There are many mortgage products in the market today. The choices and options available may appear to be endless, especially to folks who are interested in buying their first home. To assist you in this process, here are a few basic types of mortgages you should know.
With a variable rate mortgage, your interest rate can decrease or increase during the term. Most variable rate mortgages have a five-year term. When the Bank of Canada raises or lowers their overnight rate, banks will then adjust their prime interest rate which affects your variable mortgage rate. With variable rate mortgages, there are open and closed options available.
An open variable rate mortgage is similar to a line of credit. It is sometimes called a secured line of credit. This can be paid off at any time without a penalty and the minimum payment requirement is interest only. Those who would prefer to only pay interest on the mortgage can look at this product. One downside compared to a closed variable mortgage is that the interest rate is higher. Typically, it is priced between prime +0.5% to prime +1%.
In comparison, a closed variable rate mortgage is typically at a discounted rate off prime (calculated via prime minus a set number). As prime changes, the discount will remain the same. The penalty to get out of a closed variable rate mortgage is lower typically than the penalty to get out of a closed fixed rate mortgage. This penalty is usually three months of interest.
For example, the closed variable rate mortgage penalty on a $300,000 mortgage with a rate of 2.9% would be $2,175. If you feel interest rates are going to stay the same or decrease, you might wish to consider a variable rate mortgage in order to take advantage of the lower interest rates. A variable rate mortgage has lower interest than one with a five year fixed rate.
A fixed rate mortgage is one of the most popular options around. This mortgage has the same interest rate for a set period of time. Usually, this period ranges from six months up to 10 years. The longer you lock in an interest rate, the higher the interest rate. The reason for this is that having a rate held for a longer period of time gives you more security. However, it is also riskier for the lender if rates are to increase during that time. During the term, your payment will stay the same regardless of changes in interest rates. Those who are cash flow sensitive may appreciate this.
The penalty on a fixed-rate mortgage, unfortunately, cannot be known until the time you want to pay it off. This is due to fixed-rate mortgage penalties being the greater of three months of interest or an interest rate differential.
For those who do not meet traditional lending guidelines, or if their needs are a bit more time-sensitive, other options include private mortgages and alternative lending. For example, perhaps you are new to self-employed income, have bad credit or need to obtain financing within a few days. If so, these may be options worth looking at.
Normally, in order to acquire a private mortgage or alternative lending solution, the down payment needs to be at least 20%. With these types of mortgages, you can potentially obtain a solution that you otherwise would not. However, they can come with higher interest rates and possible fees. Some alternative lenders can have amortizations of up to 40 years to decrease the size of your mortgage payments while offsetting higher rates.
Many of the loans have shorter terms, such as for one year. These are ideal for those who are not quite where they need to be financially to meet traditional bank guidelines but still want to proceed with a mortgage. They can allow you a little bit of time to continue to get your finances in order and from there, at the time of renewal, you can look to refinance or renew back to a traditional lender. Some of these options also require less documentation. For those who are having trouble obtaining the documents a lender needs, this may help.
A hybrid mortgage option involves a percentage of the amount with a fixed interest rate while the remaining amount has an open or closed variable rate. This may be an option for individuals who are interested in maintaining some element of interest rate stability yet also prefer to take advantage of a current lower variable figure. Effectively, a considerable amount of the risk of this cost-saving measure is offset. Alternatively, if you’re aware of a future influx of funds but can’t predict exactly when you’ll receive them, the penalty for paying off the variable part of the mortgage will be less. This is where hybrid mortgages become applicable, as new homeowners can initially enjoy the stability of a fixed rate mortgage while also utilizing variable rate benefits.
A reverse mortgage is a loan option that often fits into retirement strategies since it relies on having ample equity in your home. Ideally, you'll have paid off your mortgage entirely and then you will take out part of the value of your equity from the lender. In practice, a reverse mortgage is less like a mortgage and is more of a collateralized loan worth a fraction of your home's value.
Customers for a reverse mortgage are usually elderly citizens looking to supplement their cash flow. Since it functions as a loan, it's a tax-free way to generate income from your home without having to go so far as to sell. Taking advantage of the equity available from the past work that went into paying off your mortgage can be a low-risk, convenient option to supplement your retirement.
The main drawback to using a reverse mortgage is the potential consequences that it will pass along to your children or other inheritors. With less equity in the home, they'll find themselves in a position to inherit less or will only receive a partially paid-off property. Reverse mortgages do have pros and cons, of course, but feel free to reach out to an experienced broker like myself, as we’re here to ensure that you can make informed, effective decisions with absolute peace of mind.
Should you be approaching renewal and not have selected a mortgage product in time, the lender may turn your mortgage into a convertible one. This is a holding pattern of sorts, giving you the time and opportunity to change your mortgage into something more appropriate that aligns with your needs. However, it’s important to bear in mind that the homeowner has a limited timeframe. This option is typically only available for a period of, say, six months.
With the purchase plus improvements option, a buyer can incorporate up to $40,000 in renovations for their home upon closing. This can be a great option for those who have found a property they like but are aware that it needs some updating. Instead of putting the renovation cost on cards and credit lines after closing or using up your savings, the renovation can instead become part of your mortgage.
In today's competitive real estate market, it can be difficult to find a home that suits your needs that's also within your price range. Unutilized land can often be surprisingly affordable, though, which opens up the potential for building your own home. While construction is a challenging and complex road to take, you can save quite a bit of money for your time.
A construction mortgage, otherwise known as construction financing, is an option for those looking to build a home or to buy a home and perform a substantial overhaul. If you’re having trouble finding a home that suits your specific needs, this makes it more feasible to build your own from the ground up.
Construction mortgages are advanced to you through phased draws in tandem with construction milestones. They come with several benefits that make them particularly suitable for building a new home. For one, these are typically interest-only during the building process, which makes the associated financial burdens much easier to handle. Lenders also usually release the funds associated with the mortgage in an incremental fashion. This typically occurs at each of the following stages:
The first draw can cover the cost of preparing the base or slab of the home. This includes the foundation of the home as well as leveling the ground and putting in plumbing.
This draw will help cover the cost of framing the home. The stage can typically take up to a month to complete.
The stage takes you to where you can lock up the home. With that, exterior walls, windows and doors have been installed. Also, the house is insulated.
This is where they install all the various fittings and fixtures of your home. For example cabinets, doors, flooring and more. Also, at this stage, the builder finishes the remaining plumbing and electrical systems.
The completion stage is where the final processes are complete. This can be painting, cleaning up, fence installation, and so on. At each stage, an inspector will need to go by to assess the progress of the build. Typically during the build, a lender will charge interest only and once the build is complete, you need to convert the mortgage to a standard mortgage.
The documentation that is required for a construction mortgage can be more in-depth than the documents required for a standard mortgage. On top of the typical verifications such as employment and down payment confirmation, a lender will require the builder purchase agreement, plans, permits and more.
By knowing the different types of products available, you can make better decisions on finding the one that best fits you. Mortgage brokers in Ottawa such as myself can help review your needs and find you the ideal solution. I not only have access to the best rates in Ottawa, but also many different types of mortgages from banks, credit unions, private lenders and more. Contact me today, and let’s chat about your mortgage needs!
Andrew Thake is a seasoned mortgage broker with over 15 years of industry experience. He’s assisted more than 2,200 clients in finding their ideal mortgage solutions. Recognized for his excellence, Andrew has received high honours and awards, including the National Rookie of the Year from TD Canada Trust and recognition as a Top 10 Ottawa Mortgage Broker in 2023. He has also been inducted into the Hall of Fame at Dominion Lending Centres and has consistently received their Platinum Award during his tenure as a mortgage broker.
Andrew’s dedication lies in serving his clients and prioritizing their needs with an empathetic approach. Throughout the application process, he provides tailored, informed, and efficient services to ensure the best mortgage solutions for his client’s unique circumstances. The best part of Andrew’s job is when he gets to see the joy on his clients’ faces following their mortgage approval.