A mortgage, like most legal transactions, can be extremely intricate. It is critical to know what you are signing up for and whether your unique contract is suitable for you. Before beginning the mortgage process, it is important to familiarize yourself with different types of mortgages in Canada, understand your payment and pre-payment plan options, and consider other add-ons such as insurance, and more.
Types of Mortgage Agreements
Open Mortgages vs. Closed Mortgages
The two main types of mortgage agreements in Canada are open agreements and closed agreements. Under an open mortgage contract, the borrower can pay off as much of their debt as they want, when they want. There are no prepayment penalties associated with an open mortgage, however, borrowers often have to pay inflated interest rates in exchange for this perk. You may want to consider an open mortgage if you have a lot of excess capital or are planning to sell your home in the near future.
There are two good alternatives to an open mortgage. A variable rate mortgage or home equity line of credit (HELOC) tend to still offer competitive interest rates, and HELOC’s are typically repayable at any time without penalty. Variable rate mortgages typically come with only a 3-month interest penalty if repaid in full prior to the renewal date.
Under a closed mortgage, your payment schedule will follow a set term and timeline. Sometimes, the borrower will be allowed to make a few prepayments without penalty, however the full term of the mortgage will not change. A closed mortgage will be accompanied by stricter conditions but will also usually charge a lower interest rate in return.
You may want to consider a closed mortgage if you plan to keep your home for the full term of the mortgage. Some closed mortgages do allow for a full or partial repayment of the principal upon bona fide sale of the home, and some are portable to new home purchases.
Other Types of Mortgage Agreements
Beyond simply deciding whether you want your agreement to be open or closed, there are a few other factors to consider when deciding on what mortgage types is best for you and your needs:
- Portable Mortgage: if you already own a home and are looking to move to a new one, you may have the option to port your mortgage. Porting your mortgage allows you to transfer part or all of your current mortgage to a new property while keeping the same interest rate and contract terms. The porting process might allow you to avoid paying prepayment penalties for breaking your mortgage contract before your term is up. You may want to consider a portable mortgage if your mortgage lender allows for it and you are satisfied with your that lender’s mortgage contract terms.
- Assumable Mortgage: if you are looking to take over someone’s property before they have finished paying it off, you may qualify for an assumable mortgage. Under an assumable mortgage, the buyer takes over the seller’s current mortgage and covers the remaining payments. This type of mortgage is only possible if the seller had a fixed interest rate mortgage and was not using a home equity line of credit (HELOC). This is a great option for buyers looking to take advantage of historical interest rates, which are much lower than the rates at the time of the new purchase.
How to Understand Your Mortgage Agreement
In order to understand your mortgage contract, there are a few key terms you should be familiar with. Here are a the most common areas that can differ from contract to contract:
Types of Interest Rates
When you take out a mortgage loan, depending on the type of mortgage you take out, you will either have to pay back the amount you borrowed plus interest over the course of monthly payments, or payback interest-only over on a monthly basis with the principal balance due upon maturity of the mortgage term. The interest that you pay is used to compensate the lender for their investment.
Interest is often expressed as a rate and represents the percentage of your principal amount that you will need to pay on top of your normal payments. If you have a 5% interest rate, every month you will pay your monthly dues plus an extra 5% of that payment’s value. The higher your interest rate, the more you will pay overall. As a buyer or homeowner, you usually want to seek out the lowest interest rate possible. In the case of a private mortgage, you will typically only be required to make monthly interest payments with the principal loan amount becoming due once the mortgage term is up.
In some private mortgage cases, the private lender will hold back some or all of the interest from the advance. In this case, you may not be required to make any monthly payments. Instead, all of the interest along with the principal balance will be payable at the maturation of the loan.
When negotiating your mortgage contract, you usually have two options— a fixed interest rate or a variable interest rate. A fixed interest rate means that your interest rate will be set at the current market rate and will stay the same throughout the entire term of your mortgage. A variable interest rate, depending on the type of variable interest rate you choose, might change as the market rate fluctuates or will stay the same, but your amortization rate may change. A fixed rate is better if you expect market interest rates to go up, while a variable interest rate is better if you expect rates to drop.
The Ideal Amortization Period
Your amortization period represents the number of years it will take for you to pay off your mortgage— including interest. You absolutely must pay off your mortgage by the end of this period, otherwise you may choose to refinance your mortgage if you wish to extend your amortization period. A shorter amortization period will require you to make larger principal payments each month, but a longer amortization will cost you more in the long-run due to increased interest payments.
Choosing a Payment Schedule
Once you take out a mortgage, you have the length of the amortization period to pay it off. But how often should you be making payments? Different mortgage contracts have different payment intervals, and it is important to choose the repayment schedule that works best for you and your financial situation. When deciding whether to pay off your mortgage on a weekly, biweekly, monthly, or bimonthly basis, it is important to consider your current income and financial position. How well can you handle the frequency and size of payments?
Besides understanding the main elements of your mortgage contract, there are a few other considerations you should look for before signing.
Mortgage Loan Insurance
If you are purchasing a property for less than $1,000,000 inclusive of all amendments and if your down payment is worth less than 20% of the total value of your home, while seeking to get the lowest rate possible on your mortgage, you will be required to qualify for, and purchase, mortgage loan insurance. By insuring your loan, you protect your lender from loss if you default on your mortgage and are unable to make your payments.
Mortgage loan insurance necessitates the payment of a premium, which is typically added to the amount of your mortgage and amortized over the course of your mortgage, or paid in full when you purchase your home. If you can afford it, it may be best to avoid paying for insurance by putting down a larger down payment.
All mortgages operate within a set term, but what happens when that term ends? If your mortgage comes to the end of its term, you must either pay off the remaining balance. If you are unable to afford this payment or prefer not to do so, you then have the option to renew your mortgage, refinance your mortgage, or transfer it out to another lender.
At the end of your term, you may want to renew your mortgage, but there is no guarantee that your lender will agree to do so. In many cases, you might need to shop around and look into different lenders and contract options. Even when your current lender offers you a renewal option, you may be better off to still shop your mortgage around for a better offer from a different lender. At this stage, you will likely want to work with a Clover Mortgage broker to find the best renewal or refinance options for you.
It is very important to thoroughly review your mortgage contract before signing it to avoid legal and financial trouble down the line. Different lenders have different policies, some of which may not be immediately obvious. For instance, some lenders will void your mortgage loan if you approve home construction or renovation projects without first notifying your lender.
There may also be policies on how you are allowed to use your property. For instance, you may not be allowed to change your residential property into a commercial one. There may also be specific rules about renting out your property preventing you from renting it out entirely. Some lenders will charge penalties for improper use while others will void your agreement and demand that you repay the loan in full immediately or risk losing your home through a power of sale.
Working With Professionals
One of the best ways to ensure you do not get stuck in an unfavourable mortgage contract is to work with a professional mortgage broker. Here at Clover Mortgage, our team of experts have helped connect thousands of buyers across the GTA to the perfect lenders for their unique needs.
Your mortgage broker here at Clover can help you explore your options, decide on the best features for your mortgage agreement, negotiate your mortgage terms with the lenders, renew your mortgage, refinance your home, and so much more!
Contact Clover Mortgage today to schedule your free mortgage consultation with one of our professional brokers!