How does a mortgage work in Canada
Are you ready to be a home owner? Sure, renting allows a lot of flexibility if you want to change jobs and cities easily, but a home offers stability and a safe personal space.
But here's the thing – most of us here in Canada can't pay for this monumental expense upfront. And sooner or later we find ourselves shopping for a mortgage.
What is a mortgage?
A friend of mine, a Toronto based mortgage broker, once said – “Simply put, a mortgage is a loan to buy a home”. Banks or other lending institutions provide the funds (known as principal) to buy a home against a collateral (or security) and this principal has to be paid back with interest over the agreed repayment period.
History of mortgage in Canada
Did you know the term mortgage originates in a French term that means "death contract?" Kind of ominous, isn't it?
Mortgages originated in Europe when people could not pay for land in a single transaction. Sellers provided loans to the buyers, and a buyer's right to the property was forfeited if they were unable to pay back the loan.
The home owning process and space in Canada was changed on January 1, 1946 when the Central Mortgage and Housing Corporation was created to enact the National Housing Act. At first, this was an endeavor to rehabilitate war veterans post WWII. The organization was renamed to Canada Mortgage and Housing Corporation (CMHC) in 1979 and is known for its home and community building efforts over the years.
World events such as the world wars and the Great Depression had significant impact on mortgages, where the buyers were often unable to pay back the loan amount. In fact, as a result of the inflation in the 1970s, buyers and lenders found themselves in a fully amortized situation that failed to reflect the interest rate changes in the house-owning market. As a result, mortgages have evolved into their modern-day partially amortized forms that are common in Canada today.
Amortization period vs. mortgage term
Amortization period is the total length of time that you and the lender have agreed on to pay off the entire loan. The most common amortization periods in Canada is 25-30 years - but remember, you will end up paying more insurance the longer your amortization period.
The mortgage term, on the other hand, is the length of time that you commit to a mortgage rate. Once this term is over, you can negotiate a new rate.
Types of mortgages
As a prospective home owner in Canada, you need to know which type of mortgage fits into your budget and aligns well with your financial planning.
These mortgages were common in the 1950s before mortgage insurance was introduced. Traditional mortgages are issued to those who meet the 20% down payment condition; the remaining 80% is paid by lenders.
In this type of mortgage, the buyer pays less than 20% of the down payment and the lender bears a higher proportion of the loan. If you're opting for this kind of mortgage, you have to get a mortgage defaulter insurance, which is commonly known as mortgage insurance.
Fixed rate mortgages
The interest rate on this type mortgage is fixed for a predefined period (the most common being a five-year period).
The best part of open mortgages is that you can pay off the loan amount if you've managed to accumulate the capital before the term ends.
Closed mortgages levy a penalty if you wish to pay off the mortgage amount before the term ends.
What to look out for when getting a mortgage
- Personal finance (income, credit history, etc.)
- Deciding on payment frequency
- Choosing an amortization period that works for you
- Choosing the mortgage term
- Protection if interest rates rise - you can perhaps ask your lender if they provide an interest cap (that is, the maximum interest rest you can be charged on a mortgage)
Mortgage rules are undergoing constant changes; for instance, the Office of the Superintendent of Financial Institutions (OSFI) recently released new guidelines for the mortgage industry that makes it compulsory even for uninsured home buyers to undergo a stress test. Also, the CMHC predicts that interest rates will be on the rise between 2018 and 2019.
Buying a home is definitely a big deal, but it doesn't have to be stressful. Are you looking for the lowest rates but high flexibility? Let us help you buy your dream home the right way.