How to Finance a Home Purchase: Types of Mortgages Explained

How to Finance a Home Purchase: Types of Mortgages Explained

There are many significant decisions involved with buying a home. From selecting an area to focus your search to completing the necessary paperwork, there's much to consider and even more to do. One of the biggest decisions in buying a home is financing. Canada offers several mortgage options, but not every mortgage type will be appropriate for every buyer. This guide walks you through the most popular mortgages in Canada, from open mortgages to private mortgage options.

Types of mortgages in Canada

Learning about the various types of mortgages available can help ensure you get the best rate and a term that aligns with your home ownership goals. Here are the most common mortgages in Canada:

Conventional mortgages

Conventional mortgages are a common type of home financing in Canada. Conventional mortgages require buyers to make a down payment of at least 20%. Conventional mortgages are also known as "uninsured mortgages" since putting down this substantial down payment means you don't have to pay mortgage insurance.

High-ratio mortgages

The opposite of a conventional mortgage is a high-ratio mortgage. This mortgage type is when the buyer doesn't offer up a 20% down payment, meaning they are financing more than 80% of the purchased property's value. When you take out a high-ratio mortgage, you'll have to purchase loan insurance as a form of protection for your lender.

Collateral mortgages

Collateral mortgages are a great option for homebuyers who want extra funds for renovations or repairs. This type of financing is when a borrower applies for a mortgage of more than the amount required to buy the home in question. The money is then given to the homeowner to use later on. Many choose to use these funds for home upgrades after the purchase is complete.

While collateral mortgages are exciting in theory, keep in mind that you might have to pay back the money at a higher interest rate, which could be dicey if your home ever decreases in value.

Private mortgages

If you have a relationship with a specialized financing institution, you might be interested in a private mortgage. Private mortgages are provided by smaller financing companies rather than banks and can offer special terms that appeal to buyers who need access to large sums. For instance, a private mortgage might be right for you if you are interested in financing a luxury home purchase and don't want to go through a traditional bank.

Remember that private mortgages could feature higher interest rates or shorter loan terms than conventional home financing options.

Variable-rate mortgages

Variable-rate mortgages typically feature lower interest rates than fixed-rate mortgages. However, there's a catch. The interest rate charged on variable-rate mortgages might fluctuate depending on how the Bank of Canada moves its rates. The higher the overnight rate at the Bank of Canada increases, the more interest you will pay with your monthly mortgage payments.

Fixed-rate mortgages

One of the most common types of mortgages in Canada is fixed-rate mortgages. This financing option offers homebuyers the same interest rate for the duration of their loan. While this stability is an attractive option, fixed-rate mortgages can also feature higher interest rates than other financing types.

Cash-back mortgages

Similar to collateral mortgages, cash-back mortgages give you additional money from your lender than what is required to purchase your property. It is delivered as a lump sum after closing, which can be helpful for houses that need major repairs, upgrades, or renovations. Most cash-back mortgages have higher interest rates than other financing types. It's also important to note that some lenders might not offer cash-back mortgages as an option, and even those that do will usually only include them with a fixed-rate mortgage.

Open mortgages

An open mortgage is a flexible option that appeals to many homebuyers. Open mortgages allow you to make large payments on your mortgage — over and beyond the agreed-upon monthly payment — or even pay off the entire amount without any penalties. There is a tradeoff to this flexibility, however. Be prepared to accept some variability in the interest rate, meaning you could pay more over time.

Closed mortgages

Unlike open mortgages, closed mortgages have rates that are pre-determined. The loan duration is also pre-determined, and if you make any significant changes to your payment amount or loan term, you could face penalties or fees. If you select a closed mortgage for your financing, you should be able to choose either a fixed or variable rate, depending on your unique needs. An advantage to closed mortgages is that the interest rate is usually lower than open mortgages.

Convertible mortgages

For maximum flexibility, you could opt for a convertible mortgage. These allow you to switch from closed to open (or vice versa) during your mortgage term without incurring penalties or fees. With a convertible mortgage, you usually get lower interest rates than an open mortgage.

How to decide what mortgage is right for you

With so many home financing options available, figuring out what mortgage to apply for could be stressful. The best tool in your kit is knowledge. Take the time to learn about each mortgage and what it would mean for your long-term homeownership plan. Are you planning on staying in one house for years, or will this be a short-term move? Do you want extra cash on hand for repairs, or are you more interested in establishing a set monthly rate and fixed interest? Finally, do you want to pay off your mortgage quickly, or do you want to incorporate monthly payments into your schedule?
Talk to your financial advisor and your lender about your options, and don't hesitate to list the pros and cons of each type of mortgage. It's also a good idea to speak with your realtor to ask if they have suggestions for lenders who offer different mortgage options. Don't rush through this process. The decision on what mortgage to take out can affect you for years.

The McKelvie Group can help you find your dream home in Canada

Whether you're new to Canada or have lived here for years, the McKelvie Group can help your real estate dreams come true. Our team of experienced Calgary real estate agents can work with every type of financing and preference to ensure you find the perfect home. Contact the McKelvie Group today to learn how we can help you find your dream home in Canada!

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