What are the different types of mortgage loans in Canada?

If you're thinking about buying a home in Canada, you need to explore your mortgage options! The average price to buy a house across Canada is over $650,000 as of December 2023. In some markets, you'll see prices significantly higher than that!

Buying a home outright is a luxury that only a few people get to experience. For most prospective homebuyers, the only way to fund a purchase is to get a mortgage.

Getting into a home you love is a big milestone, but there are several key financial decisions to make. What you decide now can impact the cost of ownership and dictate your life for the next several decades!

In this blog, we'll review the different types of mortgage loans you can get in Canada, covering the pros and cons to help you decide which choice is right for you.

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A brief introduction

Mortgages work similarly in Canada as they do in the United States. Instead of paying for your home in full, you can work with a lender to foot the upfront costs and repay your mortgage loan over several decades. The concept is simple, but there are various types of mortgages available.

The differences they hold can affect many aspects of your homeownership journey. They all have varying income, credit scores, and down payment requirements to qualify. Terms of these mortgage loans can also impact your monthly payments and how much the loan will cost you over time.

The most common mortgage loan options you'll need to consider before signing on the dotted line include fixed-rate versus variable rate and open versus closed.

Fixed-rate mortgages

With a fixed-rate mortgage, you agree to pay a specific interest rate for the term of your loan. The interest rate is how much it'll cost you to take out your loan. You get charged interest for the outstanding principal, and that interest compounds semi-annually according to Canada's Interest Act laws.

Getting a fixed-rate mortgage means you'll pay the same interest rate throughout the term of your loan. The average mortgage term is five years. However, some lenders may offer shorter or longer terms based on your needs. The fixed-rate lasts for however long your term is, not the full amortization period of the mortgage.

After the term, the interest rate may change if you decide to renew. You can reevaluate your needs, shop around to other lenders for a better rate, or switch to a variable rate after the term ends.

Fixed-rate mortgages are the most common in Canada, accounting for nearly 70 percent of mortgage funds issued at the start of 2023.

Pros and cons

The biggest benefit of getting a fixed-rate mortgage is payment stability. Because the rate doesn't fluctuate, you don't have to worry about your payment going up at any point during your term. However, that also means you won't benefit from lower rates, either.

The primary downside of fixed-rate mortgages is that they typically come with higher interest rates at the onset. The rates are higher for this type of mortgage compared to the alternative. Plus, you don't have much wiggle room to make larger payments if you want to repay your mortgage faster. If you go beyond prepayment privileges, you'll experience steep penalties.

Variable-rate mortgages

A variable-rate mortgage is the opposite of its fixed-rate counterpart. While the previous loan stays the same throughout your mortgage term, this one can fluctuate month-to-month. Interest rates depend on how the Bank of Canada moves its overnight rates. When inflation rises, the Bank of Canada often raises rates. That's been a major issue in recent years, causing significant problems for many mortgage holders.

The variable rate will change frequently throughout the term of your loan, leading to less stability. It's a gamble. When rates rise, you'll pay more. But when they decrease, you'll pay less.

The good news is that most lenders will allow you to renegotiate and switch to a fixed rate if necessary. Generally, it's easier and more affordable to go from a variable rate to a fixed rate than vice versa.

Pros and cons

The advantage of a variable-rate mortgage is access to lower overall rates. Because you're gambling on inflation and the economy, lenders grant lower rates than they do with fixed-rate mortgages. Access to those lower rates may be worth it to some buyers. Additionally, in case you need to break the mortgage, many lenders typically charge only three months of interest, providing more flexibility.

Of course, the downside is facing the unknown. You're at the economy's whims, and your rate can increase significantly, forcing you to pay more for your loan.

Open mortgages

Beyond fixed and variable rates, you'll have to decide if you want an open or closed mortgage.

An open mortgage is a lending option that allows you to pay down as much of the principal balance as you want at any time. You still have defined monthly payments with principal and interest. But with an open mortgage, you have more flexibility to make extra payments without facing prepayment penalties.

Open mortgages aren't so common in Canada, but they're worth considering if you want to repay your mortgage faster. They provide greater overall flexibility.

Pros and cons

The most significant advantage of an open mortgage is the freedom to pay down your loan. Many people want to pay off their mortgage as fast as possible to minimize the total cost of that loan. You can do that with an open mortgage!

Most mortgages come with some prepayment privileges. That means you can pay a little extra. But if you go beyond that threshold, you pay high penalty fees. That's not an issue with open mortgages.

So what's the downside?

Lenders want to make money, and they can't do that when you make extra payments with no prepayment penalties! Mortgages make money the longer you hold them, so open mortgages aren't beneficial to lenders.

As a result, these loans come with higher interest rates to make up the difference.

Closed mortgages

Finally, we have a closed mortgage. Most Canadians choose closed mortgages.

With this setup, you work with your lender to determine precisely how much you can pay back every year. Those terms get set at the start of your term, dictating the monetary amount you pay yearly, how much prepayment allowance you have, and whether you're paying monthly or biweekly.

Those rules are concrete and last the term of your loan.

Pros and cons

Closed loans are beneficial because they typically have lower rates than open loans. By setting strict definitions about how much you can pay, lenders can control how much they make from your mortgage. Therefore, they can provide lower rates than they do on the alternative.

The biggest disadvantage is a lack of payment freedom. Lenders usually provide a prepayment allowance, but it's modest. If you want to pay more, you'll pay eye-watering prepayment penalties. There are also limits to what you can change. If you need to change anything about your mortgage terms, you'll need to break the contract. That comes with even more fees.

Which option is right for you?

What's right for you will depend on your financial situation and needs.

Closed fixed-rate mortgages are popular in Canada because they provide predictability. There's no worry about changing monthly payments caused by inflation. Furthermore, the closed contract ensures you're getting a lower mortgage rate without any sudden surprises.

For most people, those mortgages are the best choice.

But those who want more freedom should look into variable-rate and open mortgage options. Variable rate mortgages are best if you have some wiggle room in your budget to handle fluctuating payments. You can take advantage of the lower interest. Meanwhile, an open contract allows you to make bigger payments as you see fit, helping you lower the overall cost of your loan.

There are many factors to consider. Look at your financial situation and long-term plans. Crunch the numbers to understand what you can afford and think about how these mortgage options will impact your ability to repay.

Learn more with Nobul

Need some expert guidance? Check out Nobul to connect with an experienced real estate agent in your area! An agent can help you understand your options and connect you with recommended lenders that meet your needs.

With Nobul, you can find the perfect agent for your home-buying venture in Canada. Check out agent profiles and get personalized offers, including cash rebates, when making your purchase. Contact agents through Nobul directly and search for your dream home. Sign up to create your Nobul account today!