How Canadian Mortgages Work

Summary

Canadian mortgages differ from other markets in three important ways: interest compounds semi-annually (not monthly), terms are typically 5 years (after which you renew at current rates), and high-ratio mortgages require CMHC insurance. The average 5-year fixed rate is around 3.69%, and the national average home price is approximately C$652,941.

How it works

Semi-annual compounding

By law, Canadian fixed-rate mortgages compound interest semi-annually, not in advance. This means the lender calculates an equivalent monthly rate from the semi-annual rate before applying it to your payments. The effective monthly rate is:

Monthly rate = (1 + annual rate / 2)^(1/6) - 1

This produces a slightly lower monthly payment than monthly compounding at the same nominal rate.

CMHC mortgage insurance

If your down payment is <20% of the purchase price, you must purchase mortgage default insurance from CMHC, Sagen, or Canada Guaranty. The premium is a percentage of the loan amount, added to the mortgage principal:

Insured mortgages are capped at a maximum 25-year amortization. Uninsured mortgages (20%+ down) can amortize up to 30 years.

The stress test (B-20 guidelines)

All borrowers must qualify at the higher of the contract rate + 2% or the Bank of Canada’s qualifying rate (currently 5.25%). This ensures affordability even if rates rise at renewal.

5-year terms

Canadian mortgages are typically 5-year terms within a 25- or 30-year amortization. At each renewal, the rate resets to market conditions. This is fundamentally different from a US 30-year fixed or a UK 2-year fix.

Worked example

C$652,941 home, 20% down payment, 3.69% fixed for 5 years, 25-year amortization:

1. Down payment: C$652,941 x 20% = C$130,588
2. Loan amount: C$652,941 - C$130,588 = C$522,353
3. Semi-annual equivalent monthly rate: (1 + 0.0369/2)^(1/6) - 1 = 0.003051 (0.3051%/month)
4. Number of payments: 25 x 12 = 300
5. Monthly payment: C$522,353 x [0.003051 x (1.003051)^300] / [(1.003051)^300 - 1] = C$2,665
6. Total interest over 25 years: (C$2,665 x 300) - C$522,353 = C$277,147
7. Balance remaining after 5-year term: approximately C$436,900 (to be renewed)

Key differences from other markets

• Semi-annual compounding is unique to Canada. The US and UK use monthly compounding, which results in slightly higher payments at the same nominal rate. At 3.69%, semi-annual compounding saves roughly C$5-10 per month on a typical mortgage.
• Mandatory renewal every 5 years exposes Canadian borrowers to interest rate risk that US 30-year fixed-rate holders avoid entirely. However, it also means Canadians benefit more quickly when rates fall.