What is a high-ratio mortgage?
Thinking of buying a home? Whether you're combing the Toronto Multiple Listing Service or homes for sale in Calgary or Vancouver, you've likely crunched a lot of numbers to determine your maximum affordability. Household income, monthly bills, long-term financial goals and existing debt obligations are all important considerations to take into account at this stage.
However, there's another factor that can make a big difference in your buying budget: the size of your down payment. How much money do you plan to pay upfront towards your new property, and how much will be borrowed as part of your mortgage?
High-ratio or low-ratio mortgage?
In Canada, buyers must pay a minimum of 5% down on a home priced at $500,000 or less, which jumps to 10% for any portion of the home price over $500,000 and up to $1 million. Homes over the million-mark require at least 20% down.
Any home purchase where less than 20% down is paid requires a "high-ratio" mortgage. This refers to the fact that the borrower has a high loan-to-value (LTV), with 80% to 95% of it mortgaged, and only 5% to 20% of equity paid into the property. A home purchase with more than 20% down is referred to as "low-ratio."
What is mortgage default insurance?
From a lender's perspective, a high-ratio mortgage is considered to be higher risk, since homeowners who buy at the top of their budgets and hold less equity are more likely to default on their loan. For this reason, mortgage default insurance is required for high-ratio mortgages. This insurance coverage protects the financial interest of the lender in the case the borrower can no longer make their mortgage payments.
Mortgage default insurance is offered by one of three institutions: The Canada Mortgage and Housing Corporation (CMHC), and two private insurers: Genworth and Canada Guaranty. Because CMHC is the largest provider, and a taxpayer-backed Crown corporation, mortgage default insurance is also commonly referred to as just CMHC insurance. Your application for insurance will be submitted during the mortgage qualification process and will be one of the conditions that must be satisfied before the lender will provide home financing.
Typically, premiums for mortgage default insurance are paid by the borrower. The premiums are usually rolled into the mortgage amount and spread over its amortization, meaning a portion of your overall monthly payments goes toward your coverage.
Insurance premiums increase based the size of the borrower's LTV, and are set by the CMHC. You can find the current premiums here. These premiums can change over time.
Generally, the larger your down payment is, the less you'll need to shell out in insurance premiums, reducing your overall mortgage costs and resulting in money saved over time.
How much will you pay for a high-ratio mortgage?
As an example, according to the CMHC's premiums calculator, a buyer purchasing a $500,000 home, putting $25,000 (5%) down, amortized over 25 years would need to pay an additional 4%, or $19,000, in insurance premiums over the life of the mortgage.
Upping that down payment to $50,000 (10%) would reduce premiums to 3.10% of the total mortgage cost, totalling $13,950 over the course of the mortgage – a difference of $5,050. Of course, putting a full 20% down ($100,000) would remove this additional cost from monthly payments altogether.
You can find the CMHC premium calculator here.