How do mortgages work? Everything you need to know

For many Canadians, becoming a homeowner is a dream. Saving up for a house can take years of hard work and determination and will likely be the single largest purchase most people ever make. A mortgage is a financial tool that can help Canadians make the purchase of a new home possible.

Whether you're a first-time homebuyer or you're looking to take on an additional property, it's important that you understand what a mortgage is, how it works, and which options are right for you.

A mortgage is a loan that you borrow from a bank, credit union or private lender that can be used to finance the purchase of a home. It can also use equity in your existing home for other purposes.  It is a legal contract between you (a.k.a. the borrower) and the lender. A mortgage outlines the details of your loan, including your monthly payments, the length of your term, interest rate and other terms you need to know.  

When looking for a mortgage, you can compare a variety of options offered by different lenders. In addition to banks and credit unions, you can also consider getting a mortgage from an insurance company, mortgage company, trust company or a loan company. Who you pick will be based around which mortgage works best for you; beyond the mortgage rate, think about things like what length of the mortgage term, amortization period and payment schedule will work best for your financial plan.

After choosing a lender, you will then go through the pre-approval process to see if you qualify for a mortgage. While different lenders have different qualification criteria, the pre-approval process typically involves a review of the following:

• Assets- what do you currently own (cars, real estate)?
• Income - do you have a steady source of income and what you can afford?
• Debt - what kind of debt and how much?
• Credit history - do you pay your bills on time?
• Down payment - how much do you have saved for a down payment?

Before making a decision, be sure to speak with multiple lenders to ensure you are getting the mortgage product that is the right fit for you.

Before applying for a mortgage, it's helpful to know what type of mortgage product you're interested in. Some options include:

STEP. The Scotia Total Equity® Plan (STEP) is a flexible borrowing plan secured against your home. STEP lets you mix and match different kinds of Scotiabank credit products (like mortgages, a line of credit, credit cards and more) based on your needs, all with one easy application. Learn more about STEP. *

Open mortgage. An open term mortgage allows you to repay your mortgage at any time during the term without a prepayment charge (though there could be administrative fees that apply).  This can be a good option for those who are interested in paying off their mortgage as fast as possible. An open mortgage typically comes with an interest rate that is higher than one associated with a closed mortgage.

Closed mortgage. With a closed term mortgage, a prepayment charge applies if you want to repay it before the end of your term. Some closed mortgages do allow for prepayment privileges which permit a limited amount of extra money to be put towards your mortgage each year. The benefit of a closed mortgage is that it typically comes with a lower interest rate.

Portable mortgage. A portable mortgage is one that can be transferred from one home to another; it may allow you to keep your current interest rate, terms, and conditions. If you know that you are going to be moving in less that five years, this is an important option to keep in mind and include in your financial plan.

A mortgage can be low or high ratio. A low ratio mortgage is one where the down payment is equal to 20% or more of the purchase price of the home. A low-ratio mortgage typically does not require mortgage default insurance. A high ratio mortgage is one where the down payment is less than 20% of the purchase price. With a high ratio mortgage, mortgage default insurance will be required.

Your mortgage interest rate is the fee you will pay to the lender in exchange for borrowing money. The higher your interest rate, the more expensive your monthly payments will be. The interest rate offered to you can depend on several factors including:

• The type of lender you choose (e.g. bank, mortgage investing company)
• The specific lender you choose
• The current posted mortgage interest rate offered by your lender
• Length of Mortgage term
• Type of interest (e.g. fixed, variable)
• Your credit history
• If you are self-employed

When applying for a mortgage, there are different types of interest rates you can choose from including fixed and variable.

When getting a mortgage, you can choose between a fixed interest rate or a variable interest rate.

With a fixed-rate mortgage, your interest payments will stay the same for the entire duration of the term of the mortgage loan. Fixed mortgage rates can be higher than variable interest rates, but provide a consistent payment schedule over the term.

With a variable rate mortgage, your interest rate can increase or decrease throughout your mortgage as your lender’s prime lending rate fluctuates. This means that your payment amount can also fluctuate during the term. A variable-rate mortgage can have a lower interest rate than a fixed-rate mortgage.

The amortization period is the amount of time it will take to fully pay off your mortgage, assuming regular payments at a set interest rate. With a longer amortization period, you will pay lower monthly mortgage payments, but you will also pay more in interest.

A shorter amortization period will result in higher mortgage payments, but less money going to interest over time.

Regular amortization periods are 15, 20, and 25 years (30 is also available for uninsured mortgages). In Canada, 25 years is the longest repayment period permitted for those that require mortgage default insurance.

A mortgage term is the period of time over which the interest rate, payment and other mortgage conditions are set.  Mortgage terms typically range from 6 months to 10 years.  At the end of the term, the mortgage loan is due and payable unless it is renewed for another term.  The term is usually shorter than the amortization period.

There are many different kinds of insurance when it comes to your mortgage. Here are some of the different types and how they work.

A mortgage broker is a licensed professional who can help you navigate the mortgage process. They act as an intermediary between you and the mortgage lender. A mortgage broker can help you to identify the right mortgage product based on your financial situation. They can negotiate for the best rate on your behalf with a mortgage lender, help you with all necessary paperwork, and answer any questions that you might have throughout the mortgage process.

The mortgage lender you pick usually pays the mortgage broker’s commission, however, there are some scenarios where you may be responsible for the broker's fees. Be sure to have this conversation when interviewing different candidates and choose the broker with the experience and expertise that feels right for you.

Buying a home is complicated, and it’s a big help to have someone on your side to explain all the options. Your lender has experts in mortgages to walk you through the process, including advisors (this can be the advisor you work with on all your financial needs) and home financing advisors.

You can meet with an advisor at any stage of your home buying process – they will help you firm up a plan and guide you through all types of mortgages to match you with the right one for you and start the pre-approval process. 

They will continue to assist you throughout your time as a homeowner, helping you make sure your home continues to work well within your financial plan as your goals evolve over time.   

When trying to figure out the total cost associated with borrowing for a mortgage, you will need to know the annual percentage rate (APR).

The APR is the cost of borrowing charged on your mortgage loan each year expressed as an interest rate. The APR includes more than just interest. It is a combination of your interest rate, certain fees and extra charges that you must pay in connection with the mortgage loan.

You will also need to budget for the closing costs associated with purchasing a home. Closing costs are fees that are paid at the end of the real estate transaction and may include:

• Administrative fees
• Legal fees
• Home inspection fees
• Additional insurance (title insurance, property insurance)
• Property taxes
• Moving costs

There is no one best type of mortgage or mortgage rate. It's important to find the mortgage product and rate that is best for you.

If you would like help navigating and understand mortgage rates, you can discuss with an expert, like an advisor or home financing advisor, who can walk you through the process.

Remember that the mortgage rates offered to you by a lender will depend on a number of criteria including:

• Your credit score
• The length of your mortgage term (6 months to 10 years)
• The type of loan you choose (fixed, variable)
• The type of lender you choose (bank or credit union vs. private lender)
• The current prime and posted interest rate
• If you qualify for a discounted interest rate
• If you are self-employed

Buying a home is an exciting decision, with a lot of elements to consider. Make sure you are getting help from experts to guide you through the process, like your home financing advisor.