Open or closed? Fixed or Variable? Learn about the options here.
Lenders offer a variety of mortgage products that give home buyers flexibility. Which one a home buyer chooses will depend on their needs and circumstances. Mortgages can be broken down into the following categories:
Conventional or high-ratio mortgagesResidential mortgages can be divided into conventional or high-ratio mortgages.
A conventional mortgage is usually when a borrower can cover 20 per cent or more of a home’s purchase price with the down payment. This means the loan they are paying down is equivalent to 80 per cent or less of the value of the home. In this case, the borrower does not require mortgage insurance. However, a particular lender may request mortgage insurance, even if the home buyer is putting more than 20 per cent down (low ratio mortgage.)
As of November 30, 2016, home buyers applying for low ratio mortgages on which the lender requires insurance must meet certain rules to get insured, including a mortgage amortization of 25 years or less, a home purchase price of less than $1 million and a credit score of at least 600. They must also plan to live in the home.
A high-ratio mortgage is when the borrower contributes less than 20 per cent of the purchase price in their down payment. The minimum down payment is five per cent on the first $500,000, 10 per cent on any amount over that. High-ratio mortgages are more risky for both the home buyer and the lender. As the mortgage will account for more than 80 per cent of the purchase price, the home buyer must obtain mortgage insurance. The insurance premiums are calculated based on the loan-to-value ratio of the mortgage: the lower the down payment, the higher the insurance costs will be.
All home buyers with an insured mortgage, regardless of down payment amount, are subject to a stress test that assures mortgage lenders that the home buyer would still be able to afford the mortgage if house prices or rates increase in the future. As well as qualifying for the mortgage loan at the rate offered by the lender therefore, you will also need to qualify at the Bank of Canada’s five-year fixed posted mortgage rate, which is usually higher.
Open or closed mortgages
An open mortgage allows a home buyer to prepay all or a portion of the mortgage without penalty. Fully open mortgages let borrowers pay additional amounts at any time during the life of the mortgage in addition to their regular payments. Interest rates are usually higher on fully open mortgages because the borrower can pay off the amount at any time. Because of this, fully opened mortgages are also harder to find.
A closed mortgage does not allow for any prepayment by the home buyer without penalty. The only payments they can make are the scheduled ones outlined in the contract. Closed mortgages usually have lower interest rates because the borrower does not have the same flexibility as in an open mortgage.
Some lenders offer variations on the open or closed mortgage, such as allowing additional payments during a certain time of the year. Borrowers should review their mortgage terms so they know the allowances of their specific contract.
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Fixed, variable or convertible rate mortgages
A fixed rate mortgage means the interest rate will stay the same for the term of the mortgage agreement (one, three or five years) regardless of whether market rates go up or down. When the term finishes, borrowers can search again for different rates. Fixed rate mortgages are popular when rates are low but expected to rise in the near future.
With a variable rate mortgage, the interest rate will fluctuate over the course of the term based on market conditions. However, one popular misconception about variable rate mortgages, is that this means your payments will also vary. In fact your payments will remain the same for the term of the mortgage.
What varies is the percentage of your payment that goes against the interest and what percentage goes against the principal. If the interest rate is higher and your payment is $500 a month, $400 might be applied against interest and $100 against the principal. If the interest rate is lower, $250 might be applied against interest and $250 against the principal.
A variable rate mortgage will be reviewed on a regular basis – daily, monthly, quarterly, semi-annually or annually – and the rate you are charged will be adjusted accordingly. Variable rate mortgages are popular when rates are expected to go down and borrowers do not want to lock themselves in to the current rate.
Capped rate variable mortgages set the maximum and minimum rates a borrower will pay regardless of fluctuations.
A convertible mortgage starts at a variable rate and the lender provides the home owner the option to change it to a fixed rate at specified times.
Special mortgage featuresThe mortgage industry in Ontario is a very competitive one. Many mortgage lenders offer special features, or entry into unique contests to attract new home buyers. These offers can include giving you cash toward moving costs, covering appraisal and registration costs or providing mortgage options for newcomers to Canada. The most common features include:
- Cash back: lenders will give the borrower a percentage cash back based on the size of their mortgage
- Loyalty programs: lenders will offer frequent flyer points or other bonus incentives
- Assumable mortgages: borrowers can take over the existing mortgage on the property they are buying
- Portable mortgages: existing borrowers can transfer their current mortgage to a new property
- Expandable mortgages: borrowers can increase the amount of money they borrow from a lender
- Step mortgages: borrowers can combine all of their loans into one plan
These and other new features can be good for borrowers. Ask your mortgage lender or broker to explore your options.