# How To Pick The Perfect Mortgage

Buying a home, especially for the first time, is an exciting venture, but once you’ve been pre-approved for a mortgage amount and found the perfect property you’ll need to make a decision on the right mortgage for you.

When my parents bought their first home here, after immigrating to Canada in the mid 1960’s, their choices were very limited – a down payment of a minimum of 25% and a 6% interest rate for a full 25 years. They had a mortgage payment of $101 a month and no prepayment options.

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Mortgages are no longer one size fits all. Many people become too fixated on the lowest interest rate, but there are numerous other choices they need to make to tailor a mortgage to best suit their needs and fit their lifestyle.

### Conventional vs. high ratio Mortgage

A conventional mortgage requires a down payment of at least 20 per cent.

If you have a down payment of less than 20% of the purchase price, you’ll have a high-ratio mortgage, which must be insured. The minimum down payment you’re required to make is five per cent.

Mortgage loan insurance, usually from CMHC, protects the mortgage lender in case you aren’t able to make your payments.

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The premium varies depending on the percentage you have as a down payment. Rates can be higher in certain circumstances such as irregular income, self-employment, or if more than one advance is being made. Typically they are as follows:

- 80+ – 85% = 1.75%
- 85+ – 90% = 2.00%
- 90+ – 95% = 2.75%

You can pay the premium yourself but most people choose to add the funds to their mortgage. (Remember this when looking at houses within a pre-approved mortgage amount.)

With the low interest rates available today there is often no benefit in continuing to rent while trying to save 20% to eliminate the CMHC fee.

**Related**: Pros And Cons Of Waiting To Buy A Home

### Little known features of CMHC insurance

- If you want to renegotiate your mortgage (e.g. to get a lower interest rate), most financial institutions will charge a prepayment penalty that is the
*greater*of three months interest or the Interest Rate Differential or IRD (the difference between your mortgage rate and the current rate on the outstanding balance for the remainder of the term). However, if your mortgage is CMHC insured the prepayment fee is*always*the three months interest penalty. - The CMHC insurance paid on a mortgage after April 1, 1997 is portable to another property.

### Open vs. Closed Mortgage

An open mortgage gives you the flexibility of paying down as much as you’d like at any time with no penalty. Interest rates are usually higher so it would only make sense if you’re expecting a large sum of money to come in, you get regular large bonuses during the year, or you expect to sell your home within the term.

Most mortgagers opt for a closed mortgage term.

### Mortgage terms

Open mortgages are available in six-month and one-year terms.

With a closed mortgage you can choose from a six-month, or one-, two-, three-, four-, five, seven- or ten-year term. The longer the term, the higher the interest rate. Rates are most often negotiable.

**Related**: Why A 1-Year Fixed Rate Mortgage Is Worth A Look

When choosing a term think about how long you plan to stay in the home and any future life changes.

### Fixed vs. variable rates

A fixed interest rate will stay the same for the duration of the mortgage term, whereas a variable interest rate will fluctuate based on market conditions (the payment remains the same but the amount paid to the principal will vary).

While some people are comfortable with the perceived risks of a variable rate, most people like to lock into a fixed interest rate.

### Payment schedule

Mortgages are set up to be paid once monthly, but if your cash flow allows you may consider more frequent payments. For example, many people are paid bi-weekly and choose this frequency for their mortgage payments too.

Weekly and semi-monthly payments are also available.

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If you want to pay your mortgage down faster make sure you choose “rapid” frequent payments. Paying a few dollars more can lop years of the amortization and save thousands of dollars in interest.

### What is the Interest Adjustment Date (IAD)?

Unlike rent, which is paid ahead, mortgage payments are paid for the period of time that has gone past. If your possession date is not on the first of the month, or you choose more frequent payments you will in most cases be charged the IAD.

Ben and Caitlyn move into their new house on Wednesday, May 1. They chose biweekly mortgage payments to coincide with their pay deposits, the next one being Friday, May 10. Since this is not a full payment period, they will pay an interest adjustment of 10 days interest on May 10 and their first full biweekly payment will be due on May 24.

### Prepayment options

Financial institutions allow different prepayment options. Amounts from 10% to 20% of the original balance can be paid once per calendar year (not only the mortgage anniversary date as many people think).

The payment can be made without penalty only once in the year. Other lump sums will be charged a fee. That means if you make a lump sum payment of $5,000 in March you can’t make a $50,000 prepayment without charge in September, even if it’s within an allowable 20%.

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Sometimes it’s easier to increase your mortgage payment rather than save up a lump sum. Increased payment options vary from 10% to 100% more.

Check to see if you can change this payment in the future and if there will be a charge to change it.

### Final words

Buying a new home is exciting, but it can also be stressful. Taking out a mortgage is a long term and expensive commitment.

Take the time to review all the options available right from the beginning to get the best mortgage product for your needs. Set up your automatic payments and then start decorating.

To clarify on the little know features of CMHC: In August 1999 CMHC removed the 3 month interest penalty cap from their policy.

@Scott Dawson: Thanks for the update. Most people don’t read their lengthy mortgage document but it can give necessary information.

@Scott: P.S. Apparently banks have the “choice” to over-ride the 3 months penalty and charge IRD. As consumers I think we have the right to loudly insist on the former.

Lenders will charge whichever is higher which is usually the IRD.

Not going to happen. The banks have full discretion and are going to want to recover the lost interest.

The only way to ensure 3 months interest is with a variable rate mortgage.

You should also note that mortgages are portable (at least from CMHC; I am unsure about Genworth). This allows an existing homeowner with a mortgage to transfer a mortgage amount (under existing terms and conditions) to a newer home that they purchase. They can top the mortgage amount up for the difference in mortgage amount but under different prevailing rates. This means that one does not have to pay for mortgage insurance on the full value of the replacement home; only the increased value (assuming the loan to value ratio on the new home is still above the minimum 80% which by law, mortgagors must take out mortgage insurance). Check this out with CMHC if you want.

@David Metzak: I know that mortgages are portable within the same financial institution with a blended interest rate given if the new mortgage amount is a higher amount. Often CMHC insurance was charged on the full new amount – not just the increase.

There is a top up rate from all the insurers. It is higher than the standard rates, but only applies to the added funds.

It should also be noted that many mortgage prepayment privileges can be made throughout the term NOT only once annually or fiscally, but on multiple regularly scheduled payment dates. (Depending on your pre chosen frequency)

@Sharon Davis: I believe that in the majority lump sum payments can only be made once a year without penalty. In addition you can increase the payment but some FI’s charge a fee if done more than once a year.

It pays to check all the details when you take out the mortgage.

Another great article! We are about 50 days from closing and looking at finalizing a mortgage soon. Based on your site and other info, I am leaning towards a 1 year fixed to start, then reassessing and likely going towards another 1 year fixed or 5-year variable in 2014. The 1 year fixed for the first year should work well since we have put 20% down but we are first time buyers. We won’t be doing too much in terms of “extra” payments for our mortgage for the first year, but intend to do so once most of our start-up costs are taken care of.

What I didn’t know until I just read it in the “Pros and Cons of Going Short With Your Mortgage” is that there is a cost associated with switching lenders once the 1 year fixed would end. I have no idea what that cost would be though, do you?

Also, in the scenario I outlined above, would it be worth it then to go 1 year? Or just go 5-year variable off the start? We can get a 1 year @ 2.29% or a 5 year variable @ 2.50%.

As always, thanks in advance for the advice. You are easily my favourite, and the best financial site out there! I recommend you to everyone I can!

@Bryan: Thanks for your kind words. I’m happy you find our posts useful.

I see you’re counting the days to your move.

To answer your questions:

1. When the term ends you have the option of paying the mortgage balance in full with no penalty. If you do a switch to another FI the original documentation stays the same. Basically you are paying a fee to transfer your file. In my past experience the new lender will absorb the transfer fee to get your business. It used to be $85 (about 100 years ago!), it’s probably a bit more now.

2. In my opinion there is no advantage to going 1 year and then 5 years unless you’re getting a really low interest rate. And why would you then switch lenders? Negotiate a good rate for a 5 year term and your payments will remain stable for that length of time, even if you decide on a variable rate. If the interest rate changes, less (or more) of the payment will go to the principal.

If you can’t afford extra payments at first, just making rapid more frequent payments – such as biweekly – will still save you thousands in interest over the long term.

Congratulations on your new home.

The prepayment options are often negotiable with your lender. They expect most people won’t actually use them, so they are often willing to re-write them to suit the customer. (unlike giving you a greatly reduced interest rate.)

So ask for the right to prepay principal, up to 25% of the original principal amount, every year with the option of making as many payments as you want per year. The worst they can do is say no! We could pay down principal whenever we wanted, so we did often put an extra $500 or $1000 at the mortgage principal when we could. Getting it in even 9 months earlier helps.

We chose a mortgage based on a rate we could pay from only one of our incomes for security in case of layoffs. Then we threw lots of early payments of the principal in whenever we could. We paid off a 25-year mortgage in less than 15 years doing this.

@Bet Crooks: You can often negotiate terms with your lender but in my experience you have to have a lot to offer in the way of business for very generous terms but, that said, there is a lot of competition out there so it certainly doesn’t hurt to ask.

Usually lump sum prepayments are only allowed once a year on closed mortgages, else why would they bother to offer an open mortgage?

Maybe that’s true now. When we had a mortgage with BMO we had unlimited lump sums per year up to 25% of our original principal. I think they knew just how few people actually do this.

With my clients (mortgage broker), if they are going to be aggressive I always choose a lender that allows double payments with no penalty as often as they like. This provides them with the ability to go beyond any other prepayment term easily.

When I had mortgage about fifteen years ago, I was able to negotiate one point off of the posted rate. Rates were higher then (my negotiated rate was 6.7%), so I am not sure if there is that much negotiation room today.

About a year into my mortgage, interest rates were falling, I paid a penalty of about $1,000 and switched to a better than prime rate variable rate (0.25 points off the variable posted rate). However, I never changed the mortgage bi-weekly payment amount. Even though I had a lower intest rate, I was still paying as if I still had that high 6.7% rate. This proved to be great move. All of the extra money from overpaying went straight to paying off the principal. For me, this took some of the risk off of going variable. Even if rates did rise down the road, the effect would be felt on a lower principal.

In most cases, a variable rate is better than a fixed rate over five years. So, if you are considering a five year fixed rate mortgage, why not take a variable mortgage, but pay as if you had fixed rate?

Also, if I recall correctly, a bi-weekly payment schedule reduced my amortization period by about 4 years.

@Jeff – That’s how we’ve got our mortgage set up right now. We initially took out a variable interest rate at prime minus 0.8 (2.2%), but set our monthly payments $500 higher than the minimum.

We’ve slowly increased that amount as we’ve become more comfortable with our cash flow (and more eager to pay off the mortgage). Now we’re paying $1,100 per month more than what our minimum monthly payment should be. That’s taken our amortization down to 10 years.

I have an alternative to a mortgage that doesn’t seem to get much press. I built an energy efficient but alternative house that my mortgage provider didn’t like so I had to look around. Eventually, I went to BMO and they gave me a line of credit for the full amount of my mortgage.

The advantages are a low interest rate, paying off as much as you want at anytime with no penalties and as you pay it down, you have a LOC that can be used for vehicles etc.

I believe it is called a BMO Readiline and it has worked really well for me!

@Andrew: Thanks for your input.

I was going to include Home Equity Secured Lines of Credit in the post but it was getting too long. I have one too – all banks offer them.

The advantages are that as long as you make the interest payment every month you can pay any amount at any time and access any available credit.

These can also be disadvantages for some people as it may be too easy and tempting to use too often and suddenly there’s thousands more that has to be repaid. Paying the interest only prolongs the debt – not for everyone.

The maximum amount available is 80% of your home value. Often the interest rate is not as negotiable as a regular mortgage.

That said, when the first term ended on our mortgage I switched to a HELOC and even thought the interest rate has fluctuated a bit over the years, I have not regretted it.

These are great vehicles for saving money on a mortgage, but require a responsible owner to ensure they are using it effectively. Also, they require significant equity, as the government has capped them at 65% when a stand alone. The combined product will still allow for 80%.

Great post, except I strongly disagreed with the statement, “With the low interest rates available today there is often no benefit in continuing to rent while trying to save 20% to eliminate the CMHC fee.”

With the highest Canadian housing prices of all time, when price:rent and price:income ratios are off-the-charts, and when a low 5-year rate will surely be much higher when people renew their monster mortgages, I think “buying is smart” is the exception not the rule.

@Joe: While I understand your reasoning, Joe, I’m not suggesting that it’s always better to buy than to rent. The fact is that many (if not most) Canadians choose home ownership even considering the risks involved with respect to the rise and fall of house prices and, while an interest rate rise is certain, who knows when?

If someone is living with their parents rent free it may justify waiting to save enough to put 20% down, but if someone spending one third of their income (or more) on rent there is usually more benefit to taking out a high ratio mortgage instead of putting off the purchase.

We have our mortgage with the Bank of Montreal and they recommended a product they call Homeowner Readiline. This product consists of 2 parts, a mortgage and a line of credit. As you make each payment on the mortgage part, the principal paid off immediately adds to your available funds on the line of credit. The mortgage part is at a lower interest rate than the line of credit part. So when we have available funds we can pay off the mortgage more quickly and still have those funds available (with interest) in the case of an emergency. We can make lump sum payments as many times throughout the year as we want as long as they are in excess of $100. The yearly maximum is 20% of the original mortgage part amount. This is our second house using this product and we have, between the two houses, used if for 7 years. We find it a good way to balance the desire to pay the mortgage quickly and to have an emergency fund.

@Diane: There are a lot of options available with different lenders and many hybrid mortgages as well (e.g. Scotiabank’s STEP & Manulife One) that are suitable and beneficial for many borrowers.

Instead of just choosing the lowest interest rate, a bit of research can uncover a mortgage product that will fit present and future situations.

I would just like to point out that a 20% or 25% annual prepayment option may sound generous it is not realistic for most. If an average mortgage is $300.000, 25% is $75,000 which is out of reach for the majority of mortgage holders. I think a better options are more frequent payments and payment increases as income allows.

Our mortgage was only $240,000 and our plan is to pay an extra $400 biweekly, if we don’t hit any roadblocks. We have also asked that presents (Christmas, birthday, etc. be in cash so that we can apply them to our mortgage, which we have done. Any bonuses or other unusual money is also being applied. We have done very well so far. Our interest rate on the mortgage part is less than prime and the line of credit part is just above prime. Again, my favourite feature is the fact that all money paid toward the principal is available if truly needed. Yes, this does require self discipline.

The main point to remember is not to buy a huge house that will eat up a large portion of your cash in expenses. Not only mortgage payments, but insurance, taxes, heating, repairs, furniture – and on and on. Everything costs more.

I had a huge house I bought in 1990. Even back then, the gas for heat was $250/month! Add up all the costs and I was working tons just to keep up with all the expenses.

These days I pay $109/month for gas in a much smaller house. So much less stressful now.

Kathi