For most people, buying a property is the greatest investment of a lifetime. Paying off a property takes a long time, which is why it’s important to choose the best mortgage product. In fact, you’ll pay a large sum of interest on your mortgage that will never be recovered. Here are some things you need to consider to make an informed choice. When you've made your choice, use For most people, buying a property is the greatest investment of a lifetime. Paying off a property takes a long time, use our mortgage comparison tool to find the one that best meets your needs.
Do you intend to pay off your mortgage early?
If so, an open mortgage gives you greater flexibility. You can increase your mortgage payments, renegotiate your mortgage at any time, change lenders, or pay off your mortgage in full. In return for this flexibility, you will pay a higher rate. You can expect to get about a 1% higher rate if you choose an open mortgage. If you think you can pay off all or part of your mortgage before the end of your term, or you are thinking about moving, an open mortgage might be a wise choice.
A closed mortgage is generally the one offered out of the box and the most popular because it has a lower interest rate. Most closed mortgages contain prepayment clauses. That is, you can increase your payments up to a certain limit, which varies from mortgage to mortgage. Typically, you can prepay up to 10% of your original loan amount each year.
If you pay off your entire closed mortgage, you can expect to pay a penalty of about 3.5% of your remaining mortgage amount. A closed mortgage is a good choice if you plan to keep your property until the end of your term and you don't expect to pay off the loan faster than the prepayment clause allows. If you want the benefits of a closed mortgage, but are considering a move during its term, apply for a portable mortgage. This will allow you to keep the same lender and the same mortgage for your new property, without having to pay prepayment fees.
How quickly do you want to pay off your mortgage?
Amortization is the number of years it will take you to pay off your mortgage in full. Amortization can be from 1 to 30 years. However, if your down payment is 5% or less, your maximum amortization is 25 years. The shorter your amortization, the less interest you will pay, but the bigger your mortgage payments.
Let’s look at this example of buying a $400,000 property for $400,000 with a down payment of $20,000, or 5% of the purchase price. So the amount to be mortgaged is $380,000, and you choose a mortgage with a 3% interest rate. Let’s see how amortization impacts the payments:
|Amortization||Monthly Payment||Total Interest Paid||Total Cost of the Property|
It’s obvious that, financially speaking, it is very advantageous to opt for the shortest possible amortization. However, not all budgets can handle this. Before granting you a mortgage, your financial institution will look at your gross debt service ratio (GDS). This is to check whether or not your mortgage expenses, including the mortgage, taxes, heating, condominium fees, etc., are less than a third of your annual salary. Do the math yourself to choose your amortization period. If the duration you choose causes your mortgage payments to meet or exceed 32% of your annual income, opt for a longer amortization.
Certainly, financial health is important. But so is your sanity, and the stress of paying too much in mortgage payments is not good money management. You could be unlucky and end up with a pay cut, an illness or losing your job. So keep a safety cushion and make sure you’re comfortable with your mortgage payments.
Fixed rate vs. variable rate mortgages
After you've chosen the type of mortgage (open or closed) and your amortization, it's time to decide if you want a fixed or a variable rate. If you're the type of person who wants to always have the same payment amount and know exactly how much money is going toward your principal and how much is going toward interest, you should choose a fixed interest rate. This choice will also protect you from fluctuations in the economy, as you’ll have the same rate for the life of your mortgage term. However, this peace of mind comes at a price – you’ll generally pay around 0.05% more with a fixed mortgage rate than with a variable mortgage rate.
Conversely, if you are comfortable with fluctuations and your budget allows you to make slightly higher monthly payments, you can opt for a variable rate. You’ll benefit from interest rate cuts, but you should also be prepared to pay more if interest rates rise.
If you want a variable rate, but aren't ready to increase your monthly payments, there’s a solution for you. Ask your lender for a fixed payment with a variable interest rate. With a mortgage contract like this, you will always pay the same amount, even if it is a variable rate mortgage. If interest rates drop, more of your payment will go towards paying off your mortgage, which you will pay off faster that way. Conversely, if rates rise, a greater proportion of your payments will go to paying interest. On the other hand, if the rates increase above a pre-established threshold in your contract, your lender will increase your payments so that you repay on time.
In any case, if you choose a variable interest rate, it would be a good idea to protect yourself against an excessively steep rise in interest rates. You could do this by asking for a cap, which is the maximum interest rate you will pay. Otherwise, opt for a convertible mortgage, which will allow you to change your rate type at any time, if you meet the conditions and bear the conversion costs.
If you want the benefits of both fixed rates and variable rates, but you're not 100% ready to jump into one type of rate, you could choose a hybrid mortgage rate (it has something for everyone when it comes to rates). Part of your mortgage amount would be subject to a fixed rate and the other part would be subject to a variable rate.
Consider the example of a $300,000 mortgage and let’s examine two scenarios: one with a variable rate and the other with a fixed rate.
|Fixed Rate Mortgage||Variable Rate Mortgage|
|Total payment after 5 years||$84,723.05||$85,318.32|
In this case, the fixed rate mortgage is slightly cheaper. If, for example, the variable mortgage rate had always fluctuated around 2.50%, the total payment after 5 years would have been around $80,634 and therefore would have been more advantageous than the fixed rate.
Do you plan to move in the next few years?
It’s not always easy to predict the future. You have to try to do it to choose your mortgage term, which is the length of time your contract is in effect. You will then keep your rate and everything that is mentioned in your mortgage contract. At the end of your term, you can renegotiate your contract or change financial institutions. You will likely have to renegotiate your contract several times as your mortgage is amortized.
Mortgage terms generally range from 6 months to 10 years. With fixed mortgage rates, the longer your term, the higher the mortgage rate. Here is a comparison of fixed mortgage rates associated with different terms.
|3 years||5 years||10 years|
|Approximate fixed rates||1.74%||1.84%||2.49%|
In the case of variable mortgage rates, the reverse is true.
|3 years||5 years||10 years|
|Approximate variable rates||2.45%||1.75%||N/A|
In order to choose the best mortgage term, you need to determine your chances of moving in the short, medium and long term. Depending on your likely moving date, choose a term that will allow you to renegotiate your contract a little before your move. With a fixed rate mortgage, you can also choose a short term if you think interest rates will fall and you want to take advantage of this possible drop to renegotiate your contract. Be careful, though…even economists have difficulty predicting how rates will move, and if they go up instead of down, you might end up having to negotiate a new contract at a higher rate.
With a fixed rate mortgage, choosing a longer term will help you budget better, since you can be sure that your mortgage payments will remain the same. However, you’ll have to wait longer to renegotiate.
How often do you want to pay your mortgage?
You can choose to make monthly (12 times per year), bi-monthly (24 times per year), bi-weekly (26 times per year), or weekly (52 times per year) payments. Obviously, the more frequently you make payments, the smaller they are. What is less obvious, perhaps, is that by making more frequent payments, even if the total repayment amount remains the same over a year, you can save on interest costs, since the average mortgage amount during the year will be lower if you make payments more often.
Despite this benefit, it would be a good idea to choose a payment frequency that coincides with your payday frequency, if only to avoid damaging your credit rating by missing a mortgage payment. That is, if you’re being paid bi-weekly, it would probably be more practical to opt for bi-weekly payments to ensure that you have the funds in your account when you make your payments.
You could also opt for an accelerated bi-weekly or accelerated weekly payment, which adds up to a thirteenth month of mortgage repayment. In fact, what this means in the industry is that the amount of the monthly payment (12 payments per year) is divided into two in the case of the bi-weekly payments and into four in the case of the weekly payments. The appearance of a “thirteenth” month is related to the fact that there are 52 weeks in a year, and the calendar months have more than 28 days. Of course, the bank doesn't give you a freebie with this payment method, but again, paying off your mortgage faster means you’ll pay less interest.
Consider the example a $300,000 mortgage, amortized over 25 years at a fixed rate of 3%, to illustrate the differences in payments.
|Number of Payments Per Year||Payments||Total Payments Per Year||Interest Costs Saved|
|In two weeks||26||$655||$17,030||$192|
|Accelerated every two weeks||26||$710||$18,460||$15,471|
|Accelerated every week||52||$355||$18,460||$15,638|
Opting for accelerated payments not only helps you finish paying sooner, but it also saves you a lot of money in interest charges.
How much should you pay as a down payment?
Obviously, putting a larger down payment will allow you to save on interest costs, because that down payment will directly decrease your mortgage amount. In Canada, you can buy a property with as little as a 5% down payment for properties selling for up to $500,000. To get a mortgage under these conditions, however, you must obtain mortgage default insurance and intend to reside in the property after the transaction is completed.
For properties between $500,000 and $ 1million, the minimum down payment is calculated as follows: you must put 5% on the first $500,000 and 10% on the remaining portion. For example, for a purchase of $700,000 you would pay a down payment of $25,000 (5% of $500,000), plus $20,000 (10% of $ 200,000), for a total down payment of $45,000. For a property over $1 million, the minimum down payment is 20%.
If your down payment is less than 20% of the purchase price, you will need to add mortgage default insurance to your mortgage. The companies that provide this insurance in Canada are Canada Mortgage and Housing Corporation (CMHC), Genworth, and Canada Guaranty. Depending on the down payment provided, the premium payable for mortgage default insurance will vary between 0.60% and 4.5% of the mortgage amount.
Let's illustrate the impact of the down payment on the cost of the mortgage, using a $325,000 property financed with a 3% fixed rate mortgage as an example:
|% Down payment||Down payment Amount||Mortgage||CMHC Amount||Mortgage including CMHC fees||Total cost of the mortgage (including interest)|
As shown in the table above, the down payment percentage has a huge impact on the total cost of your property. A larger down payment decreases the mortgage insurance premium, in addition to lowering interest charges. If you don't like doing your own calculations, you can use our Canadian mortgage insurance calculator to calculate how much your CMHC premium will cost you.
As a general rule, making a larger down payment will cost you less interest charges, which in turn will help you become wealthier. However, there is a small downside. If, for example, you need to make a minimum down payment of $16,250 (5%) and you have $25,000 in a savings or brokerage account, it is not recommended to inject all your cash into a down payment, for two reasons:
First, you should keep some cash on hand so that you have an emergency fund, which will get you through the more challenging financial times. Second, suppose you have a mortgage with an interest rate of 3% (or 3.33% if you include the additional costs of the CMHC premium due to making only a 5% down payment). By investing the money you haven't put in your down payment at a rate greater than 3.33%, you'll come out on top. There are risks associated with investing in the stock market, but over the long term, the inflation-adjusted return of the stock markets is around 7%. Therefore, emptying your investment and savings accounts to maximize your down payment is probably not a good strategy.
A conventional mortgage vs. a home equity line of credit
If you can afford a down payment of 20% or more, you could finance all or part of your home acquisition with a home equity line of credit. Since a line of credit cannot be used for more than 65% of the purchase price or the market value of the property, a down payment of 35% is then required to finance the rest of your real estate purchase.
With a 20% down payment, however, you could finance 65% of your property with a home equity line of credit, and 15% with a conventional mortgage. For example, if you buy a house for $350,000, with a down payment of $70,000, the mortgage will be $280,000. Since this is a $350,000 property, you can get a $227,500 line of credit, and get a conventional mortgage for the remaining $52,500.
A home equity line of credit offers greater flexibility, as you can pay it off at any time without penalty. The product also allows you to reduce your mortgage payments at all times, as long as you cover the interest.
This increased flexibility may be of interest to entrepreneurs or self-employed workers, whose incomes may vary. The other advantage of a home equity line of credit is that as it is repaid, the portion of the principal repaid can be withdrawn at any time, so that the line of credit could be used to finance a project, acquire another property, consolidate debts or even to invest in the stock market. It goes without saying that investing with borrowed money is risky, but low mortgage spread rates can make this type of transaction attractive.
Note that home equity lines of credit are always variable rate, so your minimum payments (which must cover interest) could increase if interest rates rise. In addition, those who buy a home as a way to provide for “forced” savings, thinking that at the end of the mortgage they will own an asset worth several hundred thousand dollars, should avoid this product. This is because if you mismanage your finances and only make the minimum payments equal to the line of credit’s interest, you could end up with a the same amount in a line of credit to repay.
Choosing a mortgage is a process to be taken seriously, as every mortgage decision could end up costing you dearly. Educate yourself properly and make sure you understand all the terms in your mortgage contract before signing anything. Lastly, feel free to consult our mortgage comparison tool.