Buying a property is exciting. But it can also be pretty overwhelming. Aside from the fact that it’s a huge investment decision, there is also a lot to know about how mortgages work in Canada.
What is a mortgage?
Most of us don’t have hundreds of thousands of dollars lying around in a bank account. So when it comes time to purchase a property, you will likely apply for a loan through a financial institution. If approved, you will pay back the loan, with interest, over a predetermined amount of time. Qualifying for a mortgage comes with many rules and restrictions. Rules also govern the amount of interest charged, and the terms of repayment.
How does a mortgage work?
To secure a mortgage in Canada, you need to qualify with a financial institution. We will discuss what it takes to qualify in greater detail below, but all lenders have basic rules and expectations. Some lenders are far stricter than others.
Once you qualify, the bank transfers money in your name to the seller of the property you have purchased. Then, you make payments back to the lender. Those payments consist of the principal amount (the actual money you borrowed) and interest (the money you pay above the principal, back to the lender). How much you pay in principal and interest, how often, and for how long, are all dictated by the terms of your individual borrowing agreement.
Is mortgage interest tax-deductible in Canada?
The short answer is no. Mortgage interest in Canada is not tax-deductible. Many people are under the false assumption that you can write off mortgage interest if you run a small business out of your home. Even in that case, you can’t write off mortgage interest. You can, however, write off a portion of your property tax.
There is a difference between how mortgage interest works in Canada and the United States. In the U.S., mortgage interest can be written off. Not so for us in the North.
How do I get a mortgage in Canada?
As for how mortgages work in Canada, you need to understand that the rules of mortgage lending change often. The government is continually looking to improve lending to protect both the borrower and the housing market in Canada. In recent years, requirements have become more stringent in order to reduce the risk of lenders granting mortgages to people who are higher credit risks.
Today, to qualify for a mortgage at a bank in Canada, you need to pass a “stress test.” This proves you can meet your monthly mortgage payments at a higher interest rate than the current one. Borrowers must prove they can continue to pay their mortgage should interest rates rise — and they will eventually rise.
Credit unions and other lenders, which aren’t federally regulated, are not mandated to conduct the stress test. However, that’s not to say they don’t otherwise have stringent qualification rules.
Determining financial fitness
Another key element to understanding how mortgages work in Canada is financial fitness. A potential lender reviews your entire financial history and current financial health to determine your financial fitness for a mortgage. They review your debts and your assets to determine how much you can reasonably afford to pay on a monthly basis.
Lenders consider your income, your current monthly spending, and your debt load. In addition, they assess the amount of money you’d like to borrow, how long you’re expected to take to pay the loan back, and your credit history.
Years ago, you didn’t need a down payment to qualify for a mortgage. But today, the Government of Canada insists buyers have a minimum of 20% of the total price of the property to put down on the home they are purchasing. They can borrow the other 80% to afford the home.
How much mortgage can I afford?
All of Canada’s major banks offer mortgage calculators so you can get a solid idea of what you can qualify for. Plug your information into the calculator to see what the bank thinks you can reasonably afford. There are a number of factors that determine the final number.
Those of us who have gone through the process can tell you that the calculated mortgage amount may be substantially higher than what you can actually afford. It is best to talk to a professional, face-to-face, to be confident that the size of your loan is within the limits of what you can really afford.
How is a mortgage calculated?
To understand how mortgages work in Canada, we need to talk numbers.
When calculating your mortgage, the lender looks at how much money you have to put down on the purchase of the home. That amount is deducted from the total cost of the property. Depending on the size of your down payment, a loan insurance premium may also be included in your payments. Finally, the total cost of borrowing is divided by the number of years you are borrowing to create your monthly costs.
How long of a mortgage can you get in Canada?
Lending rules can, and do, change. A decade ago, you could take out a 40 -year mortgage. But today, the maximum lending period is 25 years.
Depending on your down payment, you may be able to qualify for a longer amortization. The rules in Canada allow for a 30-year amortization for uninsured borrowers. These are borrowers who have 20% or more to put down on their mortgage.
What is a good interest rate for a mortgage?
The interest rates for mortgages are not static. Changes to the market and prime rate will raise or lower what you pay. Your interest rate may also depend on the length of the lending term, and if you choose a fixed- or variable-rate mortgage.
Currently, for a variable-rate mortgage, you’re looking at a range of just below 3% interest to 4.45% on the high end. Most lenders fall in the vicinity of 3.95%.
For fixed-rate mortgages, a one-year fixed rate falls in the ballpark of 2.94% on the low end and as high as 4.4%. The average falls around 3.5%. For a five-year fixed rate, 2.69% is as low as you’ll find, with 5.34% on the high end. If you can find a rate for 3.5% or less, you’re getting a good interest rate.
How is a mortgage generally repaid in Canada?
Now that you understand how to get a mortgage in Canada, it’s time to look at the different types of mortgages. We break down how each one works.
How conventional mortgages work
A conventional mortgage is the most common type of mortgage. How this type of mortgage works is very straightforward. It dictates your payment terms, the amount, and how long you have to pay it back. With a conventional mortgage, any divergence from the terms of the repayment may result in a penalty. So if you have a financial windfall and want to pay off your mortgage early, you can, but it may come with a cost.
How open mortgages work
An open mortgage comes with fewer repayment restrictions than a conventional mortgage. It allows you to pay it off as quickly as you want, without penalty, over a shorter lending period. Because of the shorter lending period, interest rates for open mortgages tend to be higher.
How closed or fixed-rate mortgages work
Once you qualify for a mortgage, you are given the option to have a fixed interest rate or variable. So how do fixed-rate mortgages work? With a closed, or fixed-rate mortgage, you agree to pay whatever the current interest rate is for the entire duration of the loan agreement. This is typically three-to-five years. These types of mortgages insulate you from prime rate increases during that period of time, but can also keep you from benefitting if interest rates fall.
How variable-rate mortgage work
Variable rate mortgages work a little bit differently. They are based on the current prime rate and change as the prime rate changes. So, if prime goes down, so do your interest payments. Of course, if they go up, so too do your interest payments and thus, your total mortgage payment.
What is a reverse mortgage?
Reverse mortgages are reserved for older homeowners who want to draw the equity from their home while still living in it. How do they work? Borrowers need to be at least 62 years old and the home must be their primary residence. Reverse mortgages are a great option for qualifying homeowners who are looking to pad their retirement income.
How to shop for a mortgage in Canada
All types of financial institutions are governed by the basic lending rules set out by the Government of Canada. However, interest rates, options and other qualifying criteria vary among different types of lenders. For example, most banks require conventional, salaried or hourly income to qualify. Meanwhile, other financial institutions will more easily lend to freelancers and people who work on contract.
Visit a financial institution to speak with them about specific qualification criteria. You can visit any of the following:
- caisses populaires
- mortgage companies
- insurance companies
- trust companies
- loan companies
- credit unions
A home is likely the single biggest investment you will make in your lifetime. Purchasing a property is a huge decision and an even bigger financial commitment.
Understanding the process of getting a mortgage and seeking guidance is the best way to ensure you can secure the home of your dreams at a price that falls within your means.
How do mortgage pre-approvals work?
If you want to get a mortgage in Canada, a vital first step is the pre-approval process. It is relatively simple. A lender will review your finances and give you a maximum amount they are willing to provide to you for a mortgage.
The lender also estimates your monthly payments so you know what your finances will look like with a new large monthly payment. The pre-approval is in effect for a specific amount of time — typically 90 days. If you do not purchase a home within the 90 days, you must go back to the lender for another pre-approval.
It is important to know that the pre-approval is a guarantee of getting that amount. It is simply the maximum the bank would consider lending.
How to pay off a mortgage faster
Now that you understand how to get a mortgage in Canada, it’s time to learn how to pay it off. Lenders tend to have strict rules about how quickly you can pay off a mortgage. Some will allow for lump-sum payments, to a specific yearly maximum.
It is advisable to pay your mortgage weekly or bi-weekly, rather than monthly. By paying weekly or bi-weekly, you add two payments a year without even trying (remember how much we live for three-paycheque months? Those months will add a mortgage payment, too!).
You can also pay an accelerated amount. Your lender can give you the option to up your payments, to a certain amount, to pay your mortgage off faster. It’s best to talk to your lender about available options to pay your mortgage down quicker. Different lenders have different options.
How does mortgage insurance work in Canada?
Mortgage insurance is a key element to understanding how mortgages work in Canada. Commonly known as CMCH insurance, the Canadian Mortgage and Housing Corporation is the entity that distributes the insurance.
A borrower is required to have, and pay for, CMHC insurance for any mortgage with a downpayment between 5% (the minimum allowable down payment in Canada) and 19.99%. The insurance doesn’t protect the borrower. It protects the lender should the borrower default on their mortgage payments.
Buying a house is a big decision. But now that you understand how mortgages work in Canada, you are one step closer to owning your dream home.