In the Canadian market, financial institutions offer a plethora of residential mortgage products. Often, consumers don’t understand the differences and pros and cons of each product.
Each mortgage type has its features and benefits and is suitable for individuals in different financial situations, with different financial objectives, risk tolerance, and long-term plans. Understanding how each works is essential to choosing the mortgage product that best suits your needs.
This Guide will help you understand the different mortgage products available in the Canadian market and, most importantly, which is best suited for each situation.
With fixed-rate mortgages, the interest rate you agreed upon when signing the contract remains the same, i.e. fixed throughout the mortgage term.
The benefit of such a product is that your monthly payments are predictable, and thus, it’s easy to budget for such mortgages. So, if you are risk-averse and prefer stability and predictability, a fixed-rate mortgage is the best solution for you. They are also the best option to consider if you’re in a rising interest rate environment.
With a variable-rate mortgage, you don’t benefit from a stable interest rate. Instead, it fluctuates based on your lender’s prime rate.
The lender’s prime rate is the interest rate at which they charge their most creditworthy clients. This rate depends on the so-called “overnight” rate set by the Bank of Canada. Economic conditions and other factors are also considered when calculating this rate. Major banks typically have very similar prime rates, resulting in a de facto standard prime rate.
Your variable-rate mortgage interest rate will be expressed as prime plus or minus a certain percentage (e.g., Prime + 1%).
Variable-rate mortgages typically have lower initial interest rates compared to fixed-rate mortgages.
On the other hand, taking out these mortgages when you expect interest to climb in the long run can be pretty risky. However, you’ll save a lot of money on interest if interest rates drop.
Variable-rate mortgages are perfect for individuals whose incomes can handle potential increases in their monthly payments and who have flexibility in their budget to handle payment fluctuations.
Hybrid adjustable-rate mortgages are, in simple terms, a combination of a fixed- and variable-rate mortgage.
Your interest rate will be fixed for an initial period at the beginning of your mortgage term. These periods are usually 3, 5, 7, or 10 years. After the fixed-rate period ends, the interest rate adjusts periodically (usually annually) based on an index (like the lender’s prime rate) plus a margin.
Your mortgage contract will also specify a rate cap, which defines the maximum amount the interest rate can change at each adjustment period.
Typically, this type of mortgage will have lower interest rates than standard fixed-rate mortgages.
Hybrid-adjustable-rate mortgages are a very specific mortgage product best suited for those who plan to refinance or sell their homes before the fixed-rate period ends or anticipate interest rates falling in the long term.
An open mortgage allows you to pay it off fully or partially at any time without paying any penalties, like interest rate differentials (IRDs) or three months' interest. However, this flexibility is compensated by higher interest rates compared to closed mortgages.
Open mortgages are best suited for individuals who expect to receive a large sum of money soon (usually an inheritance or bonuses from promotions) or plan to sell their existing home soon.
In the case of closed mortgages, you do not have the flexibility to pay off your mortgage early unless you want to incur penalties. However, such mortgages have lower interest rates compared to open mortgages.
Such mortgages are ideal for those who are purchasing a property with the intention to continue living in it for the foreseeable future.
Open and closed mortgages can both have either fixed or variable interest rates. Hybrid adjustable-rate mortgages are typically closed mortgages.
If you are a first-time buyer or low on cash to finance your down payment, high-ratio mortgages are the best solution. These mortgages are made explicitly for buyers paying a down payment of less than the standard 20%.
However, such loans require you to purchase mortgage insurance from Canada Mortgage and Housing Corporation (CMHC), Genworth, or Canada Guaranty, which is added to your overall mortgage cost. The insurance cost is determined based on your loan-to-value (LTV) ratio, which is the percentage of the home’s value financed through the mortgage. If your down payment is 5%, your LTV is 95%. The lower your LTV, the lower your insurance costs.
Interest rates on high-ratio loans are usually very similar to those on conventional mortgages. This is simply because the insurance cost, which is calculated into your mortgage costs, offsets the lender’s risk.
Although high-ratio mortgages are a solid solution for individuals entering the housing market and with limited funds available for the down payment, they do have their risks involved. As your insurance costs are part of your mortgage, you’ll be paying higher monthly installments.
Besides, starting with very low equity means accumulating significant equity in your new home will take a lot of time. This can be tricky if you need to sell your home or refinance. Also, there’s the risk of slipping into negative equity. If the value of your home decreases over time, you’ll end up paying more for your mortgage than what the property is worth on the market.
Portable mortgages allow you to transfer your incumbent mortgage to a new property without incurring any kind of penalties and maintaining the same interest rate and terms.
Such mortgages typically have interest rates similar to conventional mortgages. They are often used by individuals who plan to make a move and want to take advantage of current interest rates but avoid prepayment penalties.
Typically, the lender will impose some conditions for you to be able to port your existing mortgage to a new home. The new property you purchase must be a residential property and must undergo an appraisal. Its appraised value must meet or exceed the value of your incumbent property. The property must be in good condition with no significant repairs or renovations necessary.
Your mortgage agreement will also lay out how much in advance you need to give notice about porting your mortgage, i.e. before selling your current and purchasing a new property. Please note that some lenders may impose geographical restrictions regarding the location of your new property. They will also charge additional fees to cover the administrative costs of porting your mortgage to a new property.
The downside of portable mortgages is that if your new property’s value exceeds the value of your current home, you might need to take out a top-up loan to finance the difference. This top-up loan will have to be signed under a new interest rate and term compared to your existing mortgage.
If you’ve already purchased a home and want to access the accumulated equity in your home, you also have several options available. Here’s when to choose which one.
Mortgage refinancing means replacing your existing mortgage with a new one under a different interest rate or term. This is a standard instrument also used to access your home’s equity. In this case, it is called a cash-out refinance.
Cash-out refinance is a good option if you need to access a large sum of money for some major, unexpected expenses (like home renovations or medical expenses). Compared to a second mortgage or HELOC (Home Equity Line of Credit), cash-out refinancing has lower interest rates and thus represents the cheapest option to access your home equity. They are especially beneficial if interest rates have decreased compared to when you initially secured the mortgage. It is also easier to manage, as the cash-out amount is simply added to your mortgage cost under new terms while you still have only one monthly payment.
To understand the math behind cash-out refinance, here’s a simple example:
Suppose you bought a home for $100,000 six years ago. To fund this purchase, you obtained a mortgage of $80,000 at a 3.5% interest rate. Now, you're interested in accessing the equity you've built up in your home through mortgage refinancing.
You should consider two factors: the amount you've already repaid and the current market value of your home.
After six years of making regular mortgage payments, you've lowered your loan balance through principal payments and potentially gained equity due to any increase in the home's value. The remaining balance is approximately $70,000.
Let's also assume that your home's value has increased over these six years and is now valued at $120,000. Most lenders typically allow you to borrow up to a certain percentage of your home’s value, usually 80-85%.
Your current estimated equity is the same as your home’s current value ($120,000) minus the remaining loan balance ($70,000). So, in this case, it’s $50,000. The maximum loan amount you can take out equals $120,000 multiplied by 80% ($96,000). The new mortgage will have a different interest rate and term than your original mortgage.
By subtracting your remaining loan balance ($70,000) from the maximum new loan amount ($96,000), you'll obtain your maximum cash-out amount. In this case, it’s $26,000.
A second mortgage (or home equity loan) is simply an additional loan you are taking out against the accumulated equity you have in your home. Your original mortgage interest rates and terms remain unchanged.
If a lender refuses to allow access to your accumulated home equity for any reason, or you want your first mortgage’s terms to remain unchanged, taking out a second mortgage might be the best solution. Typically, you can borrow up against up to 80% of your home’s value.
Here’s an example scenario to understand how much money you can take out in a second mortgage.
Imagine you have a home valued at $500,000 and an outstanding balance of $300,000 on your first mortgage. If your lender permits you to borrow up to 80% of your home's value, you could potentially access $400,000.
The maximum sum available for your second mortgage is equal to the allowed borrowing amount ($400,000) minus the outstanding balance on your first mortgage ($300,000). Available for Second Mortgage: $400,000 - $300,000 = $100,000.
In this scenario, you could secure a second mortgage for $100,000.
The interest rates for second mortgages are higher due to the increased risk for the lender, as they would be in a subordinate position if you default or face foreclosure. Typically, the interest rate for second mortgages is 2-5% higher than that for first mortgages.
Similar to your first mortgage, second mortgages are repaid in monthly installments. They are usually structured as fixed-rate mortgages.
Additionally, taking out a second mortgage would mean that you cannot refinance your first mortgage until the second one has been fully repaid.
A Home Equity Line of Credit (HELOC) is a financial solution for homeowners with at least 20% equity. A HELOC is a revolving credit line secured by your home equity. This means you have flexible access to funds for ongoing expenses or future projects. They are ideal if you do not need a lump sum immediately but want to access your available funds gradually.
HELOCs typically have variable interest rates tied to the lender’s prime rate, but most lenders will offer the possibility to lock in a portion of your HELOC interest rate. They have an initial draw period (typically 5-10 years) during which you pay interest only on the amount borrowed, followed by a repayment period during which you repay both the principal and interest, typically over 10-20 years.
HELOCs often have lower initial costs due to the variable interest rates and are the most cost-effective solution for short-term borrowing.
Let’s take the following example to understand how a HELOC would work:
You purchased a property for $300,000 with a down payment of $60,000 and an initial mortgage of $240,000 at an interest rate of 2.9% for a term of 15 years. After seven years, the remaining mortgage balance would be approximately $121,238.
Assuming a modest annual appreciation rate of 3%, the current property value would be approximately $369,000. This results in a current equity of $247,762, calculated as the current property value minus the remaining mortgage balance.
Based on the current value of the home and the remaining mortgage balance, a HELOC would allow you to borrow up to $173,962.
For example, if you borrowed $50,000 from your HELOC to remodel your kitchen during the draw period, you would only need to pay interest on the borrowed amount. If the interest rate is 4%, your monthly interest payment would be $167. After the draw period, you would start repaying the $50,000 principal plus interest over the remaining term.
Reverse mortgages, also known as "equity release," are designed for homeowners over 55 who want to access their home equity. With a reverse mortgage, homeowners can borrow up to 55% of their home equity, which can be received tax-free as a lump sum or in monthly cash deposits, depending on the lender's terms. The money can be used for any purpose without restrictions.
Reverse mortgages are based solely on home equity, so lenders do not consider credit scores, and there are no income requirements. However, any existing mortgages on the home must be repaid before taking out a reverse mortgage.
The amount that can be borrowed depends on the homeowner's age, the home's location, and its appraised value. Different lenders have varying methods for calculating the maximum amount that can be borrowed, so obtaining multiple offers is crucial.
The key feature of reverse mortgages is that homeowners retain home ownership regardless of the circumstances. Repayments are not required unless the home is sold, the homeowner permanently moves out, or in the case of death. However, homeowners can make repayments if they choose to do so.
The main drawback of reverse mortgages is that the interest rates are typically higher than those of traditional mortgage products.
Let’s see how using a reverse mortgage would work as an example.
You own a property valued at $250,000 and are 65 years old. Let’s assume that for a 65-year-old individual, the percentage of the home value against which they can borrow is 40%. This means you can borrow a maximum of 40% of $250,000, which is $100,000.
Let’s say you opt for a lump sum payment. Interest on the loan accrues over time at a rate of 5% per year, and after ten years, the loan balance will have grown to approximately $162,889. When you decide to sell the property, move out, or if you pass away, the home is sold, and the loan balance is repaid from the sale proceeds.
If the property value has, for example, increased to $350,000 after ten years, the remaining equity of $187,111 goes to either you or your heirs.
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