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The Ultimate Guide to Mortgages In Canada

Despite over 60% of Canadians needing a mortgage to buy a home, many don’t really know what a mortgage is.

Most Canadians get their mortgage directly from their bank, “their bank” being where they have a chequing/savings account and maybe a credit card. Canadians show a surprising amount of brand loyalty to banks, which could be the reason that 5 of the biggest banks in Canada are also in the top 6 most profitable businesses in Canada.

If you don’t know much about mortgages before you go mortgage shopping, you’re likely to end up overpaying for your mortgage. Considering how expensive homes in Canada are, you could be throwing away thousands of dollars.

Before you apply for a mortgage, get to know how a mortgage works and where you can find the best rates. Afterwards, you can make an informed decision and may even end up saving a few thousand bucks.

 

What is a mortgage?

Home Equity

Types of Mortgages

Mortgage Features

Mortgage Default (CMHC) Insurance

Mortgage Penalties

Down Payment

 

 

 

What is a mortgage?

A mortgage is a loan you get specifically to buy a home. Unlike a personal loan, a mortgage is secured – the bank can force you into power of sale or foreclose your home if you fail to make payments for a while. This makes mortgages one of the safest investments around. Even if you can’t pay the mortgage, the bank might be able to get their money back by selling the house.

The added security means that mortgage interest rates are much lower than other loans. And with high home prices, that’s a good thing. Mortgage rates are currently near the lowest they’ve ever been in Canada, which means you can save a lot of money by locking in your mortgage rate now.

What is the interest rate?

There’s no such thing as a free lunch, and there’s certainly no such thing as a free $500,000+.

When you borrow money, you have to pay back not only the amount you borrowed, but interest as well. Interest is just money that the lender charges you to borrow money. The amount they charge you is based on both how much you borrow and what percentage they charge.

Interest is always charged as a percentage of the amount you borrow. For example, right now the best 5-year fixed mortgage rate is 2.84%, which means every year you’ll pay 2.84% of the balance of the mortgage in interest.

What’s confusing to many borrowers is exactly how much that interest costs them. Since we pay almost all of our bills monthly, you might think that you would have to pay 2.84% of the mortgage balance every month – thankfully, that’s not how it works.

Interest rates are required by law to be advertised as an annual rate. So no matter what rate you see, it’s always what you’d pay over a full year, not each month.

If it was a monthly rate, you would have to pay $8,520 in interest on a $300,000 mortgage!

 

What is a mortgage payment?

A key part of paying back a loan is that you have to pay both interest and principal.

Principal is the money you borrowed. If you got a mortgage for $300,000, your principal amount is $300,000. Every month you make your payments, your principal goes down. That’s because only a portion of your payment is used to pay interest; the rest of it is used to pay principal.

At the beginning of a mortgage, roughly half of your payment is interest. As time goes on, more and more of your payment goes towards paying the principal. In the final years of a mortgage, interest can be just a couple hundred dollars. The last payment you make on your mortgage could have an interest charge of just $10 or less!

 

What is a mortgage term?

When you get a mortgage, you’ll agree to a specific set of terms for a specified length of time. For example, you might get a 5-year fixed mortgage at an interest rate of 2.84%.

That 5 years is what’s called the mortgage term. The interest rate won’t change for 5 years, but after the term is over, you’ll have to get a new mortgage term. This is known as renewing your mortgage. The only time you won’t need to renew your mortgage is when you pay it off in full.

What happens if I don’t renew my mortgage?

You should always shop around for the best rates when it’s time to renew your mortgage so that you get the best interest rate. However, if you decide to be lazy or get too busy to fill out the paperwork yourself, your mortgage will automatically renew as a 6-month open mortgage.

This may sound convenient, but it’s really not. Open mortgages can be paid in full at any time, but are substantially more expensive than a normal mortgage. It is always in your best interest to make sure you renew ahead of time.

 

Types of Mortgages

What is a fixed/variable mortgage?

Fixed and variable mortgages aren’t special types of mortgage. Rather, it just describes what kind of interest rate you have.

Fixed mortgage rates stay the same for the length of the term. If you get a 3-year fixed mortgage of 3.05%, your rate would be exactly the same for 3 years.

Variable rates change when the Bank of Canada raises or lowers the national interest rate. Changes in your variable rate shift more of your payment towards interest if the rate goes up, but if the rate goes down more of your payment goes to principal.

Despite popular belief, variable rate mortgages don’t change the amount you pay throughout your term. Your payment will remain the same, but where the money goes changes.

You can read more about fixed vs. variable mortgages here.

 

What are open/closed mortgage?

The majority of mortgages in Canada don’t let you pay it off in full without a penalty. You’re forced to keep making payments or pay a lump sum payment to break it early. These are known as closed mortgages.

Open mortgages let you pay them in full without penalty at any time, but have much higher interest rates to make up for it. In general, you should choose a closed mortgage unless you have a plan to quickly pay off the mortgage.

You can read more about open/fixed mortgages here.

 

What is an interest-only mortgage?

Some private mortgages are interest-only, meaning that you don’t pay any principal during the term. Your monthly payments will be a lot lower with an interest-only payment because you’re basically paying half or less of what you normally would.

The downside to interest-only mortgages is that they have to be paid in full at the end of the term. Unless you have hundreds of thousands of dollars lying around, this will usually mean getting another mortgage.

Since interest-only mortgages don’t reduce your principal, you would owe exactly the same amount as when you started the interest-only mortgage.

 

What is a reverse mortgage?

A reverse mortgage is a type of mortgage that works in reverse: the bank gives you money. Only a couple banks in Canada offer reverse mortgages.

In order to get a reverse mortgage, you have to be over 55. The bank gives you a lump sum of the money you want to borrow, and you’re free to do whatever you want with it.

One defining feature of reverse mortgages is that there are never any monthly payments – not even interest.

This sounds good, but don’t forget that there’s no such thing as a free $500,000. You’ll still be charged interest on the amount you borrow. You just don’t have to pay any of it off until you sell your home.

Because you’re not paying any of it off during your term, the amount you owe increases every month. Not only is it increasing, but it’s actually increasing faster every month because you get charged interest on top of interest. So long as you don’t plan on living in your home for much longer, this isn’t too big of a problem. You get money now and you only pay it back when the house is sold.

If you stay for a long time, however, you can end up eating away at most or all of your equity. Equity is the difference between what your house is worth and what you owe on it. Having 100% equity means if you sold, you would get 100% of the money. At 50% equity, you’d only get 50% of the money – the rest would go to the bank.

As long as you hold a reverse mortgage, your equity decreases. You’ll never owe more than the home is worth, but the bank could take most or all of the proceeds of the sale, leaving you and your family next to nothing. Be sure you have a set financial plan if you take out a reverse mortgage.

You can read more about reverse mortgages here.

 

Down Payment

You can’t get a mortgage for the full price of a home. Under certain circumstances you’re allowed to borrow your down payment separately, but 99% of the time you’ll have to bring some money with you to purchase a home.

The money that you bring yourself to a home purchase is called the down payment. In Canada, you must bring at least 5% of the purchase price as a down payment, but the specific down payment rules vary depending on the total purchase price of the home.

For homes under $500,000, the minimum required down payment is 5% of the purchase price.

For homes valued between $500,000 and $999,999, the minimum down payment is $25,000 plus 10% of the amount above $500,000. So if the home is worth $600,000, the amount over $500,000 is $100,000. That would make the minimum down payment

$25,000 + (10% × $100,000) = $35,000

For home valued $1 million or more, the minimum down payment is 20%.

Borrowed Down Payments

Like I mentioned earlier, there are certain times when you can borrow your down payment. This only works under very specific circumstances because borrowing money increases your debt load, and a higher debt load reduces how much mortgage you can afford.

In order to qualify for a borrowed down payment mortgage (also known as a Flex Down mortgage) you have to have excellent credit and a good income. However, the people that are likely to have excellent credit and good income are also the same people that are likely to have lots of money saved up for a down payment. If you’re considering this, talk to a mortgage broker first to see if you actually could qualify.

If you don’t have any money saved, or have poor credit, you won’t be able to borrow your down payment.

 

Gifted Down Payment

Something that almost everyone is allowed to do is receive a gift from an immediate family member to help them with their down payment.

Not everyone has family that are well-off enough to gift them several thousands of dollars, but those that are lucky enough can find it very useful. Receiving gifts in Canada is completely tax-free, and a higher down payment results in less interest paid over the life of a mortgage.

There are still rules about gifted down payments. The gifter must be a part of your immediate family, which limits them to your parents, siblings, or grandparents. Technically this also includes your children, but not many children have enough saved up to help with a down payment.

Moreover, you’re not allowed to pay back the gift, with or without interest. The gifter must sign a letter that declares they expect no money back from you after the purchase of the home. You also can’t add the gifter to the title without them becoming a co-applicant.

You can read more about gifted down payments here.

 

Home Equity

When your home is worth more than your current mortgage amount, you have equity.

One of the biggest reasons for owning a home is building home equity. In many cities across Canada, people that bought homes in the 80’s, 90’s, and 00’s have seen their home values triple, quadruple, or even more since they bought.

Having a lot of home equity means you’re in for a huge payday when you finally sell your home, but there are other benefits, too. You can use your home equity to get loans at super low interest rates relatively easily, which you can use for whatever you want.

 

Using home equity

Normally you can only access your equity by selling your house. Money stored in equity doesn’t exist until you cash it out. If you never sell your home, you can’t use your equity – unless you get a loan against your equity.

A home equity loan is a secured loan, similar to your mortgage. The difference is that you are using just a portion of the home’s value as collateral, rather than all of it. By securing the loan, you can get lower interest rates than you would get with an unsecured personal loan. You can also borrow a substantial amount of money if you wanted to.

Unlike a mortgage, which can only be used to purchase a house, you can use your home equity loan for anything you want. When I say anything, I mean anything. It’s your money.

But that doesn’t mean you should spend it on anything. If you waste your equity on frivolous purchases, you still have to pay back the loan plus interest. Buying an expensive toy like a car or boat may be a fun use of your equity, but will end up costing you far more than the purchase itself.

The most common use for a home equity loan is home improvement, which can actually end up increasing your equity by making your home more valuable.

 

Mortgage Default (CMHC) Insurance

In Canada, you need to get something called mortgage default insurance if your down payment is less than 20% of the purchase price. It’s most commonly called CMHC insurance, after one of the 3 companies that offer it, the Canadian Mortgage and Housing Corporation.

CMHC insurance protects the lender from default, which is when the borrower doesn’t make their payments for a long time. If the mortgage is uninsured, the lender has no guarantee they’ll get their money back if the borrower stops making payments.

The lender will sell the house to get back as much money as they can, but in some cases the borrower could have owed more than what the house is worth. This happens most often when home values decrease, and can be made worse if second/third mortgages are taken out.

Despite Canada’s low mortgage delinquency rate, defaults do still happen. Mortgage lenders don’t like to take any risks, which is why mortgages need to be insured.

 

CMHC Insurance Premiums

The exact amount you need to pay in CMHC premiums depends on the purchase price of the home. The premiums will always be a percentage of the purchase price, but depending on how big your down payment, that percentage changes.

Premiums are broken down into 4 tiers in sections of 5%.

·        5% - 9.99% of a down payment is tier 1

·        10% - 14.99% is tier 2

·        15% - 19.99% is tier 3

·        and 20%+ is tier 4.

The amount you have to pay is shown below:

Premium

Down Payment as a Percentage of Purchase Price

5 – 9.99%

10 – 14.99%

15 – 19.99%

20%+

4%

3.1%

2.8%

Not required

 

The premium is the percentage of the purchase price of the home you’d have to pay. If you’re buying a $400,000 home, and your CMHC insurance premium is 4%, you’d have to pay $16,000. If your premium was 2.8% instead, you’d pay just $11,200.

What happens if I default on (stop paying) an insured mortgage?

CMHC insurance is for the benefit of the lender, not the borrower. If the lender isn’t able to get their money back from the sale of the house, they’ll get the remainder from CMHC (or another mortgage default insurance provider).

However, the buck doesn’t stop there. You don’t get off scot-free just because the bank made its money back. The CMHC can and will come after you for that money.

Let’s say your house was worth $400,000 when you defaulted, and you owed $410,000 on your mortgage. The bank would get $400,000 from the sale of the home, and CMHC would pony up the remaining $10,000.

CMHC would then send you a letter asking you nicely to pay them back the $10,000 you owe them. If you can’t pay them (for example, you just defaulted on your mortgage and therefore obviously have no money) they send that bill to a collections agency, who will then hound you until you pay it back or declare bankruptcy.

Sounds bad? That’s because it is. It’s in your best interest to avoid defaulting on your mortgage at all costs, which might explain why the Canadian mortgage default rate is so low despite soaring debt amounts.

 

Mortgage Features

When you think of a mortgage, you probably only think of how much you want to borrow and how much it’s going to cost you. You probably don’t think of it as something that has unique features.

However, mortgages are actually very complex financial products, and some features can save you thousands of dollars, even if they do come at a higher interest rate. Here are some of the features you should be looking for in your mortgage.

 

Mortgage Portability

One thing that very few homebuyers prepare for when purchasing a house is what they’re going to do when they want to move. They’re thinking about what they’re going to do in the current house, and may not be thinking about years in the future. Perhaps they even think that they won’t purchase another home, and live in that one forever. But most people don’t keep their mortgage term. Sometimes things in life happen, like a new job or starting a family, that mean you need a bigger or smaller home, or even need to move cities.

Breaking your mortgage can be a costly affair. Mortgage penalties are high, especially for fixed mortgages, but if you need to move you have no choice but to pay them. That’s where the ability to port your mortgage comes in.

When you port your mortgage, you basically move it with you when you buy a new property. This doesn’t count as “breaking” your mortgage so you avoid mortgage penalties, and if rates have gone up you get to enjoy a lower rate.

You can read more about porting your mortgage here.

 

Mortgage Assumability

This is the opposite of porting your mortgage. When someone assumes your mortgage, they take it over when they buy your property. This isn’t as popular as porting your mortgage, but can be just as useful.

 

Pre-Payment Privileges

You already know that the best mortgage rates are on closed mortgages. You also know that you can’t pay off a closed mortgage in full before the end of the term without incurring penalties. But many mortgages allow you to make additional payments throughout the term. These are known as pre-payment privileges.

The first pre-payment option is called a double-up, which allows you to pay more once per month. The amount you’re allowed to pay is a percentage of your monthly mortgage payment, and despite the name, isn’t always double your payment. Most of the time, you can pay 20% on top of your monthly mortgage payment. This amount goes straight to principal rather than interest, so you accelerate your mortgage payoff date.

The second pre-payment option is a lump sum payment. You can only make a lump sum payment once per year, and the amount is a percentage of your remaining mortgage balance. Like a double-up payment, 20% is a common amount allowed, but that’s 20% of your whole mortgage, which could be a lot.

It’s most effective to make extra payments at the start of your mortgage because that’s when most of the interest is charged. The sooner you pay down the balance, the less interest you’ll pay overall.

 

Mortgage Penalties

As discussed earlier, the mortgages with the best interest rates also come with penalties. For the average homebuyer who is just looking for a place to live, getting a closed mortgage – even with penalties for breaking – is the correct financial choice. The higher interest of no-penalty (open) mortgages far outweighs the savings on the mortgage penalty, unless you sell within 3 months.

Some mortgage features allow you to get around mortgage penalties, but not every mortgage comes with those features. You may end up paying a mortgage penalty at some point, whether you’re moving, refinancing, or going from owning to renting. Here’s all the info you need when facing mortgage penalties.

 

When are you charged a mortgage penalty?

You’re charged a mortgage penalty whenever you breach or break your mortgage contract. In fact, your mortgage contract will even have these terms written in them. All you have to do is read through the contract to see how and when the penalties will be applied.

The most common reason for breaking a mortgage contract is when you move before the end of your mortgage term. You might expect to stay in your house for 5 years, but you suddenly get a job transfer opportunity and need to move to a new city, for example. It could have been an opportunity that you wouldn’t have even thought possible when you first bought your house, which makes it hard to plan for.

You may also be charged a penalty when you overpay on your pre-payment privileges.

 

Why do mortgage penalties exist?

Lenders only make money on mortgages when you keep making the monthly payments. If you break your mortgage, they get their money back but stop earning more. So they charge penalties to make up for that lost interest.

 

What types of mortgage penalties are there?

Broadly speaking, there are two types of mortgage penalties: 3 months’ interest and the interest rate differential.

3 months’ interest is a very straightforward. When you break your mortgage, the lender will calculate the cost of 3 months’ interest based on the mortgage balance at the time you break it. So if you have $300,000 remaining at a rate of 3.00%, your penalty will be $2,250. (The cost of a single month of interest is $750). 3 months’ interest is the normal penalty for all variable rate mortgages.

For fixed rate mortgages, most lenders use a different calculation to determine you penalty called the interest rate differential. In short, it takes the difference between your interest rate and a comparable current interest rate and charges you based on that.

The cost of an IRD penalty is higher than a 3 months’ interest penalty, usually by a lot. However, the IRD is only high when interest rates have gone down from the time you originally got your mortgage. If rates have gone up, you may simply be charged 3 months’ interest anyway.

You can read more about the interest rate differential calculation here.

 

 

In Conclusion

Banks know that most people are likely to just get a mortgage from them without even considering other options. Many people don’t even know they can get a mortgage from somewhere else! This knowledge lets them charge higher interest rates. That’s right – even though they’re some of the biggest businesses in Canada, they’re nearly always more expensive than smaller lenders.

The best mortgage rate in Canada is often found at a lender that you may not have heard of. That doesn’t mean they’re shady, it just means that they don’t spend as much on advertising as the big banks. There’s no BMO Field, Scotiabank Arena, or TD Place Stadium for smaller lenders, but they provide better rates and just as good service.

The first step to getting a great mortgage rate is start shopping online. You won’t get the best deals if you don’t look for them!


Chris Chris 04/24/2019
Canadian personal finance buff and all-around writing enthusiast, Chris loves breaking down complicated money ideas to show that they're really not so complex. 
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