5 Types of Mortgages: How to Choose the Best Home Loan
Many home buyers are familiar with the concept of a mortgage, but they may not know that there are several different types of home loans. The type of mortgage affects the interest rate, the monthly payment, and how long it takes to pay off the loan. Whether you're buying your first house or you're experienced with all types of real estate investments, it's important to choose the best mortgage for your unique needs. With this information, buyers will know the types of mortgages they can consider and be well on their way to navigating the home closing process.
Conventional mortgages play an essential role in the Canadian housing market. They are offered by financial institutions such as banks or credit unions and designed for borrowers with good credit ratings and a substantial down payment. A conventional mortgage typically requires that the borrower provide 20% of the purchase price as a down payment, although this can vary depending on the cost of your home.
Minimum down payment amounts in Canada vary at three cost tiers:
- Home cost of $500,000 or less: minimum down payment is 5%
- Home cost of $500,000 to $999,999: minimum down payment is 5% on the first $500,000, 10% for the difference exceeding $500,000
- Home cost of $1 million or more: minimum down payment is 20%
There are pros and cons to paying large down payments on conventional mortgages. The biggest advantage of larger down payments—those of 20% or more—is that you're no longer required to purchase lenders' mortgage insurance (LMI). However, paying a smaller amount upfront can help buyers remain liquid.
A fixed-rate mortgage is one of the most common methods to structure a mortgage payment. With most mortgages, the interest rate is the biggest determiner of the monthly payment. A fixed-rate mortgage ensures that the rate stays the same for the entire duration of the loan. Even if the average mortgage interest rate rises or drops over time, the loan terms do not. A fixed-rate mortgage gives home buyers the benefit of predictability, but if the interest rate is high, homeowners would have to refinance to access a lower rate.
A variable-rate mortgage is significantly different from a fixed-rate loan. Typically, the loan provides a predictable interest rate and payment for a defined amount of time at the beginning of the loan. This term might last 2–10 years, depending on the lender. After that period, the rate resets based on an index that tracks with the Bank of Canada's overnight rate. When the overnight right goes up, your mortgage payment goes up, too. When they drop, your payments go down with them. Variable-rate borrowing requires borrowers to be more hands-on than fixed-rate.
Open vs. Closed Mortgages
Mortgages in Canada essentially come in two varieties: open and closed. Open mortgages provide homeowners more flexibility to make larger payments or pay off their mortgage early without penalty. In contrast, closed mortgages are characterized by fixed terms that can't be changed throughout the life of the loan.
Deciding between an open and a closed mortgage is a personal choice based on your financial needs. Generally, an open mortgage could be ideal for you if you're trying to pay a mortgage off quickly. Paying off a mortgage faster isn't always better. You might prefer a closed mortgage if you want a consistent, reliable financial plan.
Many people fall right in between and enjoy the benefits of convertible mortgages. These hybrid models allow borrowers to switch from open to closed and vice versa at authorized points during the mortgage.
A collateral mortgage in Canada is a loan made against an asset you own, such as your home. Collateral mortgages are popular options homeowners use to raise money for value-increasing home renovations or investments. Essentially, the borrowers will take out more money than what's needed to buy the property. This helps them consolidate debt and ensures they'll have the funds available when needed.
Depreciating property values is one of the biggest risks related to collateral mortgages. If your home loses value, you won't be able to use as much of the borrowed money. To avoid inflation or rising interest rates, some lenders may offer flexible repayment options so homeowners can customize their payments according to their needs and budget.
What's the Best Mortgage For Your New Home?
Deciding on the right mortgage can be a daunting task. There are many factors to consider, such as whether you want a fixed or variable interest rate, how long you plan on being in your home, and what kind of down payment you can afford.
This resource should help clear up some common questions about mortgages in Canada so that you can make an informed decision about the best options for your circumstances. With this information, homebuyers will be able to focus on avoiding common moving mistakes rather than reading through mortgage offers and calling LMI providers!