Just like searching for a home, there are many options beyond fixed or variable rates when it comes to mortgages. In Canada, there are several types of residential mortgages available for everyone’s unique financial circumstances, no matter if you’re looking for an open mortgage or a hybrid option.
So whether you’re a new buyer qualifying for your first mortgage or an existing holder, what are the key things you need to know about the most common mortgage types? Frances Hinojosa, CEO, co-founder, and principal mortgage broker at Tribe Financial Group offers some insights.
Open and closed mortgages
If you anticipate making any lump sum payments on your mortgage, you might want to weigh your options between a closed or open mortgage.
Hinojosa explains most traditional mortgages in Canada are considered to be closed, which have a predetermined interest rate over a predetermined amount of time. Because of their predictability, a closed mortgage might be of interest to a borrower who wants stability and to “set it and forget it”, such as a household working off of a fixed income or budget.
“They’re comfortable with the timeline,” said Hinojosa. “They know what the payments are going to be for the next five years and they don’t even have to worry about that mortgage at all until it comes up to maturity.”
Closed mortgages still offer pre-payment options, which is when you can prepay your mortgage balance before the maturity date or when the mortgage term ends. However, closed mortgages may be limited to the amount you can pay.
For example, Hinojosa says if you have a closed mortgage worth $100,000, most major banks will allow for a 20% prepayment limit, meaning you can pre-pay up to $20,000 each year without penalty. If you’re planning to make a substantial payment, an open mortgage that will allow for large payments—or let you pay off the mortgage entirely—may be a better fit.
“If someone says, ‘Hey, I know I’m going to come into a large lump sum of money that’s going to exceed the pre-payment ability that a closed mortgage has,’ then I would suggest to them an open term,” said Hinojosa.
She explains closed mortgages can appear enticing due to their comparatively lower interest rates, but it’s important not to forget about potential breakage fees and the other features of closed mortgages. She says mortgage holders should understand breakage costs and their mortgage’s portability should they decide to part from their closed mortgage mid-term in the event of a lifestyle change or plans to move.
If you don’t want to stick with a closed or open mortgage for your entire term, you have the option to switch types through a convertible mortgage.
Convertible mortgages allow the holder to transition between a closed or open type during their term. With some lenders, it may also be possible to opt into a fixed rate mortgage if a variable rate was originally selected.
In cases where the market is in a falling interest rate environment like at the start of the pandemic, Hinojosa said clients may opt into a convertible mortgage so they can capture a lower interest rate in the near future. Clients who also anticipate selling their home and using the funds to make a substantial payment on their next property may also opt for a convertible mortgage type.
“It gives the client the ability to take that large chunk of money from the proceeds, pay down the open portion of that new house and then convert whatever is remaining over into a more faithful term,” explained Hinojosa.
If you’re debating between fixed and variable interest rates, a hybrid mortgage can offer a bit of both.
With a hybrid mortgage, you have the ability to have multiple styles of mortgages under one umbrella, which can include a combination of fixed and variable rates, a line of credit, and other financial products. If a client isn’t comfortable with the risks of a fully variable rate mortgage in the event interest rates rise, but wants some of the stability offered with a fixed rate, a hybrid mortgage fuses the two together.
“It allows you to soften that risk by splitting your mortgage off between fixed and variable, whatever percentage that you want,” said Hinojosa. “A little bit of fixed, a little bit of variable. You’re getting the best of both worlds there.”
Exclusive to home owners aged 55 and older, a reverse mortgage is a loan connected to the value of the property and allows older Canadians to convert their home’s equity into a lump sum of cash or regular payments.
Mortgage holders with a fixed income like a pension who want to use cash for renovations, living expenses, or to give as living inheritances to family are often interested in reverse mortgages, Hinojosa explained. These mortgages are also becoming increasingly popular as the Baby Boomer generation lives longer and enjoys an active lifestyle in their homes.
Penalties for breaking a reverse mortgage vary by lender. If the home is sold or the occupant dies, the balance of the loan is due, which can be settled through the sale.
What else should you know about mortgage types?
Whether you’re a first-time home buyer or your mortgage term is coming up to maturity, Hinojosa said it’s important to work with a mortgage professional who you can have an in-depth conversation with about your finances, goals, and options. Be sure to ask questions about all of your mortgage’s features, including pre-payment options and the costs to break your mortgage, as well as clarification on interest rates.
Whenever your mortgage term comes up for renewal, Hinojosa said it’s a vital moment to reassess your life goals and priorities and how this affects the mortgage type you may have. As your life evolves, the mortgage type you signed up for during your last term may no longer be the best fit for you in the future, which might warrant a change.
“Like any of us, life changes. What your goals were five years ago will always be different five years moving forward because your life is moving forward. Your goals are going to be different,” said Hinojosa.
If you’re looking for referrals on mortgage brokers, a REALTOR® is a great source for financial experts as well as the most up-to-date advice on your local housing market.