your mortgage and you will end up paying extra interest charges by using this feature but it's a safety net if you fall on hard times.
Cash Back - some Lenders like to use cash-back mortgages to attract customers. this is where the Lender will give you $2000 cash, for example, when you sign a mortgage contract with them. These funds can come in handy to cover the many miscellaneous expenses that come along with purchasing a home. However, often the interest rates on cash-back mortgages are higher than what you could get elsewhere. Also, if you need to break the mortgage contract early, not only will you have to pay a penalty, you will also need to pay some or all of the cash incentive amount back as well. It's important to read the fine print on cash back offers
Home Warranty - Some Lenders offer a complimentary home systems warranty with their mortgages. This warranty is usually free for 6 months or a year and then you have the option to keep it after that for a small monthly fee which can just be added to your mortgage payment. This warranty covers heating, cooling, plumbing and electrical systems in the house in case they need to be repaired or replaced.
The features above can really improve the overall value of the mortgage you get depending on your specific needs.
Here's a list of some of the more common features:
Portability - this is where the mortgage is able to be ported (transferred) from one property to another. This feature comes in handy if you decide to change homes before your mortgage term expires. If your mortgage has this feature, you would be able to take your existing mortgage at it's current balance and interest rate, over to the new home and avoid having to pay a penalty to break the mortgage contract.
Assumability/Transferability - this is where you have the option to transfer the mortgage to someone else or have someone assume it from you. This would come in handy if you wanted to get out of the property, and therefore the mortgage, but not purchase another home. You could essentially have someone step in and take over your mortgage payments and therefore avoid paying a penalty to break the mortgage contract.
Skip-A-Payment - this is there the Lender will allow you to miss a mortgage payment once per year if you run into financial hardship. You don't get to avoid that payment altogether. The payment gets tacked on to the end of your mortgage and you will end up paying extra interest charges by using this feature but it's a safety net if you fall on hard times.
Cash Back - some Lenders like to use cash-back mortgages to attract customers. this is where the Lender will give you $2000 cash, for example, when you sign a mortgage contract with them. These funds can come in handy to cover the many miscellaneous expenses that come along with purchasing a home. However, often the interest rates on cash-back mortgages are higher than what you could get elsewhere. Also, if you need to break the mortgage contract early, not only will you have to pay a penalty, you will also need to pay some or all of the cash incentive amount back as well. It's important to read the fine print on cash back offers
Home Warranty - Some Lenders offer a complimentary home systems warranty with their mortgages. This warranty is usually free for 6 months or a year and then you have the option to keep it after that for a small monthly fee which can just be added to your mortgage payment. This warranty covers heating, cooling, plumbing and electrical systems in the house in case they need to be repaired or replaced.
The features above can really improve the overall value of the mortgage you get depending on your specific needs.
Summary
As you can see, there are a lot of details involved in a mortgage contract.
There really is no "best type of mortgage" because it depends on your specific needs and situation.
Everyone's financial situation is different so it's important that their mortgage includes the right features and is set up the right way in order to save the most money possible overall.
Working with a Mortgage Broker, such as Castle Mortgage Group, is your one-stop-shop for the best deal on your mortgage because we have access to hundreds of different mortgage products from dozens of different Lenders to be able to match you with the perfect mortgage.
My job, as your Mortgage Specialist, is to get a full understanding of your needs and then find you the best deal on the right mortgage!
There really is no "best type of mortgage" because it depends on your specific needs and situation.
Everyone's financial situation is different so it's important that their mortgage includes the right features and is set up the right way in order to save the most money possible overall.
Working with a Mortgage Broker, such as Castle Mortgage Group, is your one-stop-shop for the best deal on your mortgage because we have access to hundreds of different mortgage products from dozens of different Lenders to be able to match you with the perfect mortgage.
My job, as your Mortgage Specialist, is to get a full understanding of your needs and then find you the best deal on the right mortgage!
