A to Z Guide on Mortgages€¦ · Chango A to Z Guide on Mortgages 01 If you are planning to buy a...

2019

A to ZGuide onMortgages

Chango A to Z Guide on Mortgages 01

If you are planning to buy a car, or a house or to start a new business, you

need capital. Financial institutes help you get that capital, but they need

some sort of guarantee from you that you will return their money on time

with interest, thus comes into play is the mortgage.

Oxford dictionary defines mortgage as “A legal agreement by which a

bank, building society, etc. lends money at interest in exchange for taking

title of the debtor's property, with the condition that the conveyance of title

becomes void upon the payment of the debt.”

According to the definition, it is clear that your property is not truly yours

unless you pay off your loan.

Now there are variety of loans available for Canadians / North Americans

to choose from (depending on the type of property purchased and your

ability to repay the loan).

In this guide we will discuss about all the different type of mortgages

available for Canadians, what they mean and when you should apply for

what kind of mortgage.

Terms andDefinitionsBut before we dive into the details of different types of mortgages, lets

discuss the terms and factors you will be considering before deciding on

an appropriate mortgage.

Prepayments: Adding extra money to your installments to close your loan

early is called prepayment. It allows you to pay down your mortgage

faster.

Open/Closed Mortgage: An open mortgage is the one with no limitations

on prepayments. The interest rate on open mortgages is usually higher

than the closed mortgage but open mortgage gives you the flexibility to

pay off your mortgage faster. Likewise, closed mortgages have a fixed

interest and fixed installments towards your mortgage. You may have to

pay the penalty in case you break the mortgage contract.

Amortization: Amortization is the process of allocating the cost of an asset

over a period of time. In easier terms, this is the complete duration of your

mortgage period and the time it takes to pay off your loan. Longer

amortization would allow you to have lower monthly installments, but you

will also be paying higher interest.

Term of Mortgage: It is the duration for which the mortgage contract will

be in effect. At the end of each terms, the mortgage contract is renewed

with new terms and conditions, including new interest rates or different

penalties on closed mortgage etc. A term can range from a few months to

five years or longer. If you pay off your loan before the end of the term,

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Chango A to Z Guide on Mortgages

Fixed / Variable Interest Rates: Interest is the amount of money you pay

on top of your principal amount to the lender. A fixed interest rate is the

one that stays the same for an entire mortgage term. Fixed rate makes

sense in case you expect the market rates to go higher in the future, or

when you want to know in advance your total interest versus principal

breakdown of your installments.

Variable interest can change during the term. Going with this option allows

you to find a better deal with lesser interest rate than the fixed interest

mortgage, but the volatility in market rates can affect your budget

drastically.

Hybrid or Combination Mortgage: These mortgages allow you to divide

your mortgage in parts with fixed interest rate and remainder with variable

interest rate. Such mortgage gives you the best of both worlds. However,

because of their complexity these mortgages are hard to transfer to

another lender.

Payment Frequency: It is the frequency with which you make your

mortgage payments. There are many options available to choose from. For

example, you can make your mortgage payments monthly, semi-monthly,

biweekly, weekly, and other accelerated options.

Standard Charge / Collateral Charge: In case of non-repayment of a loan,

a charge allows your lender to sell your property to recover the money you

owe.

Standard charge secures the mortgage loan on the property you have with

the lender and not any other loan. Collateral charge can be used to secure

multiple loans with your lender, including a mortgage and line of credit.

Portable / Assumable Mortgage: Portable mortgage allows you to

transfer all the terms and conditions of an existing mortgage on a property

as it is to another property. You may or may not have to give the

prepayment penalty depending on the original terms. Portable mortgage

makes sense when you want to purchase another property before ending

the mortgage on another property.

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Assumable mortgage allows you to take over someone else’s mortgage

and their property. In this case, you will take over the property along with

the original terms of the existing mortgage on that property. This mortgage

makes sense when you are a buyer and the interest rates have gone up or if

you are a seller and want to move to a different property with assumable

mortgage you can avoid prepayment penalty by transferring the mortgage

to someone else.

Cash Back: Some lenders give the option of having a cash back that gives

you a part of your mortgage as a cash. The interest rate on such lending is

usually high. Cash back option provides you with some emergency fund

you might need in order to spend on your property before moving in.

Title Insurance: a title on a home or a property is a legal term used to

define who owns the land. When you buy a property, the title on the

property is transferred to you. This insurance protects you as a property

owner against the losses related to property’s ownership.

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Now that we understand the basic terms and common jargons used in the

industry, it is time to discuss in detail what sort of mortgages are available

for people in Canada and try to understand which mortgage is best suited

for you.

Thanks to the free market and competition, we now have a variety of

mortgages available for us to pick from. Depending on the amount,

amortization, terms and payment frequency you can choose a mortgage

type that is best suited for you.

Types ofMortgages


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ConventionalMortgagesA mortgage where you make a

payment of at least 20% of the value of

the property upfront and the lender

provides the rest. Conventional

mortgages have the lowest

loan-to-value ratio, meaning, the

amount of loan is low relative to the

value of the property.

For example, if you are buying a

property worth $1,000,000 you must

make a down payment of $200,000

upfront in order to qualify for a

conventional mortgage. The down

payment for the loan must come from

other sources, like cash or proceeds

from the sale of other property.

The benefits of conventional mortgages

are many since the buyer is making a

larger down payment. In this case, the

owner will have more equity in the

property, this also means they have a

lower risk of default2. Financial institutes

offer many different benefits to loans

with lower risk of default, like HELOC –

Home Equity Line of Credit (more

about it later) and other benefits.

Now conventional mortgages are the

go-to mortgage for a first-time buyer,

but these are not suitable for a

real-estate investor.

The speed of implementation is one of

the major drawbacks for an investor, if

the funds are not received on time that

could make or break a deal in an ever

changing real-estate market. The

approval process, also known as

“underwriting” is a long and tedious

process wherein the lender will cross

examine the credit history, income,

employment status etc of the borrower.

For a first-time home buyer, paying an

upfront down payment of more than

20% makes sense as it helps in interest

repayment later, but for a short-term

investor the benefits of conventional

mortgage don’t add up.

Common Question

How much down payment do

I need to be eligible for

conventional mortgage?

20% of the value of the property

you are buying.


20%

High RatioMortgagesAny mortgage with a down payment of

less than 20 percent is considered a

high-ratio mortgage. What it means is,

the loan-to-property value ratio is high,

in other words, you have very high

amount of loan compared to the value

of your property. Please note that the

maximum property value for high ration

insurance must be less than

$1,000,000.

In case of high ratio mortgages you are

required by law to get mortgage

default insurance (commonly called

mortgage insurance). This insurance is

not to protect you but to protect your

lender in case you default on your loan.

Mortgage insurance premium is usually

added to your mortgage loan

payments.

The amount of mortgage insurance

premium depends on the borrowed

amount, from 2.8% if you borrow 85%

to 4% if you borrow 95%3.

These mortgages were thought to be

undesirable in the past but with a

constant low interest rates, these

mortgages have gain popularity. People

who can pay 20% down payment have

also started opting for high ratio

mortgage thus keeping the extra cash

for other purposes.

Common Question

What is the maximum amount I

can mortgage with High Ratio

Mortgage?

The maximum property value

must be less than $1,000,000.

07Chango A to Z Guide on Mortgages

Fixed Rate MortgagesAs explained above in the definitions

section, a fixed rate mortgage is the

one where the rate of interest remains

fix for the mortgage term even if the

federal rates changes. A term for a fixed

rate mortgage is usually between 1 and

5 years. Fixed interest rate is usually

higher than variable interest rates and

these rates are based on the

government of Canada bond yields of

similar terms4.

Five-year fixed rate mortgages are one

of the most popular mortgage products

in Canada. These are beneficial if you

want to keep your payments same over

the term of your mortgage. It also

allows you to know in advance the

amount of principal that would be paid

off by the end of the term. Fixed rate

mortgage also makes sense when you

expect the interest rate to increase in

the future, a fixed rate will save you

money if in case the rate increases5.

The limitations of having a fixed rate

mortgage is the limited scope. The

lenders might not be able to give you

more options with this type of

mortgage as compared to adjustable

rate or variable rate mortgages.

Common Question

Are the interest rates on fixed-rate mortgage higher than the variable rate mortgage?Yes, fixed rate mortgages have higher interest rate than the variable rate mortgages.


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Variable RateMortgages (VRM)In this type of mortgage, the interest

rate fluctuates in tandem with the

current prime rate. Prime rate is the rate

at which the commercial bank lend

money to its customers. This rate is

usually lower than the fixed rate

mortgages.

The benefit of this type of mortgage is

that you can keep your monthly

payment fixed even if the interest rates

goes up or down. The only difference is

that you will be paying more money out

of your installment towards interest in

case the interest rate appreciates, and

you will be paying more money out of

your installment towards the principal

in case the interest rate depreciates.

Thus, VRMs provides you the option to

have a fix monthly installment but also

lets you reap the benefits in case the

interest rate drops.

The biggest risk of variable rate

mortgages is the rise in interest rates,

that could lead to significantly higher

interest payments, thus extending your

amortization period.

Official website for Canadian

government has provided an excellent

example to compare the amount you

will be paying monthly for fixed rate

mortgages and variable rate

mortgages. Take a look at this

screenshot in the next page for further

clarity:


For this example let’s assume you have a mortgage of $200,000 with a 25-year

amortization and five-year term. The interest rates offered by the lender are 3.5% for

variable interest rate mortgage and 4% for a fixed-rate mortgage.

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Taken from: www.canada.ca6

Compare variable and fixed interest rates

Interestrate

Year 1 4.0% $1,052 3.5% $999 3.5% $999 3.5% $999

Year 2 4.0% $1,052 4.0% $1,050 4.0% $1,103 3.5% $999

Year 3 4.0% $1,052 4.5% $1,101 4.5% $1,209 3.5% $999

Year 4 4.0% $1,052 5.0% $1,152 5.0% $1,316 3.5% $999

Year 5 4.0% $1,052 5.5% $1,202 5.5% $1,423 3.5%

Totalpaymentover five-year term

$63,122 $66,044 $72,607 $59,912

Amountleft on yourmortgageafter fiveyears

$174,108 $175,576 $178,223 $172,560

Interestpaid overfive-yearterm (partof totalpayment)

$37,230 $41,620 $50,830 $32,472

$999

Monthlypayment

Interestrate

Monthlypayment

Interestrate

Monthlypayment

Interestrate

Monthlypayment

Scenario 1:» fixed interest rate mortgage» interest rate not affected by changes in market interest rate

Scenario 2:» variable interest rate mortgage» increases by 2% during five-year term

Scenario 3:» variable interest rate mortgage» interest rate increases by 4% during five-year term

Scenario 4:» variable interest rate mortgage» interest rate stays the same during five-year term


Over the life of the five-year term:

• Scenario 1: your payments would

remain the same at $1,052


increase by $203 (from $999 to

$1,202)


increase by $424 (from $999 to

$1,423)


remain the same at $999

From this table it is evident that

scenario 1 is for people who needs

peace of mind and who does not mind

paying a few thousand dollars extra in a

five-year term. Scenario 2 and 3

presents the situation where the

variable rate mortgage might prove to

be a burden as the monthly payments

have increased with the increase in the

interest rates. Scenario 4 seems ideal,

but the rates would hardly stay the

same for half a decade.

There could have been one more

scenario, scenario 5 where the interest

rates have fallen during the five years,

in that case you would have saved a

substantial amount of money and you

would be able to pay off your loan

quicker than expected.

Common Question

Are Variable Rate Mortgage riskier than other types of mortgages?

Yes. If the interest rate increases your monthly payments will also increase thus

affecting your budget.


Adjustable RateMortgage (ARM)These mortgages are reviewed at

intervals and the interest rate is then

adjusted based on the current prime

rate.

If you have an ARM and the interest rate

falls, you tend to benefit from the lower

mortgage rate instead of being locked

in to a higher rate in fixed rate

mortgages. The risk on the contrary is

when the interest rate rises, then you

will end up paying more interest and

higher monthly installments which

might affect your budget in the long

run.

This mortgage is beneficial only if you

are comfortable with the changing

monthly installments and fluctuations in

the payments, but you also want to take

the advantage of lower rates.

There are few more options that the

lenders provide to the borrowers if in

case the interest rate rise:

a. an interest raise cap: you can

negotiate with your lender a maximum

interest rate charged even if the prime

rate rises above the decided rate. Also

known as putting a cap on the rising

interest rate.

b. a convertibility feature: this feature

allows you to convert your variable rate

mortgage to a fixed rate mortgage

whenever you want during the term.

Common Question

Is it possible for me to switch from

a variable rate mortgage to a fixed

rate mortgage?

Yes, always confirm with your

lender before entering into any

mortgage agreement.


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HybridMortgageIt is a type of ARM wherein this

mortgage type provides you the best of

both the worlds as it is a 50-50

combination of fixed rate mortgages

and variable rate mortgages. This

mortgage allows the borrower to take

advantage of the low interest rates of

variable rates and to have the stability

of a fixed rate mortgage.

In this type of mortgage, the mortgage

is split into multiple components, each

having a different term lengths, rates

and rate types. If the prime rate goes

down, the variable rate component

adds to the benefits but if the prime

rate goes up, the fixed rate component

adds to the benefits.

Hybrid mortgage has its share of pros

and cons. The pros include the ability to

have a long, fixed rate term, this would

allow you to have a fixed interest rate

for a decent amount of time.

Combining this with the variable

interest rate later would give you the

benefit of both the mortgage types.

Hybrid mortgages have rate caps in

place, so the interest rate cannot

increase uncontrollably once the fixed

rate term gets over. Hybrid mortgages

have lower starting interest compared

to other fixed rate mortgages, this

would help you in more savings which

can then be used for other purposes.

The cons of hybrid mortgage include

the risk and uncertainty after fixed

period. Even though this mortgage has

an interest rate cap, the uncertainty on

the rates 5, 10 or 15 years down the line

always exists. You can never be sure

about the payment you will be making

in the future7.

Hybrid mortgages are not suitable for

people who have a major expenses

coming around the time when the loan

begins to adjust. For example, sending

your kids to college, planning a

wedding etc, even a small increase in

your loan payments could disturb your

budget.

Common Question

What are rate caps and how are

they beneficial for me?

In case of excessive rate increase,

rate caps act as a ceiling and

protects buyers from higher

interest rates. If you have a rate

cap on your mortgage, even if the

interest goes beyond the cap you

will not pay more than the capped

amount.


Open/Closed MortgagesAn open mortgage is the one that

provides you the flexibility to make the

prepayments at any time, even leading

to the loan pay off before the end of

the mortgage term with no prepayment

penalty.

The interest rate of open mortgages is

usually higher than the closed

mortgage. The main advantage of open

mortgages is the flexibility to pay off

your mortgage. In case you come

across a lump sum, you can dedicate it

towards the payment of your loan

without incurring any charges.

The disadvantage of open mortgage is

the higher mortgage you will have to

pay in case of interest rate increase.

Closed mortgages are the one that

does not provide this flexibility of

making prepayments without incurring

penalty. Once an agreement is made,

you cannot renegotiate or refinance the

mortgage for that term.

The biggest advantage of closed

mortgage is the lower interest rate as

compared to open mortgages Closed

mortgages are better choice for a

mortgage with longer term as it will

help save money on interest costs as

the rate will be lower than open

mortgages8.

The advantage of open mortgage is the

disadvantage for closed mortgages as

they do not offer the flexibility to alter

the mortgage agreement without

paying a penalty.

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Common Question

I am looking for a long term loan,

should I go with an open or a

closed mortgage?

Closed mortgage.


Reverse Mortgage /Shared Equity MortgageA mortgage that allows you to

transform the equity in their home to

cash while still living in the property.

The cash can be received as a lump

sum, regular payments or a

combination of the two.

The agreement is a life-term loan, which

is essentially a loan sanctioned till the

lifetime of the owners or the life of the

ownership of the home. Thus, this

mortgage type is perfect for people

older than 55 years and who are

approaching their retirement. This

mortgage type allows them to receive

regular payments on the equity they

have in the form of their house.

Some of the most lucrative benefits of a

reverse mortgage includes: tax-free

payments from reverse mortgage, no

need to repay the mortgage unless you

sell your house or you and your

surviving partner pass away, you can

repay the loan anytime, the amount you

owe can never exceed the value of your

property, funds can be received either

as lump sum or regular payments or a

combination of two.

Some of the disadvantages are: interest

accumulation on the amount borrowed,

more expensive than conventional

mortgages because of the start-up fee

and higher interest rates, very limited

options as only two companies in

Canada offers reverse mortgage, the

borrowed amount varies dramatically

depending on the geographic

location9.

Contrary to standard mortgages,

instead of depleting the debt this

mortgage adds on to the debt and

consumes the equity in your home. The

amount of debt piles up quickly and eat

up your equity thus not giving you the

chance to downsize your property.

Common Question

I have paid off my loan on my

house, can I borrow cash using my

property as an equity?

Yes, by taking a reverse mortgage.


16

PortableMortgagesImagine buying a house but a few years

down the lane you come across a better

property and you plan to move. Instead

of starting a new mortgage on the new

property you can transfer your older

mortgage on the new one.

The benefit of portable mortgage is

that you won’t have to pay the penalties

if you move your loan to a new property

and you get to keep the same interest

rate without going through the approv-

al process again, in other words, you

can avoid the closing cost. This mort-

gage is also beneficial if the rates on

your current mortgage are less than the

available rates in the market. This would

also save you from paying more interest

if in case your credit score gets a hit in

future, you can still reap the benefits of

lower interest rates with a not-so-good

credit history.

Not every lender offers the portable

mortgages, so you must check the

terms and conditions with your lender

before getting into a contract. Another

disadvantage is that you need an excel-

lent credit history to qualify for this type

of mortgage.

This type of mortgage is perfect for

people who move a lot, or a company

that shifts its office to different cities

every few years as this mortgage helps

you keep the interest rate the same.

This is not a good choice for people

looking to stay long term.

Common Question

I plan to move to a different location in future and buy property there,

what type of mortgage is best suitable for me in this case?

A portable mortgage.


AssumableMortgagesA type of housing loan that can be

carried over from the current owner to

the new owner. This type of mortgage

will allow you to sell your house to a

new buyer and transfer the remaining

mortgage to them (just like we do with

vehicles), in this case, the new buyer

“assumes” your mortgage.

One of the reasons why the new buyer

would assume someone else’s

mortgage is the availability of a lower

interest rate than the current market

rates. This is advantageous to both

buyer and seller if the interest rate is

low the seller might raise the asking

price on the property.

Now the biggest disadvantage of this

type of mortgages is the down payment

the new owner has to make. Suppose

your house is worth $200,000 and in 5

years you have already paid $60,000

and your current loan is just $140,000,

in this case, the new owner will assume

your loan but he/she will have to make

a down payment of the remaining

$60,000 or they will have to take a

second mortgage, which is 30% of the

original amount.

In the case of historic low-interest rates,

assumable mortgages might prove to

be disadvantageous to the buyer. Also,

if the mortgage term has a prepayment

penalty which the new owner will have

to pay, this could be disadvantageous

to the seller as they won’t have the

leverage to increase the ask price on

their property10.

Common Question

How can I get an interest rate

lower than what is being offered in

the market right now?

By assuming someone’s mortgage

opened at a lower interest rate

than current market rate.


Home Equity Line of Credit(HELOC)As evident from the name, this type of

mortgage allows you to borrow money

on the equity of your property. You can

borrow up to 65% of your house’s

worth using HELOC but the HELOC and

your mortgage must not exceed 80% of

your home’s value.

Majority of the people use the HELOC

to refinance their mortgage. Using

HELOC to refinance the older

mortgage saves a lot of money in

short-term but it could be a risky

substitute.

A common HELOC has a draw period

and a repayment period. A draw period

is usually 5 to 10 years wherein the

borrower can draw the line of credit

and have just to pay the interest on the

credit taken. The repayment period

lasts 10 to 20 years after the draw

period and the borrower is supposed

to repay the principal during that term.

The payments are divided by the

number of months in the repayment

period.

The interesting thing about HELOCs is

that the interest is calculated daily as

the principal keeps changing daily

depending on the draws and

repayments. The interest is applied to

the average daily balance of the month

to calculate the daily amount due which

is then multiplied by the number of

days in the month. Daily interest costs

more than the monthly interest.

HELOCs are useful in case immediate

need of money like paying college

tuitions, home renovation etc. In this

case, you draw and pay interest on what

you need. Some HELOCs are

convertible to fixed-rate loans at the

time of drawing, this would save a huge


Biggest disadvantage is the interest rate

risk, as all HELOCs are adjustable rate

mortgages. These

are riskier as the change in interest rate

is applied the very next day, hence the

exposure to the higher interest rate is

more in HELOCs. The interest rates are

tied to the prime interest rate, even

though the prime rate does not change

daily, but in some cases, it can change

as many as 20 times in a year depending

on how frequently the central bank

meets11.

A traditional ARM can have a rate cap,

but HELOCs have no rate caps thus

making them even riskier.

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Common Question

I have been advised to refinance

with a HELOC rather than with a

standard mortgage. Could you

explain the difference, and why

one might be better than the

other?

HELOC allows you to pay the

interest on what you borrow which

makes it a better choice for

short-term needs.


20

Cash BackMortgagesA mortgage where you receive the cash

up-front. Cashback mortgages offer you

a percentage of your property as cash

that can be used for anything other

than the down payment. The interest

rate for this mortgage is usually high

costing the borrower twice the value of

cash loaned. This mortgage is only

helpful for people who need urgent

cash to make purchases for their home

etc.

The banks have an incentive of

financing this type of mortgage as they

can charge a high interest rate, as high

as 2 percentage point than the best

available mortgage rate. Also, there are

penalties in case you refinance, transfer

or renew your cashback mortgage

before maturity.

The eligibility criteria for cashback

mortgage include high credit score, low

debt-to-income ratio, and steady

income. The only good situation to

consider taking cashback mortgage is

when you urgently need the cash after

you purchase a home and that you are

confident about closing the mortgage

on time without hassle12.

Common Question

How risky are the cash back mortgages and when should I consider taking one?The riskiest mortgage type of all, you should only consider taking a cash back mortgage when you have exhausted all other options.


References1,6 Choosing a mortgage that is right for you. (2018). Retrieved August 6, 2019 from

https://www.canada.ca/en/financial-consumer-agency/services/mortgages/

choose-mortgage.html

2 Conventional mortgage definition. (n.d.). Retrieved August 6, 2019 from

https://www.firstfoundation.ca/mortgage-glossary/conventional-mortgage/

3 What is the difference between a conventional mortgage and a high ratio mortgage. (n.d.).

Retrieved August 6, 2019 from https://canadianmortgagepro.com/what-is-the-difference-

between-a-conventional-mortgage-and-a-high-ratio-mortgage/

4 Carter, G. (2018, October 22). Types of mortgages in Canada and how they apply to you.

Retrieved from

https://canadianmortgagesinc.ca/2018/10/types-of-mortgages-in-canada-and-

how-they-apply-to-you.html

5 Kenny, P. (n.d.). Advantages and disadvantages of fixed rate mortgage. Retrieved from

https://www.streetdirectory.com/travel_guide/195406/mortgages/advantages_and_

disadvantages_of_fixed_rate_mortgage.html

7 Gordon, T. K. (2018, June). What is a hybrid mortgage? Is it right for you? Retrieved from

https://www.lendingtree.com/home/mortgage/what-is-a-hybrid-mortgage/

8 Closed versus open mortgages explained by mortgage brokers. (2014, December).

Retrieved August 6, 2019 from

https://www.yourmortgagenow.ca/understanding-closed-and-open-mortgages/

9 French, T. (n.d.). the pros and cons of a reverse mortgag. Retrieved from

https://retirehappy.ca/thepros-and-cons-of-a-reverse-mortgage/

10 Babich, L. (2019, February). The pros and cons of assumable mortgages for home buyers.

Retrieved from

https://listwithclever.com/real-estate-blog/pros-and-cons-assumable-mortgages/

11 What is a HELOC? (2009, July). Retrieved August 6, 2019 from

https://www.mtgprofessor.com/A%20-%20Second%20Mortgages/what_is_a_heloc.htm

12 Cash back mortgages: the pros and cons you must know. (2016, July). Retrieved August 6,

2019 from https://insureye.com/cash-back-mortgage-the-pros-and-cons-you-must-know/

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