How Does a Mortgage Work in Canada?

About 66% of Canadian households own the home they live in, according to the 2021 Census, and Canadians had more than $1.5 trillion in outstanding mortgage balances on those homes as of November 2024.[1] Despite the widespread use of mortgages, these types of loans can be tough to comprehend.

If asked to explain how a mortgage works, you might say: “A bank lends you money to buy a home, and you repay it, with interest.” That description isn’t wrong, but there are many other important variables that affect the experience of applying for, obtaining and repaying a mortgage. Having a good grasp on how mortgages work allows you to make better decisions about the mortgage that’s right for you.

Mortgage basics

A mortgage is a loan that’s specifically used to purchase real estate. You must bring some cash to the table — the down payment — but you’ll likely need a mortgage from a financial institution or private lender to cover the balance. Key components of any mortgage include:

Loan amount (principal): The sum you borrow to buy your home.
Repayment period (amortization): The amount of time needed to repay the entire loan amount — 25 years is common.
Interest: The fee lenders charge for lending money. The mortgage interest rate you agree to determines the amount of interest you pay.
Mortgage payment: The amount you regularly make to the lender to repay the loan, plus interest. Mortgage payments often include property taxes, home insurance and mortgage insurance. This is usually a monthly payment, but some lenders offer other cadences, such as biweekly.
Mortgage length (term): The amount of time a specific mortgage contract remains in place — five years is most common. When the term is up, you’ll renew your mortgage, which means agreeing to a new mortgage contract for the remaining principal. A mortgage renewal means a new set of terms, including interest rate.

Key takeaway: You’ll likely agree to several different mortgage contracts during the life of your loan. The terms that work best in one instance may not be the best the next time around.

How mortgage interest rates work

Interest is the cost of borrowing money. Instead of charging a flat dollar-amount, like you’d see on a price tag at a store, lenders calculate the cost with interest rates. The interest rate is applied to the amount you borrow, so if either number increases, you’ll pay more in interest. For example, let’s say the current interest rate is 5%. That means you would pay $5 for every $100 borrowed. This is a very simplified answer as other factors come into play when calculating interest, but you get the idea.

How lenders determine your mortgage interest rate

When you shop for something at a store, the price you see for an item is typically the same for anyone shopping there. However, when you shop for a mortgage, the price or interest rate varies from person to person. That’s because lenders consider risk, or your expected ability to repay the loan, when they offer you an interest rate.

To determine your risk level, lenders consider a range of factors, including your credit score, income and any other debt you have. If your application shows markers of lower risk, you’ll likely be offered lower rates.

There’s one additional factor to consider: The interest rate that banks pay to borrow money, called the prime rate, underpins the rates it offers customers. When a bank’s prime rate drops, the rates it offers drop, too. When it rises, as we saw in 2022 and 2023, rates rise. The upshot is that a person with mediocre credit in a period of low prime rates might get a lower rate than a person with great credit who takes out a mortgage when prime rates are high.

Key takeaway: Trying to predict interest-rate movement can lead to disappointment. Instead, to ensure you get the best possible rate, focus on what’s in your control: Your credit score, income, other debt and down payment savings.

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What happens to your interest rate after you sign a mortgage?

When getting a mortgage, you have two options: agree to pay a set rate for the entire mortgage term or pay whatever the prevailing rate is from month to month.

	Fixed rate	Variable Rate
Interest rate details	Your rate is locked for the entire mortgage term, even if market rates change.	Your rate adjusts if market rates change.
Pros	Your mortgage payment is dependable.	If rates fall during the mortgage term, your interest payments decrease.
Cons	If market rates fall, you don’t benefit.	If rates rise, you’ll pay more in interest.

Rules about paying your mortgage off early

There are multiple reasons you might want some flexibility in your mortgage contract. Here are two:

You’re expecting an inflow of cash during your mortgage’s term and want to be able to pay off some or all of your mortgage.
You want to renegotiate your mortgage.

Most homeowners have closed-term mortgages, which don’t have much flexibility. If you pay off your mortgage beyond a predetermined limit, you’ll pay penalties.

If you want repayment flexibility, look for an open-term mortgage. These allow you to repay your mortgage without penalty. This flexibility does have a cost, though: Open mortgages have higher rates than closed mortgages.

Mortgage contracts: How long they last

Your mortgage term is how long the contract with your mortgage lender lasts. Most people go with a five-year term, but terms can range from one to 10 years. A longer term usually costs more, but the rate you get is locked in for longer. A short term is appealing for the lower rates, but when your term is up, you’ll need to renew at whatever the rates are at that time.

Don’t confuse your term length with amortization. Amortization is the total time needed to pay off the entire mortgage principal — a length of time that’s likely to span multiple mortgage contracts. Most new homeowners get a mortgage with an amortization period of 25 years. New government rules have made 30-year amortizations available to more people, especially first-time buyers, but it’s unclear whether these changes will make home ownership more affordable.

Key takeaway: Focusing on the lowest available rate isn’t always the best choice when it comes to choosing a mortgage term. Sometimes other factors, like term length, matter just as much. For example, when rates were at historic lows, locking in a longer term could have been a great choice, even if the rate was a bit higher compared to shorter terms. Conversely, if your credit score is high enough to be approved for a mortgage but not good enough for the lowest rates, you might opt for a shorter term in hopes of improving your financial profile and securing a better rate later. Work with your lender or broker to understand your options.

Getting approved for a mortgage

To get approved for a mortgage, a lender will focus on:

Your credit score. Lenders want to ensure that you’re creditworthy.
Down payment savings. You need to have at least 5% of the purchase price saved to qualify for a mortgage.
Secured income. A letter of employment proves that you have a steady income and will be able to keep up with mortgage payments.
Other debt. If you have student loans, a car payment or other forms of debt, you will have less flexibility to make mortgage payments.

If your financial situation has any red flags — a low credit score or an inconsistent income history, for example — you may still have mortgage options.

🤓 Nerdy Tip: If you’re looking into mortgages for the first time, look at lenders that offer easy online pre-qualification. Getting pre-qualified will help you estimate what kind of mortgage and loan amount you could be approved for. Pre-qualification is non-binding and doesn’t affect your credit score. Before you begin making offers on homes, you’ll want to get pre-approved.