What are the Different Mortgage Types?

If you’re looking to get a mortgage for your (soon to be) purchased home for the first time, the different mortgage terms and types that are offered by lenders out there might be overwhelming at first. Here are the most common mortgage types and their definitions:

TRADITIONAL (CONVENTIONAL) VS. HIGH-RATIO

Traditional or Conventional Mortgage

Traditional or conventional mortgages typically have low loan-to-value ratio. In other words, the amount of the loan is low, relative to the value of the property. Mortgages where the house down payment is 20% or higher are usually considered as traditional or conventional mortgages.

High-Ratio Mortgage

Having a high-ratio mortgage (because down payment is less than 20%) mandates the borrower to get a mortgage default insurance. The insurance premiums are then included in the mortgage payments.

OPEN VS. CLOSED

Open Mortgage

An open mortgage offers maximum flexibility because you can make repayment of the principal amount at any time, without any penalty. The terms are usually more flexible than a closed mortgage. If you think you might want to pay off the full mortgage amount before maturity, you might want to consider getting an open mortgage.

Closed Mortgage

A closed mortgage is a commitment to make mortgage payments with a pre-determined interest rate, over a pre-determined period of time (called the “mortgage term”). In Canada the most common term durations for closed mortgage are 1, 3, and 5 years. If you want to fully pay off the mortgage before the term is over, you have to pay a penalty. Closed mortgage can have a fixed or variable / adjustable rate.

Because closed mortgages are less flexible, and you’re tied to more terms and conditions, the interest rates are usually lower compared to those of open mortgages. Most lenders allow borrowers to make a lump sum payment of up to 10%, 15%, or 20% of the original mortgage amount annually without having to pay any penalty. Some lenders also allow mortgage payment increases by a certain amount.

DIFFERENT MORTGAGE RATE TYPES

Fixed Rate Mortgage

In a fixed rate mortgage, the interest rate is pre-determined and stays constant throughout the duration of the mortgage term. Usually the time duration is between 1 and 5 years. With a fixed rate mortgage, the payments are more predictable. Borrowers benefit when interest rates are low and expected to rise over the length of the term.

Adjustable Rate Mortgage

Adjustable rate mortgage is reviewed at intervals and adjusted based on the prime rate at the time of review. Prime rate is the rate at which a bank’s optimal customers can borrow money. Monthly payment is impacted by this adjustment. If interest rate decreases, you benefit from the adjustment to a lower mortgage rate. However, taking on this type of mortgage means that there is risk that interest rate may go up.

Variable Rate Mortgage

With variable rate mortgage, the interest rate of the loan fluctuates based on the current prime rate. The difference compared to an adjustable rate mortgage is that your monthly mortgage payment can stay the same, but if interest rate rises, the amount of money that goes into paying off the original balance of the loan (the principal) decreases. This type of mortgage provides stability in terms of a consistent monthly payment amount, and is beneficial if interest rate falls (since more of your monthly mortgage payment amount will go towards the principal instead of interest).

OTHER MORTGAGE TYPES & TERMS

Convertible Mortgage

With a convertible mortgage, you can change the type of mortgage you hold during its term, without having to wait until term maturity. The interest rate of a convertible mortgage is usually lower compared to the interest rate of an open mortgage. You can start with an open mortgage and then change it to a closed mortgage, or from a variable rate mortgage to a fixed rate mortgage.

Hybrid Mortgage

When a single mortgage registration contains more than one type of mortgage, this is called “hybrid mortgage”. For example, a mortgage registration could include any combination of: fixed rate portion, variable rate portion, line of credit portion. This type of mortgage is geared more towards savvy borrowers who might want to use a hybrid mortgage as part of their overall financial plan and management. Different lenders offer different combinations of products that can be combined in a single mortgage registration.

Reverse Mortgage

Reverse mortgage is a special type of mortgage that allows home owners to convert their home equity into a lump sum payment or monthly cash payments. This is generally used for living expenses by home owners aged 55 years and older. The home owner’s equity is drawn down by the lender, and given to the borrower (home owner). The loan balance is due when the home owner passes away, or when the home owner no longer wishes to occupy the property as their principal residence. The loan balance is usually settled from the proceeds of the sale of the property.

Cash Back Mortgage

A cash back mortgage offers a percentage of the to-be-purchased property as cash up-front. This cash can be used for anything other than the down payment for the purchase of that property. The interest rate for cash back mortgage is usually high, and is only recommended if you are in urgent need of cash.

Collateral Mortgage

A collateral mortgage is a mortgage in which a lender loans money as the property value increases. The property acts as a collateral. With a collateral mortgage, you do not need to refinance your mortgage. The drawback is that if you fall behind on payments, the lender can raise the interest rate by as much as 10%.

Home Equity Line of Credit (HELOC)

You can use a HELOC to borrow money up to the amount determined at HELOC opening. The interest is tied to the prime rate, which can change at any time. HELOC can be used in conjunction with a mortgage, but it can also be used as a mortgage on its own for up to 65% of the property’s assessed value. A HELOC is quite flexible as most lenders allow you to pay as much of the loan as you would like, or make interest-only payments.