Mortgage Basics

Types of Mortgages in Canada

Types of Mortgages in Canada

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    When financing your home in Canada, many mortgage options are available to suit every borrower’s unique needs. Understanding the types of mortgages and their features and benefits can help you decide the most suitable choice for your home financing or refinancing needs. 

    In this article, we will explain the mortgage financing options available, their features and benefits, and what type of borrower they are most suitable for, whether you’re a first-time buyer, renewing, or refinancing. 

    Key Takeaways

    • Various types of mortgages are available in Canada, each catering to different financial situations and needs.
    • The type of mortgage you opt for will influence your interest rate, repayment terms, and flexibility in making additional payments or transferring the mortgage.
    • Working with a mortgage expert can help you simplify the process of selecting the right mortgage and ensure you choose the best solution for your circumstances.

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    High-Ratio Mortgages

    High-ratio mortgages are exclusively for homebuyers with a downpayment of less than 20% of the purchase price. High-ratio refers to the loan-to-value (LTV) ratio making up more than 80% of the property’s value. These types of mortgages are sometimes referred to as insured or default-insured mortgages. 

    A high-ratio mortgage cannot exceed a purchase price of $1 million and will require mortgage default insurance. Default insurance protects the lender, reducing their risk if you default on your mortgage payments. Canada has 3 mortgage loan insurance providers: Canada Mortgage and Housing Corporation (CMHC), a crown corporation, and private insurers Canada Guaranty and Sagen.

    First-time homebuyers could benefit from high-ratio mortgages due to the smaller downpayment requirement. Downpayments and closing costs are significant barriers for first-time buyers entering the housing market. Interest rates on high-ratio mortgages are typically lower than as there is a reduced risk to lenders since they are default-insured. Insurance premiums are added to the total mortgage amount or can be paid in cash by borrowers.

    Conventional Mortgages

    Conventional mortgages are for borrowers who can afford a downpayment of 20% or more or who are purchasing a home valued at $1 million or more. These types of mortgages are sometimes referred to as uninsured mortgages. With this type of mortgage, you are not required to pay for mortgage default insurance, as the equity from the downpayment is sufficient to protect the lender. 

    Homebuyers who can afford a 20% or more downpayment can benefit from this type of mortgage by avoiding the additional cost of default insurance. The interest-carrying cost savings from not including default insurance premiums on your total mortgage amount can be substantial over the life of the mortgage. Conventional mortgages also benefit those purchasing in areas with high living costs, as there is no $1 million cap on the purchase price. 

    Additionally, putting down 20% or more as a downpayment provides you with more equity in your home from the start, potentially lowering mortgage payments and interest-carrying costs over the life of the mortgage. However, conventional mortgages typically have higher interest rates than high-ratio mortgages, which could offset any savings.

    Insurable (Low-Ratio) Mortgages

    Insurable mortgages have the same criteria as insured mortgages but require a 20% or more downpayment. Default insurance isn’t mandatory; however, depending on the lender, either the lender or borrower can insure the mortgage. 

    Typically, the lender insures this type of mortgage, known as low-ratio or portfolio insurance, but the borrower may cover the cost if the lender allows. When default-insured, you will have access to interest rates that are almost as low as high-ratio mortgages. To qualify as low-ratio, a mortgage cannot carry an amortization in excess of 25 years.

    Fixed-Rate Mortgages

    Fixed-rate mortgages have a principal and interest amount that remain the same throughout the mortgage term. This type of mortgage provides stability and predictability with mortgage payments that won’t change if interest rates change. 

    Homeowners who have less risk tolerance, prefer stable payments or are on a set budget benefit the most from fixed-rate mortgages. These types of mortgages are also suitable if interest rates are predicted to increase, as you will be locked into a rate for a fixed period of time, helping you to ride out any increases in interest rates.

    However, fixed-rate mortgages have historically had higher interest rates than variable-rate mortgages. If you break a fixed-rate mortgage before your term ends, the penalty could be quite high, as it is calculated based on the interest rate differential (IRD) or three months of interest, whichever is higher. 

    Typically, all fixed-rate mortgages carry prepayment penalties, which are higher if the interest rate at the time of early payout is lower than the mortgage’s contract rate. In such cases, the lender would need to make up for the lost revenue in interest costs, as the borrower will be able to re-borrow that money at a lower ongoing rate.

    Variable-Rate Mortgages

    Variable-rate mortgages have interest rates that fluctuate based on changes to the Bank of Canada policy interest rate. There are two types of variable-rate mortgages: adjustable-rate (ARM) and variable-rate (VRM). 

    Adjustable-rate mortgages (ARMs) are a type of variable mortgage in which the payment adjusts up or down based on changes to the lender’s prime rate. The principal portion will remain fixed throughout the term, but the interest portion will change to reflect any changes to prime rates. If interest rates increase, your mortgage payments will increase. If interest rates decrease, your mortgage payments will decrease. 

    Variable-rate mortgages (VRM) are a type of variable mortgage with fixed payments. This means your mortgage payments will remain the same throughout the term regardless of changes to interest rates. However, your principal and interest portions will adjust based on changes to the lender’s prime rate. 

    If interest rates increase and you have a VRM, more of your payment will go toward interest, decreasing the principal portion. If interest rates decrease, more of your payment will go toward the principal, decreasing the interest portion. Adjustments by the Bank of Canada on its benchmark policy rate during your mortgage term on a VRM will impact your amortization.

    VRMs risk hitting trigger rates or trigger points when interest rates continue to increase. A trigger rate is reached when your mortgage payment entirely goes toward interest, with nothing going toward the principal. Your trigger point is reached when your payment is insufficient to cover even the interest portion on the mortgage. When this happens, you risk negative amortization on your mortgage, meaning you owe more than the original mortgage amount.

    Homeowners with the risk appetite and finances to adjust their budget with changes to interest rates will benefit from both types of variable mortgages. Variable-rate and adjustable-rate mortgages typically carry lower interest rates than fixed-rate mortgages, resulting in lower mortgage payments. 

    If interest rates remain low, variable rates have the potential to save you money in interest-carrying costs. Additionally, the penalties for breaking the term early are typically lower than those for fixed-rate mortgages, with a penalty calculation typically limited to 3 months of interest. 

    Open, Closed, and Convertible Mortgages

    Open, closed, and convertible mortgages offer different levels of flexibility in terms of what you can do with your mortgage. This mortgage solutions let you customize the best option for your mortgage strategy to reach your financial goals.

    Open Mortgages allow homeowners to make extra payments or pay off the entire mortgage balance before the term ends without penalty. An open mortgage can be beneficial if you anticipate additional money, such as an inheritance or substantial bonus, that you wish to use toward the mortgage or plan to pay off your mortgage sooner than the end of its term. 

    This flexibility typically comes in exchange for higher interest rates than closed mortgages. However, the tradeoff will result in much higher interest-carrying costs if you don’t take advantage of this flexibility.

    Closed mortgages limit mortgagors to how much they can prepay toward their mortgage each year. Typically, most mortgages are implicitly closed unless stated otherwise and will come with lower rates than open mortgages. This is a beneficial option if you plan to stay in your home for the entire mortgage term or don’t anticipate having the extra funds above your annual prepayment limits to put toward your mortgage. 

    Lenders typically allow you to make a certain percentage, usually 10% to 20% of the mortgage balance, as a prepayment each year without penalty. Breaking or paying off the mortgage before the term ends can result in significant prepayment penalties. 

    Convertible Mortgages allow homeowners the flexibility of a short-term mortgage (typically 6 months) with an option to switch to a longer term at any time. This option can be beneficial if you are unsure how long you plan to stay in your home or anticipate interest rates may decrease before the end of your term. 

    Convertible mortgages have the same prepayment restrictions as closed mortgages during the term. However, the tradeoff is the lower interest rates compared to open mortgages. This makes them appealing to those who want short-term flexibility while avoiding higher borrowing costs.  

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    Types of Mortgage Registrations

    When you obtain a mortgage, the lender will need to register your mortgage as a charge or lien against the subject property’s title. This allows the lender to secure the loan and legally claim the property should you default. There are two types of mortgage registrations: standard mortgages and collateral mortgages.

    Standard Mortgages

    Standard mortgages, better known as standard charge mortgages, involve the lender registering the mortgage (charge) and securing it for the exact dollar amount. Borrowers will have limited options to make changes to the mortgage or access additional funds. If you need to access equity, you would need to arrange a second mortgage or refinance. However, standard charge mortgages provide the benefits of switching or transferring the mortgage at renewal to a new lender without needing to be paid off or discharged first. 

    Collateral Mortgages

    Collateral mortgages, better known as collateral charge mortgages, involve the lender registering the mortgage (charge) for an amount that exceeds the actual mortgage amount. This charge covers on-demand loans, also known as re-advanceable mortgages, allowing borrowers to access the equity in the home as the mortgage is paid down. These funds can be accessed anytime without needing to refinance the mortgage. 

    Collateral mortgages can have multiple mortgage products like home equity lines of credit (HELOCs), re-advanceable credit facilities, and hybrid mortgages. Last year, the federal mortgage regulator reduced the re-advanceable portion of limits on the collateral charges registrations in Canada from 80% to 65% on the subject property’s valuation. 

    Mortgage Features

    Homeowners should consider various features when choosing a mortgage. Depending on your mortgage goals, these features can provide additional flexibility and benefits.

    Portable Mortgages

    Portable mortgages allow homeowners to transfer their existing mortgage to a new property without incurring penalties for breaking the mortgage. This is beneficial if you plan to sell your current home and purchase a new one. Porting the mortgage will allow you to keep your existing mortgage while transferring the interest rate, remaining term, remaining amortization, loan terms, and mortgage balance to the new property. 

    However, depending on your situation, you may have limitations or conditions. You could incur prepayment penalties if the new property is less than your remaining mortgage balance. If the new property is more than your current mortgage, you will need a new mortgage amount and may be required to blend your current interest rate with a higher rate. Also, if your current mortgage is insured or insurable and the new property you purchase is valued at $1 million or more, you may not be able to transfer the mortgage.

    Assumable Mortgages

    Assumable mortgages allow homebuyers to assume an existing mortgage from the current homeowner. The buyer would take over the original mortgage contract and continue with the remaining mortgage payments, terms, and conditions. This is beneficial if interest rates have increased since the original mortgage was obtained. It allows you to benefit from savings on the financing costs of having a higher mortgage due to a higher interest rate. 

    Not all mortgages are assumable. In most cases, the lender must approve the buyer’s assumption of the mortgage. You may be required to make a large downpayment to assume the current mortgage or take out a second mortgage to cover the remaining balance owed to the seller that the existing mortgage doesn’t cover if there is significant equity in the home from the seller. The seller could still be at risk of recourse if the buyer misses any future payment on the assumed mortgage.

    Blended Mortgages

    Blended mortgages allow homeowners to combine their existing mortgage rate with a new rate, extending the mortgage terms. These types of mortgages are a beneficial renewal option if interest rates have fallen and you want to blend and extend into a new rate and term to secure a lower interest rate without refinancing. Blending and extending will give you a better rate that falls somewhere between the two rates based on a weighted average determined by how much time is left on your current term.  

    Cash-Back Mortgages 

    Cash-back mortgages provide the borrower with a cash incentive from the lender. When the mortgage is finalized, you will receive a lump sum, either a fixed dollar amount or a percentage in addition to your mortgage amount. These funds can be used for immediate financial needs, such as furniture for your new home, paying debts, repairs and renovations, or moving expenses.  

    True cash-back mortgages allow the borrower to pay down debt at the time of the mortgage transaction, thereby achieving a lower total debt servicing ratio (TDSR) toward their mortgage qualification.

    Homeownership Structures for Mortgages

    If more than one person is purchasing and financing the home through a mortgage, the ownership structure will be important to consider in protecting your homeownership rights. The two common structures are tenants-in-common and joint tenancy. 

    Tenants-in-Common Mortgages

    Tenants-in-common mortgages mean that each co-owner has a share in the property. This share can be specified as a percentage based on financial contributions. Each owner has the right to leave their share to any beneficiary, next of kin, or heir upon death. 

    This option is suitable for situations where 2 or more individuals will hold an interest in the property, such as friends purchasing a home. This structure allows owners to sell or transfer their shares without needing consent from the other co-owners. 

    Joint Tenancy Mortgages

    Joint tenancy mortgages mean that each co-owner has an equal share in the property. If a co-owner passes away, their share automatically transfers to the other co-owner(s). Each owner has an equal share of the property, and each co-owner must approve it before any changes occur. This option is suitable for spouses or partners who purchase property together where the individuals want to ensure the property goes to the surviving co-owner(s) in the event of death. 

    Alternative Mortgage Solutions

    Alternative mortgage solutions provide additional options for those with unique financial circumstances that would not qualify for traditional lending solutions. 

    Private Mortgages

    Private mortgages are offered by companies or individuals who lend their money. These types of mortgages are often used by borrowers who cannot qualify for the strict lending criteria for mortgages through a prime lender for various reasons such as poor credit, property location or conditions or being over-leveraged, unverifiable, irregular or foreign income sources. 

    This solution typically has higher interest rates, additional fees, and shorter loan terms than traditional lending sources. Regulated private mortgages, also known as syndicated mortgages, require an exit strategy as they cannot typically be sustained long term without a very high risk of default. 

    Second Mortgages 

    Second mortgages allow homeowners to take out another mortgage on an already mortgaged property. This will enable you to borrow against the equity you have built up without altering your existing mortgage. A second mortgage will fall behind the original or first mortgage, and if you default on your mortgage payments, the first mortgage will have priority when recovering funds. 

    These mortgages can be set up as a home equity line of credit (HELOC), home equity loan, or private mortgage. However, if you have a second mortgage and wish to switch lenders, you may be required to refinance instead of renewing. Any second mortgage would need to be paid off, or a mortgage postponement would need to be granted by the new lender to approve a switch.

    Reverse Mortgages 

    Reverse mortgages are typically available for homeowners aged 55 or older. Like HELOCs, they use the equity in your home to give you access to up to 55% of the home value in cash on a tax-free basis. The maximum allowable amount will depend on the lender, your age, and the home’s appraised value. Loan repayments are deferred until you sell, move, or the death of the last borrower occurs. Reverse mortgages offer the benefit of being non-income qualified (NIQ) and are most suitable for older Canadians who typically have the equity but lack the income to qualify.

    Vendor Take-Back Mortgages

    Vendor take-back mortgages (VTB) allow the buyer to finance the property through the seller. The seller acts like a private mortgage lender; you would make regular payments to them instead of a bank as with a traditional mortgage. This can be ideal for those who cannot qualify for a mortgage. 

    This type of mortgage can only be offered if the seller owns the property outright without a mortgage. Interest rates could often be much higher, and the terms could be shorter than typical mortgage options available through regulated lenders.    

    Halal Mortgages

    Halal mortgages are a type of mortgage that complies with Islamic law, which does not allow the paying or receiving of interest. Some Canadian lenders are now offering halal mortgages as an alternative lending solution to help meet the needs of homebuyers. These mortgage solutions are ideal for Muslim homebuyers who cannot purchase a home with traditional mortgages that charge interest. 

    Frequently Asked Questions

    Welcome to our Frequently-Asked Questions (FAQ) section, where we answer the most popular questions designed and crafted by our in-house mortgage experts to help you make informed mortgage financing decisions.

    How do I know which type of mortgage is right for me?

    Choosing the right type of mortgage will depend on your financial circumstances, short—and long-term goals, downpayment, and risk tolerance. You will also need to assess important mortgage features, like the ability to make prepayments or transfer your mortgage to another property. Consulting a mortgage expert can help you narrow your choices to the most suitable solution. 

    What do I need for a downpayment to get a mortgage?

    Your downpayment requirements will depend on the purchase price of the home. In Canada, the minimum downpayment is 5% on homes valued at $500,000 or less. For homes with a purchase price between $500,001 and $999,999, a downpayment of 5% on the first $500,000 and 10% on the remaining amount is required. If the home is valued at $1 million or more, a 20% downpayment will be required.

    When is an open mortgage the right choice for me?

    An open mortgage could be the right choice if you anticipate a large bonus or inheritance you want to put toward your mortgage. The prepayment limits on an open mortgage would be higher than those on a closed mortgage. It could also be the right choice if you plan to pay off your mortgage in full before the end of your term.

    Final Thoughts

    A wide range of mortgages are available in Canada designed to suit the diverse needs of homeowners and homebuyers. Whether you’re a first-time buyer, refinancing, or renewing, there is a mortgage solution for you. 

    The right mortgage for you depends on your unique circumstances. Consult a mortgage expert at nesto who can help you narrow down your search and find the solution best suited to your needs.

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