When buying a house, there are many decisions that must be made. You need to think about the size of the property, the location, and what colour of paint you plan to use on the walls. You also must think about how you plan to pay for your new home. There is a variety of mortgage options available when making this choice, and it is important to consider which one is right for you. One of the most important steps is deciding what kind of mortgage fits your short and long-term needs. This article highlights the five main types of mortgages in Canada, giving you a summary of their benefits and limitations. With this information, the difficult decision of financing your new house will be that much easier, allowing you to focus on what really matters: red paint or blue?
Choosing a mortgage
When you buy a house, condo, or other property, you generally won’t pay the full price right away. You will make a down payment and sign a contract with a bank or other lender to pay the rest of the purchase price. This agreement is your mortgage, containing the information about the loan your bank has given you and how you will be expected to pay it off.
Among other things, a mortgage typically includes the following:
- A principal amount
- Interest rates
- Payment frequency
The best way to understand how all of these things work together is to use a mortgage calculator. You can see change your frequency, amortization, principal amount, and interest rate so that you are better prepared to shop for a house. You can use the calculator to see if you qualify for a mortgage. If the numbers are scary, you can estimate what a Canadian Housing and Mortgage Corporation (CMHC) mortgage insurance would add to your payment.
The principal amount is how much you borrowed from your lender. This is the main price you will have to pay back to the bank. That amount depends on the size of your available money for a downpayment.
You agree to pay an interest rate. The interest portion is added to each payment. This means your overall expenses are greater than the principal amount of the loan. Interest rates can be fixed or variable, meaning they either stay the same or can go up or down. Your interest rate is dependent on your credit score.
Your payments will be spread out over a length of time, allowing you to pay periodically. The payment frequency is the agreed-upon timing of when these payments are made; it determines how often and how much you will pay each time.
Amortization is the length of time over which all these payments are spread; it allows you to take the high overall cost and break it into pieces, often taking years or decades to fulfill your mortgage contract and pay off the loan.
Types of mortgages
In Canada, there are different kinds of mortgage plans that you might choose, based on how you want to make your payments and what specific agreement you wish to sign with your bank. The following are five of the most important types of mortgages.
1. Open mortgages
Open mortgages allow you to pay off your mortgage earlier than expected; they give you the option of paying a larger amount so you can complete the contract quickly if you decide that you have enough money to make these higher payments. You might be expecting to receive funds through higher wages, an inheritance, or a sale of other properties or valuables. With more money on its way, you may wish to have the flexibility to either pay a large lump sum towards your mortgage or make higher regular payments. You may even want to pay off the rest of your mortgage, ending your contract and owning your property outright, without being in debt to your lender.
In other mortgage agreements, there might be prepayment charges if you pay earlier than your agreed frequency of payment. Banks don’t always want to end the mortgage before the expected time because they may not get as much interest and therefore risk lower profits. In an open mortgage, you have the freedom to pay larger amounts without any penalties. It also makes it easier to refinance your home.
2. Closed mortgages
In many ways, closed mortgages are the opposite of open mortgages; they give you less flexibility on ending the mortgage early, often requiring you to pay a fee if you pay the mortgage loan off before the expected time. However, they also generally offer lower interest rates, with these rates predetermined or variable, depending on your particular contract. Closed mortgages are more common in Canada than open mortgages because many people prefer to have low-interest rates and do not plan to make bigger, earlier payments.
A closed mortgage with fixed rates can offer you the stability of knowing exactly what you will pay without having to worry about rising interest. If you plan to stick to a set schedule and do not expect your wages to rise or any extra funds to materialize, you may benefit from this increased stability. Closed mortgages are likely to have lower interest rates but may also require you to pay prepayment fees if you eventually decide to make larger and earlier payments. Furthermore, you won’t have the flexibility that an open mortgage offers you.
3. Hybrid mortgages
Hybrid mortgages offer you the chance to combine different types of mortgages. You might wish to have an open mortgage for a certain period and a closed mortgage for another part of the amortization period. Perhaps you are only able to make small payments now but are planning to have higher wages later; a hybrid mortgage might allow you to make bigger payments in the second half of your agreement so you can pay back the remainder of the loan early. Whatever your reasons, a hybrid mortgage allows you to create a customized agreement that combines different forms of mortgages in a way that makes sense for your specific situation.
Hybrid mortgages can combine various different terms and conditions into a single mortgage package. You may have a fixed rate portion and a variable rate portion, have access to a line of credit for part of the mortgage, or have other financing options that your bank is willing to include in the overall contract. There are many different combinations to choose, and a hybrid mortgage is a good option for people with the financial knowledge to negotiate a more complex mixture of agreements.
Nevertheless, you can design a hybrid option to your benefit. The interest rates are rarely better than a closed variable-rate mortgage. Your overall savings may actually be less than picking a specific kind of mortgage for your entire amortization term.
4. Convertible mortgages
A convertible mortgage offers the option to change the mortgage type at a later date. This means that you don’t have to decide at the beginning. You may decide to have a fixed-rate mortgage and then switch to a variable rate mortgage. You can begin with an open mortgage and then realize that a closed version is better for you. Convertible mortgages offer you the ability to make these choices even during the contract, giving you greater freedom to make decisions. Each convertible mortgage may have its own built-in terms and conditions; some will offer a greater choice than others, or different fee or interest packages. However, having the additional flexibility is a valuable tool for many homeowners who want the option of changing their agreement; they may feel more comfortable having the power to adjust their mortgage as life changes occur and new possibilities open up.
5. Reverse mortgages
Reverse mortgages allow you to access your home equity. It lets you to take out a loan based on the overall value of your property. This is an option for people who already own a house and have paid into their mortgage. If your home’s value is higher than the remaining mortgage loan, you can withdraw the surplus cash. You don’t have to sell the property. This is usually an option for seniors. You can usually borrow up to 55% of your home’s overall value. You repay the loan when you sell the house. The estate heirs settle it if the owner dies.
What type of mortgage should I choose?
Mortgages are sometimes confusing, but they don’t have to be. By choosing the type of mortgage that fits your goals, you can find options that work for your timeline and your budget. Each individual has their own needs and preferences; with so many mortgage financing options, there is something out there for everyone. Whether a closed or an open mortgage, fixed rates or variable, with a little bit of research, you will be able to sign the contract that is right for you.