The purchase of a home is one the biggest investments of your life. That is why it is essential to understand what a mortgage loan is so that you can make the best choice.
What is a mortgage loan?
A mortgage loan is a long-term loan granted by a financial institution to help you reach your real estate objective. A mortgage loan can be granted when purchasing your home, or at another point in time.
It is a cash loan that is subject to an interest rate. You and your financial institution will determine a repayment method for you to pay back the loan. You can choose weekly, bi-weekly or monthly payments.
In exchange for the money lent, your home will be used as a guarantee to cover the financial institution’s risk in relation to the repayment of your loan. In some cases, this guarantee may give your financial institution the right to sell your home in order to reimburse itself for the loan.
To help you understand better, here are a few basic definitions with respect to mortgage loans:
A down payment is a portion of the purchase price of your home that is not financed by the mortgage loan.
You must pay the down payment out of your own pocket. Several options are available. Your financial institution can help guide you based on your situation.
When buying a single-family home, the minimum down payment is 5%.
Insured loan and conventional loan
When your down payment is between 5% and 20%, your financial institution will ask that your loan be insured by a mortgage insurer like CMHC or Genworth to cover the risk related to the repayment of the loan granted. The insurance premium will be calculated based on the percentage of the down payment made and will be financed by your mortgage loan.
If your down payment is 20% or higher, your mortgage loan will be a conventional loan, which means there is no need for a mortgage insurer.
The amortization period is the number of years it will take you to repay the mortgage loan in full. A standard amortization period is 25 years, but it can be longer or shorter. When repaying the mortgage loan, and depending on the product chosen, certain elements can cause the amortization period to vary: the interest rate (fixed or adjustable), lump-sum payments and payment amounts.
A term is the period during which you agree to meet the conditions set for the repayment of your mortgage loan, and can vary between one and five years; five years being the most popular. The conditions to be met include, but are not limited to, the interest rate and payment frequency.
At the end of the term, you can negotiate the conditions of a new term with your financial institution or repay your loan in full without penalty.
If, however, you want to repay your loan in full before the end of the term, the repayment conditions before maturity become applicable. A penalty will be added to the balance of your mortgage, which will be calculated according to the conditions stated in your mortgage loan agreement.
There are two types of term: closed and open. Closed terms have advantageous interest rates and are used for longer maturities. Open terms are usually granted for shorter maturities, at a higher interest rate. A significant advantage of the open term is the ability to repay the loan penalty-free before maturity.
An interest rate is a percentage calculated on the amount of the mortgage loan that you are required to pay in addition to the amount borrowed from your financial institution. Thus, each payment will include a portion of the capital borrowed and a portion of interest.
There are two types of interest rate: fixed and adjustable. A fixed rate guarantees that you will pay the same rate and same amount for the duration of the term. An adjustable rate is calculated based on the Bank of Canada’s prime rate less a discount established with your financial institution. The Bank of Canada’s prime rate can vary at any time during the term.
Regardless the type of rate you choose, that rate will be in effect for the duration of the term and can be renegotiated at the end of the term.
Ready to shop for your new home?
Try our borrowing capacity calculator to determine the maximum amount you can borrow for your mortgage loan to buy your new home. You can also use our mortgage loan calculator to determine the amount of your mortgage loan payments.