Home ownership may be one of the most pivotal goals in life, but like many things worth having, it isn’t always easy to attain. Most people would never be able to buy a home without a mortgage—something that allows you to purchase a property and pay it off over a long period of time.
In this guide, we’ll cover the basic definition of a mortgage, how mortgages work in Canada, and the various types of mortgages homeowners can get. We’ll also help you explain to your kids the potential risks they’ll need to consider when taking on mortgage debt. Hint: It’s a commitment, but it’s not impossible.
Key takeaways
- A mortgage works on an amortization period, which is a fancy way of saying a schedule. It’s the amount of time it will take someone to pay off the mortgage in full—or example, 20, 25, or 30 years.
- When making mortgage payments, an individual is paying off both the principal (the amount borrowed to buy the home) and interest (the price they pay to borrow money).
- An individual can choose a fixed-interest rate, with which the monthly payments will remain the same for the duration of the loan (usually reset every five years), or a variable-interest rate, with which payments may go up and down depending on the state of the economy.
- Typically, in the earlier phase of a mortgage, the majority of payments go toward interest. Later, the bigger portion will go toward the principal.
- Some mortgages allow the borrower to make extra payments on the loan so they can pay it off ahead of schedule.
How much money do you need to buy a house in Canada?
The figures as of July 2022 from The Canadian Real Estate Association (CREA) show that the national average home price is near $700,000. But if you live in Vancouver or Toronto, prices are more than $1 million.
While Canada’s booming housing market may have eased off a bit since earlier in the COVID-19 pandemic, the average home price in this country is still pretty daunting. Now, that doesn’t mean your teen needs to come up with $1 million (or more!) when the time comes in order to buy a house or condo. (Although here’s your opportunity to gently remind your teens—again—why savings goals and investing are so important.)
What is a mortgage and how does it work?
A mortgage is a special type of loan often used to buy a home or other property. It’s typically a large, secured loan that is paid off over many years. (More on this later.) A mortgage allows the lender, such as a bank, to take back the home or property if the borrower doesn’t keep up with their payments. The home or property acts like collateral, or a guarantee, for the money that’s being borrowed.
There are two parts of a mortgage that need to be paid over time: the principal and the interest. The principal is the initial amount borrowed to buy the house. The interest is the cost to borrow the money in the first place.
Read more about essential banking terms you need to know.
What is a down payment?
If your kid eventually wants to buy a house or apartment using a mortgage, they’ll still need to pay a good chunk of change up front. That’s called a down payment. (There are seriously no breaks in life!) The bigger the down payment, the less they’ll need to borrow in the form of a mortgage to pay for their dream property.
In Canada, the typical down payment required for a home is 20 per cent. If they have less than that, they could still apply for a mortgage, but they will need to get mortgage insurance. That means they have to pay an additional fee, which gets added to their monthly mortgage payments and protects the lender in case the homeowner can’t make their mortgage payments. That being said, if the home’s purchase price is $1,000,000 or more, mortgage insurance does not apply—i.e., your teen will need the entire 20 per cent.
In Canada, the absolute minimum down payment for any property worth up to $500,000 is five per cent. For example, if in the future your teen ends up buying a condo for $450,000, their down payment will be a minimum of $22,500. With a 20 per cent down payment, that number jumps to $90,000. (Right now, your teen might be thinking it could take years to save up enough cash from their weekly allowance, part-time-job payments, and babysitting money… and they’d be correct.)
How do you get a mortgage in Canada?
While it may sound overwhelming, the process of applying for a mortgage is actually pretty straightforward, and your teen could eventually even get pre-approved online. They’ll need to present a list of things to a bank or other lender, including proof of employment, pay stubs, and proof that they have enough money in the bank for their down payment and closing costs, such as land transfer tax (tax you pay to the province or territory), lawyer fees, etc.
Some experts suggest budgeting about 1.5 per cent of the house purchase price to cover closing costs. Going back to the example of your teen’s future pad, they’d need to factor in an additional $6,750 on top of the cost of a $450,000 condo.
They’ll also need to show how much debt they already have in the form of credit cards, car loans, student loans, or any other personal loans, and they may also need to show their monthly expenses. Lastly, their lender will be looking for a good credit score (which is that three-digit number that tells the credit bureau or bank how well someone handles their finances).
Read Credit reports 101: A guide for parents and teens to learn more.
Is there a minimum age to get a mortgage in Canada?
If your kid is over the age of 18 (a.k.a. a legal adult), they can apply for their own mortgage in Canada. In other words, even post-secondary students can apply for a mortgage, but whether or not they can afford it is a whole other story.
How much income will your kid need for a mortgage?
When your teen thinks about how much they can afford to spend on a mortgage, a good rule of thumb is that no more than 30–32 per cent of their total income should go toward their mortgage and housing costs. For example, if they’re making $55,000 a year (an average starting salary for a recent grad), a maximum of $1,500 should go toward their home each month. Aside from their monthly mortgage payments, this figure should include related housing expenses such as heating and cooling, property taxes, home insurance, and monthly maintenance fees.
Read Insurance 101: A guide for parents and teens to learn more.
What is the mortgage amortization period?
An amortization period for a mortgage is the total length of time it takes to pay off a mortgage. Tell your kid not to worry: It will probably take them decades, and that’s totally normal—roughly half of Canadian homeowners choose a 25-year amortization period.
If they have a longer amortization—say, 30 years—it usually means lower monthly mortgage payments. That’s a pretty sweet deal, right? The catch with having a longer amortization period is that they’ll ultimately pay more interest overall because they’re taking longer to pay back the initial loan.
If they choose an amortization over 25 years, they also must have a down payment of at least 20 per cent.
What types of mortgages are available in Canada?
We’re not done yet. Another thing to consider when thinking about purchasing a home is the different types of basic mortgages that are available. (Decision fatigue, anyone?) Here are some of the types on the market:
Open mortgage versus closed mortgage
The interest rate on an open mortgage is typically higher than it is on a closed mortgage, but it allows more flexibility if your kid plans to have extra money or savings to put toward their mortgage once in a while or they plan to sell their home in the near future. Closed mortgages limit the extra payments they can make. For example, their bank may cap any pre-payments at 10 per cent of the original mortgage principal each year. If that’s enough flexibility for them and they plan to stay in their home for the entire mortgage term, this might be a good option.
Standard mortgage versus collateral charge mortgage
A standard or conventional mortgage will provide your kid with a loan for the exact value of their house (minus their down payment). A collateral charge mortgage will provide them with up to 25 per cent more than the current value of their house. Why would they want to borrow more than they actually need? Maybe they want to decorate it with all the charming vintage furniture they found on Instagram, or maybe they want to renovate the kitchen and bathrooms if they’ve seen better days. A collateral charge mortgage allows them to have more financial flexibility without having to take out a new loan. While they only have to make payments on what they actually borrow, the downside is that on paper, it looks like they have more debt—even if they don’t use the extra amount. This may make it harder to borrow for other things, such as buying a car.
How much interest will your kids pay on a mortgage loan?
How much interest your kids end up paying on their mortgage loan will largely depend on what’s going on with the economy, including the Bank of Canada’s policy rate (which your kid has no control over), and what type of mortgage they get (which they do have some control over). They can choose between a fixed-rate mortgage and a variable-rate mortgage, and each has its pros and cons.
Fixed-rate mortgage
A fixed-rate mortgage has a locked interest rate for the full mortgage term, which is usually five years. This is the best type of mortgage for your kid if they don’t like to take risks and they want to know that their regular interest payments aren’t going to increase over the term of their loan.
Variable-rate mortgage
A variable-rate mortgage is typically lower than a fixed-rate mortgage, but it comes with a catch. The monthly payments may increase, like they’re doing in 2022, thanks to world events and higher prices on everything from food and gas to houses.
Still, this type of mortgage may be right for them if they’re comfortable taking risks and if they understand that their mortgage interest rate and monthly payments may swing. Variable mortgages tend to cost less over time compared with fixed mortgages, but it’s not guaranteed. Instead of saving money, they could end up paying more over the long term.
How do mortgage payments work?
As discussed above, each mortgage payment includes two parts: principal repayment (for the amount you borrowed) and interest (the amount the lender charges the borrower to keep carrying the loan). What many people actually don’t know is that in the earlier phase of paying off a mortgage, most of their payments go toward the interest. Yikes, right? But that’s normal—over time, the portion that goes toward interest will decrease while the principal portion increases, so one day your kid can pay it off entirely. (Can we get a woot woot?)
Another fun fact is that your kid can choose more-frequent payment options such as biweekly instead of monthly, which will save on interest in the long run because it equates to one extra payment per year. Extra one-off payments are also recommended because they go straight to reducing the principal and can help them pay their mortgage off faster. If they have an open mortgage and can spare a few hundred dollars every month, they can actually take years off a mortgage.
What are the risks of a mortgage?
Most people will have a mortgage at some point in their lives. In fact, it’s the most common type of debt in Canada. But that doesn’t mean it’s risk-free. (Here we go again with responsibility!) Even if your kid is eventually able to afford a mortgage, many different scenarios could throw all their plans out the window.
They could lose their job, decide to fulfill their dream of going back to school, go into debt, become ill or disabled, or even assume caregiver responsibilities. If they can’t make their mortgage payments on time (and in full), there are serious consequences, including penalty fees or defaulting on their mortgage (which is when someone fails to keep up with payments).
In that worst-case scenario, the bank can actually take possession of their property and sell it to recoup their losses, a process called foreclosure. Needless to say, any problems your kids have in paying their mortgage will hurt their credit score and make it difficult to borrow any money in the future.
Should a parent co-sign a mortgage for their children?
Most parents want to help their kids succeed and get ahead in life, but everyone’s situation is different. By co-signing a mortgage for them, you are essentially backing them up in case they can’t make their mortgage payments. On the upside, if you believe in your kid but they aren’t making enough money on paper to qualify for a mortgage, co-signing for them may be the only way for them to get approved.
The downside is that as a co-signer, you often don’t have any rights to the property but you’re ultimately on the hook for all of the debt—a massive responsibility! (But so was having a kid in the first place, right?) In many cases, helping them with a down payment might actually be a better idea. If they default on a mortgage, it could be a disaster for your own credit rating, savings, and retirement plans.
Mortgages may seem overwhelming, but the sooner your teen or tween can wrap their head around them, the better. This type of loan is the main path to home ownership for the majority of Canadians. It’s likely to be the biggest investment they’ll ever make but probably also the most rewarding.
If you want to raise money-savvy kids and help them reach this meaningful goal, it’s important to practise financial literacy and decision-making with them early on. Meanwhile, the Mydoh app can help kids and teens gain real-life experience by letting them manage their own money and save for what really matters to them.
Download Mydoh and help build the foundation of financial literacy for your kids and teenagers.
This article offers general information only and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or its affiliates.
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