There are enough mortgage options in the marketplace to make your head spin. How do you know which one is right for you? Here are the most common mortgage types, terms, and options that you will come across, how they differ from one another, and why they might be right for you (or not).
Traditional or conventional mortgages
are those that meet the requirement of having a 20 per cent down payment, with the remaining 80 per cent being provided by the lender. These have a low loan-to-value ratio, which means that the amount of the loan is low, relative to the value of the property. Before mortgage insurance was introduced in the 1950s, almost all mortgages were conventional mortgages, with borrowers paying at least 50 per cent of the cost of the home upfront.
are those in which the borrower has a down payment of less than 20 per cent, requiring the lender to provide a higher ratio of the loan. If you’re a borrower with a high-ratio mortgage then you are required by law to get mortgage default insurance, which is commonly known as mortgage insurance. The premiums for mortgage insurance are often rolled into the mortgage loan payments. High-ratio mortgages were generally thought of as being undesirable, but in an environment with historically low interest rates, high-ratio mortgages are the norm rather than the exception. Even people who might be able to afford the 20 per cent down payment required for a traditional mortgage sometimes choose to get mortgage insurance instead of fronting a 20 per cent down payment, keeping the extra cash liquid for closing costs or emergency funds.
Fixed rate mortgage
s feature an interest rate that doesn’t change, or is “fixed”, for a set period of time, often between 1 and 5 years. It’s easier to manage a budget with a fixed rate mortgage, since your payments won’t change during that fixed term. The interest rates for fixed mortgages tend to be slightly higher than other types of mortgages where the rate changes; what you gain in stability, you pay for with a higher mortgage interest rate. Fixed rate mortgages are most beneficial when interest rates are low and expected to rise over the length of the term – although predicting rate increases and decreases are far from an exact science. Five-year fixed rate mortgages are one of the most popular mortgage products in Canada.
An adjustable rate mortgage (ARM)
is reviewed at intervals and then adjusted based on the current prime rate, the rate at which a commercial bank’s optimal customers can borrow money. This rate adjustment affects both the monthly payment as well as the interest rate of the loan. If you have an adjustable rate mortgage and the interest rate drops, then you benefit from the lower mortgage rate instead of being locked into the higher mortgage rate as you would be with a fixed mortgage. The risk, of course, is that if interest rates rise, then you are on the hook for those increase in payments as well. Adjustments can happen without much notice, and as often as eight times per year. Adjustable rate mortgages are beneficial if you can withstand fluctuation in monthly payments but want to take advantage of lower rates.
A variable rate mortgage (VRM)
is another type of mortgage where the interest rate of the loan fluctuates based on the current prime rate. With a VRM, though, your monthly payment remains the same because the fluctuating amount is the amount of the payment that’s applied to the mortgage principal. A VRM allows you to keep some stability in terms of consistent monthly payments, but also reap the benefits if interest rates fall. Rates are typically lower with a VRM than they would be with a fixed rate mortgage.
A convertible mortgage
is one that can move from a variable to a fixed rate, or a shorter to a longer term, at any time without a penalty. If you take advantage of this option, then your interest rate will also change to the current rate offered by the lender for the new term. This would be a good option to consider if you want to stick with a variable rate for the moment, but expect rates to rise.
A hybrid mortgage
, also known as a 50/50 mortgage, is a combination of fixed and variable rate mortgages, allowing you to get the best of both worlds. With a hybrid mortgage, part of the loan is financed at a fixed rate and the other part of the loan is financed at a variable rate. The terms for both parts may be different, which may be tricky to manage when it comes time to renew your term, and it also may be difficult to transfer a hybrid mortgage to another lender. Still, you benefit from stability as well as potentially falling rates.
have restrictions when it comes to being paid off or renegotiated before the specified loan term is complete. Some closed mortgages cannot be paid off before the term ends without paying a large penalty, and other closed mortgages have a prepayment limit, with the borrower incurring severe penalties if any payment over that limit is made.
are flexible in that you can make lump sum prepayments or accelerated payments without penalty in order to pay the loan before the end of the amortization period. Although open mortgages have greater flexibility, they tend to have slightly higher interest rates than that of a closed mortgage.
, or home equity conversion mortgages, are mortgages that allow you to transform the equity in their home to cash while still living in the property. This has been touted as a good option for homeowners who are nearing retirement and who have considerable equity in their homes if they aren’t planning on moving and need to supplement their retirement income.
A portable mortgage
is exactly what it sounds like: it can move when you do. With a portable mortgage, you can take your current mortgage and apply it to another property if you move. You usually won’t have to pay penalties for breaking your mortgage contract, and you get to keep the interest rate of your current loan without going through the approval process again. This is beneficial if your current mortgage has a lower interest than anything you could get with your new home purchase.
An assumable mortgage
is one that can be assumed by someone else. If you’re looking to assume someone’s mortgage, then you’d usually have to be approved by the current lender, and the terms of that mortgage have to remain the same once transferred.
A Home Equity Line of Credit (HELOC)
is often used in conjunction with a mortgage but can also be used as a mortgage on its own for up to 65% of the property’s assessed value. With a HELOC, you can borrow money as needed up to that amount, although the interest is tied to the prime rate and can change at any time. With a HELOC you have the flexibility of paying as much of the loan as you want or making interest-only payments.
A cash back mortgage
is a product that offers you a percentage of the to-be-purchased property as cash upfront, and can be used for anything other than the down payment. The interest rate for this type of loan is high, generally costing the borrower almost twice the value of the cash. This option is generally used by people who need cash immediately following the purchase of their home for anything from moving expenses to furniture.
A collateral mortgage
is a mortgage in which your lender can lend you more money as your property value increases without needing to refinance your mortgage. It’s a good option if you think you’ll need another loan in the future. If you fell behind on payments, however, the bank has the right to raise your interest rate by as much as 10 percentage points. It is not transferrable to another lender, even at the end of the loan term, and that fact has made it a very attractive product for banks who want to retain their customers. Some banks only offer collateral mortgages, so be sure to read the fine print and ensure that you're getting what you think you're getting.
As you can see, there are many mortgage types, terms, and options, and some of them can be combined to fit your needs. You can discuss all options with a mortgage professional to find a product that’s right for you and your existing financial situation.
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