Introduction to Mortgage Types

There are many options to consider when getting a mortgage. Selecting the right mortgage type for your situation is critical because a poorly selected mortgage can have significant financial implications. My role as a mortgage advisor is to take the time to fully understand your needs and then make recommendations as to which options will best meet your specific circumstances.

Mortgages fall into two categories depending on what percentage of the purchase price you need to borrow.

1. If you have a down payment equivalent to 20% or more of the purchase price, you will have what is called a Conventional Mortgage.
2. If your down payment is less than 20% of the purchase price, you will have what is called a High Ratio Mortgage. A high ratio mortgage must be insured to protect the lender. This insurance is known as either Mortgage Default Insurance or Mortgage Loan Insurance for which a fee will need to be paid by the borrower. It protects the lender in case the borrower isn’t able to repay the loan. Most lenders accept mortgage default insurance provided by either the Canada Mortgage and Housing Corporation (CMHC) or Genworth Financial.

The mortgage types that need to be decided between include:

• Fixed Rate Mortgage or Variable Rate Mortgage;
• Short Term mortgage or Long Term Mortgage; and
• Open Mortgage or Closed Mortgage.

Fixed Rate Mortgages

When you take out at a fixed-rate mortgage, your interest rate will not change throughout the entire term of your mortgage. As a result, you'll know exactly how much your payments will be and how much of your mortgage will be paid off at the end or your term.

Variable Rate Mortgages

With a variable-rate mortgage, your rate will be set in relation to Bank Prime at the beginning of each month. In other words, it may vary from month-to-month. Historically, variable-rate mortgages have tended to cost less than fixed-rate mortgages when interest rates are fairly stable.

When rates change, your payment amount remains the same. However, the amount that is applied toward interest and principal will change. If interest rates drop, more of your mortgage payment is applied to the principal balance owing. This can help you pay off your mortgage faster.

Short Term Mortgages

The term is the length of time that the lender is lending the mortgage amount to the borrower. A mortgage typically has a term of 6 months to 10 years. Usually, the shorter the term the lower the interest rate. Short-term mortgages are appropriate for buyers who believe interest rates will drop at renewal time. A short term mortgage is usually for two years or less.

Long Term Mortgages

A long-term mortgage is generally for three years or more. Long-term mortgages are suitable when current rates are reasonable and borrowers want the security of budgeting for the future. The key to choosing between short and long terms is to feel comfortable with your mortgage payments. After a term expires, the balance of the principal owing on the mortgage can be repaid, or a new mortgage agreement can be established at the then-current interest rates.

Open Mortgages

Open mortgages can be paid off at any time without penalty and are usually negotiated for very short terms. They are suited to homeowners who are planning to sell in the near future or those who want the flexibility to make large, lump-sum payments before maturity. These homeowners are willing to accept some fluctuation in the interest rate for the flexibility of paying off the entire mortgage before the term is complete.

It is important to keep in mind that most regular mortgages will allow homeowners to make lump sum payments of up to 20% of the entire mortgage once a year without penalty. These are often called privilege payments. That payment goes directly towards paying down the principal of the amount borrowed. You may therefore not need an open mortgage, with higher interest rates, to make additional payments.

Closed Mortgages

A closed mortgage is a commitment with a pre-determined interest rate, over a pre-determined period of time. A buyer who uses a closed mortgage will likely have to pay the lender a penalty if the loan is fully paid before the end of the closed term.

With a closed mortgage, the interest rate will not change over the length of the term and the length of the term will not change. Payment amounts are predictable and the principal amount owing at the end of the term is predictable.

Closed mortgages generally have lower interest rates than open mortgages. Most closed mortgages will allow the homeowner to make a payment up to 20% of the entire mortgage once a year without penalty. This payment goes directly toward paying down the principal of the amount owing.