What is a Mortgage?
A mortgage is a loan you get from a bank or a lender to buy a home. It lets you purchase a property even if you don't have all the money upfront. Think of it like this: you ask to borrow some money to buy a house, and you promise to pay it back over time.
Down Payments
Down payments are your initial contribution when buying a home. In Canada, down payments are usually between 5% and 20% of the home's price. Suppose you're eyeing a $300,000 house and make a 10% down payment. You'd pay $30,000 upfront; the rest would be part of your mortgage.
The Repayment Period – Amortization Explained
Amortization is just a fancy word for how long it takes to pay back your mortgage. You can choose between 5 and 30 years in Canada. Longer amortization means smaller monthly payments, but you'll pay more interest over time. When choosing your amortization, you have to decide what you'd rather have. Better cash flow or less interest paid over time. Here's something most people don't know - if you take a longer amortization, you will have a higher interest rate, on top of paying more interest over time.
Interest Rates – The Cost of Borrowing
Interest rates are a big deal when it comes to mortgages. In Canada, we mainly have two types: fixed-rate and variable-rate (adjustable-rate mortgages).
Fixed-Rate Mortgage: With this, your interest rate stays the same for the whole term. It's like knowing your monthly phone bill won't change.
Variable-Rate Mortgage: This type can change based on market conditions. It might start lower, but it can go up or down, like gas prices.
Mortgage Insurance – Lender's Protection
If your down payment is less than 20% of the home's price, you'll need mortgage insurance. This insurance protects the lender in case you can't make payments.
Imagine it as insurance on your car – you hope you won't need it, but it's there for protection. Some people get confused and think this insurance is for the borrower. That's why it's important to know this insurance is for the lender, and you will still require home insurance when you purchase or refinance your home.
Most people don't know this, but you will receive a better interest rate if you put down less than 20% on the home purchase. Although it may sound counterintuitive, the lender has less risk when the mortgage is insured because it is guaranteed the mortgage will be paid if the borrower defaults. Therefore, the lender is willing to give the borrower a better interest rate.
Mortgage Terms
In Canada, you'll come across various mortgage types, each with its perks. Here are some common ones:
1. Fixed-Rate Mortgage:
The interest rate stays the same.
1-5 year terms. Terms can extend up to 10 years and more with some lenders.
Gives you stable, predictable payments.
2. Variable-Rate Mortgage:
Interest rates and payments can change.
3 and 5 year terms.
Lower pre-payment penalties if you want to pay out your mortgage within the term
3. Open Mortgage:
Allows the mortgage balance to be paid out without penalties.
Great if you want flexibility in paying it off faster.
This type of mortgage is seen a lot with private lenders and borrowers looking to complete flip home projects.
4. Closed Mortgage:
Offers lower interest rates.
Gives stability but fewer prepayment options.
Higher payout penalty if you want to break the term early.
Most mortgages in Canada are a combination of the 4 mortgages mentioned above. For example, you will often see a 5-year fixed term that is a closed mortgage or a 1-year term mortgage that is open.
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Practical Example
Let's put all this into action. Suppose you're buying a $400,000 home with a 20% down payment and a 25-year amortization. It is a 5-year closed fixed-rate mortgage at 3.5% interest. Using a mortgage calculator, your monthly payment would be around $1,602. Over 25 years, you'd make 300 payments, gradually paying off both the loan amount and interest. If you'd like to calculate your mortgage payment, visit and download our mortgage calculator from our Mortgage Master Kit here.
The History and Etymology of Mortgages
Now, let's take a brief trip down memory lane to explore the history and etymology of the word "mortgage." Understanding where it comes from can shed some light on its significance.
The word "mortgage" has its roots in Old French, combining two words: "mort," meaning "dead," and "gage," meaning "pledge." So, quite literally, "mortgage" originally referred to a "dead pledge." But don't worry; it doesn't mean your finances are doomed. Instead, it signifies that the pledge (your home) becomes "dead" once you've paid off the loan.
The concept of mortgages dates back centuries. In medieval Europe, land ownership was essential for power and status. However, it was often challenging to acquire large estates without financial assistance.
To bridge this gap, the idea of mortgaging property emerged. Borrowers would pledge their land as collateral in exchange for funds, with the understanding that if they failed to repay, the lender could take ownership of the property.
Today, while the term "mortgage" might not sound as ominous, the fundamental principle remains the same – you're pledging your property as security to borrow money.
The Pros and Cons of Taking on a Mortgage
Now that we've covered the ins and outs of Canadian mortgages let's talk about the pros and cons.
Pros:
Homeownership: The most significant advantage of a mortgage is that it enables homeownership. Instead of waiting for years to save up enough money to buy a house outright, you can start building equity and enjoying the benefits of owning a home sooner.
Low-Interest Rates: Mortgages typically come with lower interest rates compared to other types of unsecured loans, like personal loans or credit cards. This can save you a significant amount of money in interest payments over time.
Tax Benefits: In Canada, you may be eligible for tax benefits related to your mortgage, such as the First-Time Home Buyers' Tax Credit and the Home Buyers' Plan, which allows you to withdraw money from your RRSP (Registered Retirement Savings Plan) to buy or build a home.
Appreciation: Historically, real estate has shown the potential for property values to appreciate over time. This can lead to long-term financial gains if you decide to sell your home in the future. In Canada, we've witnessed life-altering wealth growth from owning real estate. In most cases, this was made possible because of the use of mortgages and lending.
Cons:
Debt: Taking on a mortgage means you're committing to a significant amount of debt. You'll be making monthly payments for many years, which can feel overwhelming at times.
Interest Costs: While mortgage interest rates are lower than some other forms of borrowing, you'll still end up paying a substantial amount of interest over the life of the loan. This is especially true for longer amortization periods.
Risk of Default: If you can't keep up with your mortgage payments, you risk foreclosure, which means losing your home. Mortgage insurance can help protect the lender but doesn't shield you from the financial and emotional stress of losing your home.
Less Liquid Assets: A large portion of your income will go toward your mortgage payments, which can limit your ability to invest in other opportunities or save for other financial goals.
Canadian mortgages are a practical way for many people to achieve homeownership and build wealth over time. However, they come with responsibilities and financial commitments. It's crucial to carefully consider your financial situation, goals, and risk tolerance before taking on a mortgage. Consulting with a financial advisor can help you make an informed decision that aligns with your long-term plans.
With this understanding, you'll be better equipped to navigate the world of Canadian mortgages and make choices that best suit your financial needs. So, whether you're starting your journey as a homeowner or contemplating refinancing, you can approach it with confidence and clarity.
TL;DR (Too Long; Didn't Read):
A mortgage is a loan that helps you buy a home without paying the full price upfront, with down payments typically ranging from 5% to 20% of the home's price in Canada.
The length of time it takes to repay your mortgage (amortization) affects your monthly payments and total interest costs, with longer periods offering lower monthly payments but higher interest expenses.
Mortgage options in Canada include fixed and variable rates, each with advantages, with multiple different terms available to you.
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