Mortgage Basics

A Definitive Guide To All Mortgage Terms Any First-Time Buyer Should Know

A Definitive Guide To All Mortgage Terms Any First-Time Buyer Should Know
Written by
  • Ashley Howard
| 25 September 2023
Reviewed, 25 September 2023

Table of contents

    Purchasing your first home is an exciting milestone. Still, it can also be overwhelming, especially when understanding mortgage lingo. By familiarizing yourself with the terms you may come across and understanding the language of mortgages, you will be better equipped to navigate the complexities and secure the best possible mortgage for your needs.

    Homeownership offers numerous benefits, including building equity, stability, and the potential for long-term financial growth. By understanding mortgage terms, you can make sound financial choices and take advantage of the various incentives and programs available to first-time buyers. So, let’s get started demystifying the world of mortgage jargon.

    Key Takeaways

    • A mortgage is a loan used when purchasing a property. The property is used to secure the loan. 
    • Obtaining a preapproval or prequalification gives you a realistic understanding of your purchasing power so you can shop for homes that align with the mortgage amount you qualify for.
    • Mortgage default insurance is necessary if putting down less than 20% as a down payment.

    What Defines A First-Time Homebuyer In Canada? 

    Before we get into the intricacies of mortgages, it’s important to know if you meet the criteria of a first-time homebuyer in Canada. The definition of a first-time homebuyer varies slightly between the various incentives and available programs designed for first-time buyers.

    Most of the incentives, grants, and programs available, at a minimum, define a first-time buyer as someone who has not owned or lived in a home owned by them or their current spouse/common-law partner. However, this definition of a first-time homebuyer may differ, and there may be more qualifying criteria that you must meet in addition to this to qualify for each program.

    To ensure you meet the specific criteria in your province and understand the incentives available to first-time buyers, consult with a mortgage professional or seek professional legal advice. Doing so lets you determine your eligibility and make the most of the programs designed to support first-time homebuyers.

    Mortgage Basics 101

    A mortgage is a loan that allows you to purchase a property by using the property itself as collateral. In simpler terms, it is a financial agreement between you (the borrower) and a lender. The borrower in this relationship is also known as the mortgagor, and the lender is known as the mortgagee. The lender provides you with funds to purchase the property, and in return, you agree to repay the loan over a specified period, typically with interest.

    In Canada, there are two main types of residential mortgages: standard charge mortgages and collateral charge mortgages. A standard charge mortgage is registered against the property’s title and includes specific terms and conditions. A collateral charge mortgage registers a charge against the property for an amount greater than the mortgage balance, allowing borrowers to re-advance funds as the mortgage is paid down.

    Understanding these basic concepts will provide a solid foundation as we delve deeper into mortgage terminology.

    Get To Know Down Payments for First-Time Buyers

    One of the most significant hurdles for first-time homebuyers is the down payment. A down payment is the initial capital (cash) amount you put towards purchasing your home, demonstrating your financial commitment to the mortgage loan.

    Canada’s minimum down payment requirement is 5% of the purchase price for properties valued up to $500,000. The down payment requirements for properties between $500,000 and $999,999 are 5% of the first $500,000 and 10% of the remaining amount. If the property purchase price is over $1 million, the down payment requirement is 20%. It’s also important to note that a down payment of 20% or more is required to avoid paying mortgage default insurance.

    However, there are additional exceptions to the 20% rule. If you opt for a 30-year mortgage amortization, a 20% down payment is necessary. Additionally, if you’re buying an investment property, a 20% down payment will be required.

    While a 20% down payment may be appealing to avoid paying mortgage default insurance, it’s important to consider your unique financial situation and goals. Waiting to save a 20% down payment may result in missing out on potential appreciation and future homeownership opportunities. Consult with a licensed mortgage professional to find the down payment option that aligns with your financial objectives.

    What is The Preapproval Process?

    A mortgage preapproval or a prequalification is highly recommended before you start shopping for your dream home. A pre-approval provides you with an estimate of how much you can borrow based on your financial situation and creditworthiness.

    The pre-approval process typically involves the following steps:

    • Application: Complete an application for pre-approval, providing details about your income, assets, and liabilities. This step is done before you find a specific property, as the pre-approval is based on your financial information.
    • Get Advice: A mortgage expert will review your application and ask questions to gain a thorough understanding of your financial situation. It’s important to be honest and transparent during this stage to receive accurate advice.
    • Verify and Confirm: Once your application is reviewed, you will need to provide documentation to validate your information, such as identification, pay stubs, and employment letters. Being forthcoming about your financial details is crucial to avoid issues during the underwriting process.
    • Underwriting: The underwriting department will review your application, credit file, and documents to ensure everything is in order. They will determine whether you are pre-approved for the requested mortgage amount or suggest a different amount based on your qualifications.
    • Pre-Approval Letter: If you meet the lender’s criteria, you will receive a pre-approval letter indicating the qualifying amount and any necessary disclosures. This letter is valuable when making offers on properties and provides you with a clear understanding of your budget.

    By going through the pre-approval process, you can gain a realistic understanding of your purchasing power, set a budget, and shop for homes that align with what you can qualify for. It’s important to note that a pre-approval is not a guarantee of mortgage approval. Once you find a specific property, the lender will conduct a thorough assessment before finalizing the approval.

    Note: Preapproval and prequalification are similar processes and neither guarantees approval. An approval can only be granted after a thorough review and consideration of the subject property upon the acceptance of your purchase offer.  The main difference between them is a rate hold for you provided with a preapproval. However, you should know that typically the lender will add a premium to the rate while they hold it for you.

    What Are Mortgage Rates? 

    Mortgage rates play a significant role in determining the overall cost of your mortgage. It’s essential to understand how mortgage rates are determined and the factors that can influence them.

    Mortgage rates are influenced by various factors, including the Bank of Canada’s policy rate, bond yields, inflation, and the lender’s own funding and origination costs. As the Bank of Canada adjusts its policy rate, lenders may increase or decrease their prime rates, affecting variable mortgage rates. 

    Bond yields influence fixed mortgage rates. When bond yields rise, fixed mortgage rates tend to rise to reflect the higher cost of borrowing for lenders. When bond yields fall, fixed mortgage rates tend to fall. When bond yields rise, mortgage rates tend to react quickly to reflect this change. When bond yields fall, mortgage rates tend to react more slowly to this change due to volatility risk on bond yields.

    It’s important to note that the lowest mortgage rate may only sometimes be the best option for your financial plans. While securing a low rate is desirable, other factors, such as prepayment options, flexibility, and overall mortgage features, should also be considered. Work with a licensed mortgage professional to understand the options available and select the mortgage rate that aligns with your financial goals.

    How to Choose Between Fixed vs. Variable Rates? 

    When it comes to choosing a mortgage, you have the option to select either a fixed rate or a variable rate. Each has pros and cons, and understanding the differences can help you choose the one that best aligns with your financial situation and goals.

    A fixed-rate mortgage offers stability and predictability. With a fixed rate, your interest rate remains unchanged throughout the term of your mortgage. This means your mortgage payments will remain the same, providing you with a sense of financial security and allowing you to budget effectively.

    On the other hand, a variable-rate mortgage offers the potential for savings but comes with a level of uncertainty. With a variable rate, your interest rate can fluctuate based on changes in the lender’s prime rate. If interest rates decrease, you can benefit from lower mortgage payments or having more of your payments go toward the principal amount of the mortgage. However, if rates increase, your mortgage payment may go up, or more of the payment will go toward the interest portion, potentially impacting your budget.

    Choosing between fixed and variable rates depends on risk tolerance, financial goals, and market conditions. If you prefer stability and want to know exactly what your mortgage payments will be, a fixed-rate mortgage may be the right choice. If you’re comfortable with some level of uncertainty and believe interest rates may decrease, a variable-rate mortgage could potentially save you money.

    Note: There are 2 types of variable-rate mortgages, and they have their own pros and cons. Typically a variable-rate mortgage (VRM) comes with a fixed payment, and an adjustable-rate mortgage (ARM) comes with a payment that adjusts with changes to the lender’s prime rate. 

    What Do Mortgage Term and Amortization Mean? 

    Two important concepts to understand when it comes to mortgages are mortgage term and amortization. While these terms may sound similar, they refer to different aspects of your mortgage agreement.

    Mortgage Term 

    The mortgage term is the length of time during which the specific terms and conditions of your mortgage agreement bind you. Terms typically range from 1 to 10 years, with 5-year terms being the most popular option in Canada. At the end of the term, you will have the option to renew your mortgage, pay it off in full, or switch to a different lender.

    Mortgage Amortization 

    Amortization refers to the total time it will take to pay off your mortgage in full, including the principal amount and the interest. The maximum allowable amortization period in Canada is 25 years for mortgages with less than a 20% down payment. If you have a down payment of 20% or more, you may be eligible for an amortization period of up to 30 years.

    It’s important to note that the longer the amortization period, the lower your mortgage payments will be. However, a longer amortization period also means you will pay more interest over the life of your mortgage. Balancing the length of your mortgage term and the amortization period is necessary to find a payment schedule that aligns with your financial goals while also saving you as much as possible on interest-carrying costs.

    What Is Mortgage Default Insurance for First-Time Buyers? 

    For many first-time buyers in Canada, mortgage default insurance is a necessary consideration. Mortgage default insurance, also known as high-ratio or CMHC insurance, protects the lender in the event that you default on your mortgage payments.

    When your down payment is less than 20% of the purchase price, you are considered a high-ratio borrower, and mortgage default insurance is required. This insurance allows lenders to provide mortgages to borrowers with a lower down payment, reducing the risk for the lender.

    Mortgage default insurance is provided by crown corporation Canada Mortgage and Housing Corporation (CMHC) or private insurers Canada Guaranty (CG)  and Sagen (GW). The cost of mortgage default insurance is determined as a percentage of the mortgage amount and is added to your mortgage balance or can be paid as a lump sum upfront if you prefer to avoid paying interest on this amount.

    While mortgage default insurance adds an extra cost to your mortgage, it also offers several benefits. First, it allows you to access homeownership with a lower down payment, making it more attainable for many first-time buyers. Second, it enables you to secure lower mortgage rates, as lenders view insured mortgages as a lower risk. Finally, mortgage default insurance is portable, allowing you to transfer your insurance to a new property or lender if you decide to move before your mortgage is paid off.

    Note: One of the best ways to save on your mortgage and interest is to put down a down payment of 19.99% and pay for your default insurance with cash. This maneuver will keep your default insurance premium as low as possible while avoiding interest if added to your mortgage. You’ll also get the lowest (insured) rate on your mortgage. 

    Frequently Asked Questions

    What is a mortgage, and how does it work?

    A mortgage is a loan agreement between a lender and borrower that uses the property as collateral.

    What is an interest rate, and does my down payment matter?

    The interest rate is the fee your lender will charge on your mortgage for the set term expressed as a percentage. The size of your down payment will determine whether you need to purchase mortgage default insurance. Mortgage rates will be lower on mortgages that require mortgage default insurance as these mortgages come with the least risk to the lender.

    Can I get a discount on mortgage default insurance?

    While you cannot get a discount on mortgage default insurance, putting more of a down payment toward your mortgage will give you lower premiums on the insurance required. If you put down the minimum 5%, your premium would be 4%. If you can increase your down payment to 10%, the premium goes down to 3.10%.

    Final Thoughts 

    You’ve made it to the end of our comprehensive guide to understanding mortgage terms for first-time homebuyers in Canada. By familiarizing yourself with these key mortgage terms and concepts, you are now well-equipped to navigate the mortgage process with confidence.

    Remember, seeking knowledgeable and licensed professional advice from a mortgage expert is always recommended to ensure you make a financial decision that matches your risk tolerance, budget, finances, and goals. A mortgage expert can guide you through the intricacies of the mortgage process, help you explore the best mortgage options, and provide personalized advice based on your unique circumstances.

    If you have any further questions or need assistance with your mortgage journey, don’t hesitate to contact a mortgage expert. They are there to support and guide you every step of the way.