Before buying your first home, it’s crucial to grasp the fundamentals of how mortgages work in Canada. While mortgage specialists can assist, familiarizing yourself with the basics ensures a smoother experience from start to finish.
What Is a Mortgage?
A mortgage is a financial agreement that allows you to borrow money to purchase a home.
In exchange, the property serves as collateral until the loan is fully repaid. Canadian mortgages are structured to provide flexible terms, enabling you to choose options that best fit your financial circumstances.
A mortgage consists of two primary components: the principal (the amount borrowed) and the interest (the cost of borrowing). You’ll repay both over an agreed term through regular installments. Banks, credit unions, or private lenders, among other financing institutions, may offer varying terms, rates, and features.
Key things to know about mortgages:
A mortgage is a legally binding agreement between you and your lender.
You may be required to undergo a stress test to confirm your ability to afford the payments. (this is qualifying you at a higher rate than the one your mortgage will have to ensure you can handle future fluctuations in interest)
Renewing your mortgage with a different lender in the future could help you secure better interest rates or terms that align with your financial goals. Get your free mortgage transfer eBook to understand all the possibilities and requirements of moving your mortgage.
Breaking the terms of your mortgage agreement early may result in penalties.
The lender holds a legal right to your property, meaning failure to make timely payments could lead to foreclosure.
The loan amount you qualify for depends on the lender's specific qualification criteria, which can vary between institutions.
Mortgage Terminology
Here are some important mortgage-related terms that we speak to throughout this blog. They’ll help you better understand mortgages in general and any future conversations you have with a mortgage specialist:
Amortization: The duration of the loan, often described as its lifespan.
Amortization period: The total duration over which the mortgage is fully repaid.
Mortgage term: The length of time your agreement with the lender is in effect, typically ranging from 6 months to 10 years, as determined by your financial institution.
Mortgage broker: A specialist who assists in finding favorable mortgage deals from various lenders.
Lien: The legal right to retain possession of a property until a debt associated with it is fully repaid.
How Mortgage Interest Rates Work
Mortgage interest rates determine how much you pay to borrow money for your home. They are expressed as a percentage of the loan amount and directly impact your monthly payments and the overall cost of the loan.
Rates can be fixed or variable. A fixed or variable mortgage determines payment stability. Fixed rates remain consistent throughout the loan term, offering predictable payments. Variable rates fluctuate based on market conditions, often tied to a benchmark like the prime rate. Variable rates may start lower but carry the risk of increasing over time.
Several factors influence your mortgage interest rate. Personal factors include your credit score, income, and debt-to-income ratio, which help lenders assess your financial reliability. Market factors like inflation, economic growth, and Bank of Canada policies also play a role in the overall cost of borrowing.
Lenders may offer discounts based on larger down payments or shorter mortgage terms. Shopping around and comparing offers from multiple lenders can help secure a competitive rate. Additionally, locking in your rate before closing protects you from potential increases during the application process.
Understanding how mortgages work in Canada empowers you to make informed decisions and manage your long-term financial commitments effectively.
Factors That Influence Your Mortgage Interest Rate
Lenders determine your interest rate based on a combination of personal and market factors. Your credit score, income stability, debt-to-income ratio, and mortgage down payment size play a crucial role in assessing your financial reliability.
Additionally, external factors such as inflation, economic trends, and central bank policies influence the rates offered. The loan term and type—fixed or variable—also affect the rate. Comparing offers from multiple lenders and maintaining a strong financial profile can help you secure a competitive mortgage rate tailored to your needs.
The Right Type of Mortgage for You
When buying a home, one of the most important decisions is selecting the mortgage that best aligns with your financial goals. This involves considering the type, the mortgage term, and the amortization period.
Types of mortgages: Open vs. Closed
Open mortgages: Open mortgages offer flexibility, allowing you to make large payments or pay off the mortgage entirely without penalties. This option is ideal if you anticipate receiving additional income or plan to pay off your mortgage faster. However, open mortgages typically come with higher interest rates.
Closed mortgages: Closed mortgages usually have lower interest rates than open mortgages but charge penalties for early repayment. For additional flexibility, you can opt for a variable interest rate within a closed mortgage, which may start lower than a fixed rate but can increase or decrease depending on market conditions.
You can also check whether your financial institution has prepayment options that allow you to pay down a closed mortgage without penalties. For example, we have a 20/20 prepayment option that lets you pay up to 20% of your original mortgage principal each year plus increase your monthly payments by 20% without penalty.
The best mortgage type depends on your financial situation and long-term plans. Choose an open mortgage for flexibility or a closed one for potentially lower interest rates. Understanding the pros and cons of both options ensures your choice supports your homeownership goals.
Professional tip: Opting for a longer amortization period can lower your monthly payments, making homeownership more manageable. This choice, however, may increase the total interest you pay over time.
How Do I Apply for a Mortgage?
Congratulations on starting your journey toward homeownership! Applying for a mortgage with us is a simple and straightforward process.
To get started, we’ll need some essential details to assess your application and guide you through the next steps. Here is a comprehensive mortgage application checklist (pdf) to help you gather the necessary information. Feel free to reach out—our team is ready to support you every step of the way.
Types of Mortgage Lenders
Finding the right mortgage lender is a key step in securing your dream home. Different lenders offer varying rates, mortgage terms, and services tailored to meet diverse financial needs. Here’s an overview of the main types of mortgage lenders to consider:
Credit unions: Offer personalized service, competitive rates, and lower fees for members. Some credit unions even share their profits with their mortgage members.
Banks: Provide conventional mortgages with competitive rates.
Mortgage brokers: Help find the best mortgage deals across multiple lenders.
Private lenders: Cater to those with unique financial situations.
Online lenders: Offer fast, convenient applications and approval processes.
How to Get Approved for a Mortgage
Securing approval requires preparation and a clear understanding of lender requirements. Here are key steps to improve your chances:
Assess your financial health: Review your credit score, income stability, and debt-to-income ratio. Aim to maintain a credit score of 720 or higher for better rates and terms.
Save for a down payment: Reduce your interest rate with a larger down payment (typically 20% or more).
Gather important documents: Prepare proof of income (pay stubs, tax returns), bank statements, employment verification, and identification. Accurate documentation demonstrates readiness and reliability.
Calculate your budget: Use mortgage calculators to estimate affordability, including monthly payments, property taxes, and insurance. Choose a loan amount within your means.
Get pre-approved: Consider getting pre-approved to show sellers you’re a serious buyer. This involves a lender reviewing your financial information and determining how much you qualify to borrow.
Analyze terms and rates: Compare rates and terms from banks, credit unions, and other lenders.
By understanding lender expectations and being financially prepared, you can enhance your eligibility and navigate the application process confidently.
How Do I Pay Off My Mortgage Sooner?
Paying off your mortgage early can save you thousands in interest and provide financial freedom. Here’s how to do it:
Check with your lender: Make sure you’re able to make additional payments to your mortgage without penalty. Your lender can let you know how much you’re allowed to pay (if at all) each month and/or year.
Make extra payments: Allocate additional funds toward your principal. Even small extra payments can reduce your loan term significantly.
Switch to bi-weekly payments: Accelerate your loan repayment by splitting your monthly payment into two smaller bi-weekly payments. You’ll make 26 payments annually, equivalent to 13 monthly mortgage payments. This adds an extra full monthly payment each year, reducing the principal faster and saving on interest over the life of the loan.
Round up your payments: Round your monthly payment to the nearest hundred to gradually chip away at your balance without stretching your budget.
Allocate windfalls: Apply bonuses, tax refunds, or other unexpected income directly to your mortgage principal.
Shorten the term: Explore refinancing to a shorter loan term (e.g., 15 years), which often comes with lower interest rates and accelerates repayment.
Avoid missed payments: Stay consistent to ensure no additional interest accrues, keeping you on track for an early payoff.
Always understand how your mortgage term impacts your repayment schedule and consider potential tax implications before committing to an early payoff strategy.
Mortgage Payment Schedule
A mortgage payment schedule, or amortization schedule, outlines how your loan will be paid off, detailing each payment and how much goes toward principal and interest.
Payment frequency options include:
Monthly: 12 payments per year (most common option)
Semi-monthly: 24 payments per year (twice a month)
Bi-weekly: 26 payments per year (every two weeks)
Accelerated weekly: 52 payments per year
The mortgage term defines how long you’re committed to your loan terms. Short terms mean higher payments but less interest, while longer terms lower payments but increase total interest. Align your mortgage term with your financial goals.
What Happens If I Can't Pay Off My Mortgage?
Life doesn't always go according to plan, which can make mortgage payments seem overwhelming. This is exactly why getting loan protection insurance makes sense. For a bit more added to your monthly payment, you can get protection that keeps your home safe. Mortgage Loan protection at Innovation can include life, disability, critical illness, and job loss protection.
If you run into payment troubles without insurance, your mortgage lender will usually explore different ways to help you stay on track. A skip-a-payment program is one of them. There’s also the option of taking your home and selling it at auction. But this is the last resort when there's simply no other solution for lenders to recover their loan money.
Can My Mortgage Application Be Denied?
Not every application gets the green light. Banks might say no based on your financial picture, which includes any outstanding debts, payment history, and the overall credit score. But don't get discouraged since each lender looks at things differently.
If a bank declines your application, keep searching for alternatives. Some lenders are more flexible with their requirements than the big banks, so you might have better luck with them.
Ready to Get Started?
Figuring out how mortgages work doesn’t have to be complicated. Whether you’re buying your first home or looking for better options, understanding the basics can make the process much smoother.
If you’re feeling stuck or unsure about the next step, we’re here to help. Get in touch with us today, and let’s make your journey to homeownership as easy and straightforward as possible!