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A mortgage is a loan that can help you buy the perfect home. Here’s how they work, how to apply for one and what you need to get approved.
Mortgage negotiations can be overwhelming, especially for first-timers. If you’re wondering about mortgages—how they work, what types of mortgages exist, who can apply and how to get approved—you’ve come to the right place.
In its simplest form, a mortgage is a loan used to buy a home or property. Like other loans, each comes with its own interest rate, amortization (repayment) schedule and other terms. With a mortgage, the home itself is used to secure the loan. This means if the mortgage holder fails to make payments, the home could be repossessed by the lender.
Not all mortgages are built the same, so it’s important to find a mortgage that works for you and your situation. At the beginning of the application process, you should educate yourself about the following variables:
While it can vary, the basic steps to getting a mortgage are as follows:
A down payment is a lump sum that’s paid up-front on a property purchase. The higher your down payment, the less you’ll need to take out in the form of a mortgage. In Canada, the minimum down payment depends on the purchase price. For a home of $500,000 or less, it’s 5%. For homes between $500,000 and $999,999, it’s 5% on the first $500,000 and 10% on the rest. For homes selling for $1 million or more, you’ll need a minimum down payment of 20% of the purchase price.
You can get a mortgage pre-approval by visiting your lender and having them view your finances. They can then tell you how much they’ll lend you and at what interest rate—and those terms are locked in for a specified period of time.
Once you’re ready to take out a mortgage, you’ll need to prepare some documentation. Mortgage lenders will want to see your government-issued ID, proof of employment and income, documentation of your down payment and information about other assets and debts. After they’ve reviewed your financial situation, they will tell you how much they’ll lend you and on what terms.
A mortgage is a type of loan, secured with real estate, designed specifically to finance the purchase of a property. So, while all mortgages are loans, not all loans are mortgages.
Here are some of the key differences between a loan and a mortgage:
| Loan | Mortgage | |
|---|---|---|
| Definition | A financial agreement in which the borrower agrees to repay the lender the principal amount borrowed plus interest over a period of time. | A secured loan used to buy a home or property. The home itself is used to secure the loan. |
| Secured/Unsecured | Loans can be secured or unsecured. Whereas secured loans are borrowed against the borrower’s existing assets, unsecured loans do not require collateral. | All mortgages are secured loans in which the house or property is used as collateral. |
| Terms | Loans are often offered on shorter terms than mortgages, with most terms ranging from 6 months to 5 years. | In Canada, most mortgages have terms of five to 30 years. |
| Interest rates | Loans generally carry a higher interest rate than mortgages, especially when they are unsecured. | Mortgages typically carry a lower interest rate than personal loans. Several factors influence the interest rate, including the borrower’s credit score, income and other debts, and the type of mortgage (variable- or fixed-rate). |
| Amount available | In Canada, most personal loans range from $100 to $50,000. | The size of the mortgage depends on the price of the property and the size of your down payment. During Q2 of 2021, the average Canadian mortgage was $351,862. |
Your mortgage value is not the same as the listing price of the home you wish to buy but rather the purchase price minus the down payment. So, for example, if your home costs $500,000 and you have a down payment of 5% ($25,000), your mortgage would be $475,000. That amount is called your principal—or the base loan.
It’s important to remember that a mortgage is a loan, which means that on top of repaying the principal amount, you’ll also be responsible for interest payments over the repayment period. In fact, when you make a mortgage payment, only part of it goes towards the principal while some of it is applied to your interest.
Other possible expenses you should be aware of that are not included in your mortgage are taxes on the purchase, legal fees, title and mortgage default insurance. Mortgage brokers typically do not charge borrowers but rather receive compensation from lenders.
Watch: What is mortgage affordability?
Just like with other types of loans, eligibility for a mortgage will depend on your entire financial profile. These are some of the factors that lenders take into account:
Credit score: Your credit score takes into account factors like the length of your credit history, your payment history and the amount of debt that you’re carrying. Scores range from Poor (300 to 659) to Good (660 to 724), Very Good (725 to 759) and Excellent (760 to 900), and it is generally recommended that you aim for a score of at least 680 to receive competitive mortgage rates. A good credit score will not only help convince a lender that you’re a trust-worthy borrower, but it will also help get you lower interest rates.
Income: Those with steady, well-paid work represent less risk to lenders. If your work is low-paid or sporadic, you will likely need to have a higher down payment. Your interest rates might also be higher.
Assets and debts: Those with significant assets and insignificant debts are typically eligible for higher mortgages, often with lower interest rates.
Lenders want to work with people who already have assets and an established history of paying off their debts, they will reward these applicants with favourable interest rates and terms. The easiest way to make yourself more attractive to a lender is to build up your credit score by paying down your debts in a timely and regular fashion. Showing a healthy down payment and the assets to cover closing costs is also important.
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When I got my first mortgage one of the selling features was portability. What I did not know was that it is only the terms of the mortgage that are portable but a person has to re-qualify for the new mortgage. I am not the only one who got caught by this. Both a friend and I are stuck owning too much house, wanting to down size but cannot qualify for a new mortgage. So, even though it would make financial sense to move, we cannot.
The other thing about mortgages that I learnt too late is that when the renewal agreement was sent, if I had signed it right away, the new lower rate would have applied then and not from the renewal date several months later. I could have saved some interest. Not sure if all banks are like that.