What is a High Ratio Mortgage?
A high ratio mortgage is a loan for more than 80% of your home’s purchase price.
If you contribute a down payment of less than 20% toward your property, you’ll be obtaining a high ratio mortgage from your lender.
High Ratio Mortgages vs Conventional Mortgages
Here’s how a high ratio mortgage compares against a conventional or low ratio mortgage, which requires a down payment of at least 20% of a property’s selling price:
|High Ratio Mortgage||Conventional Mortgage|
|Down Payment||Less than 20%||20% or higher|
|Mortgage Loan Insurance||Required||Not required|
|Mortgage Interest Rate||Low||High|
|Maximum Home Price||$1,000,000||No limit|
|Maximum amortization period allowed||25 years||35 – 40 years (depends on lenders’ policy)|
If you put down less than 20% of your home’s selling price, your mortgage automatically becomes a high ratio or nonconventional mortgage.
The gap in down payment size between a high ratio and conventional mortgage can be substantial.
For example, let’s assume you’re looking to buy a home with a listed price of $800,000.
You must put down a minimum payment equal to 5% of the first $500,000 and 10% on the remaining balance by law.
This means you’ll need to make an upfront payment of $55,000 ($500,000 x 5% + $300,000 x 10%).
In contrast, if you wish to contribute the bare minimum of 20% to be eligible for a conventional mortgage, you’d need to save up $160,000, which is about 3x more.
You must present proof of your down payment for a home purchase, and the funds must originate from a permitted source, such as a Tax-Free Savings Account.
Mortgage Loan Insurance
An essential aspect of a high ratio mortgage that distinguishes it from its low ratio counterpart requires you to purchase mortgage loan insurance.
The role of mortgage loan insurance is to compensate your lender for the loss they may incur if you default on your mortgage payments.
Mortgage Interest Rate
In general, lenders set lower mortgage rates on high ratio mortgages than conventional mortgages.
At first glance, this practice may seem counterintuitive.
Why would a lender assign a higher rate to a borrower who requires less financing than one who needs substantially more?
The reasoning from lenders’ perspective is that a conventional mortgage typically lacks mortgage loan insurance, which increases their risk each time they issue one.
Should a default occur, the lender must personally absorb any financial loss rather than collect an insurance payout.
High Ratio Mortgage Insurance
There’s no avoiding mortgage loan insurance if you apply for a high ratio mortgage.
As discussed above, mortgage loan insurance acts to protect your lender against the risk of you defaulting on your payment obligations.
If you fail to service your mortgage debt, your lender can legally repossess your home and sell it to cover their loss.
However, if they receive less than the existing mortgage principal through the sale, the insurer will reimburse them for the difference.
Even though mortgage loan insurance acts to protect the lender, you’re responsible for paying for it.
In Canada, a well-known issuer of this insurance product is the Canada Mortgage and Housing Corporation (CMHC).
According to the CMHC website, mortgage loan insurance is calculated as a percentage of your total mortgage.
The rate that applies is based on your loan-to-value ratio (LTV), which measures your mortgage size relative to your home’s purchase price.
As an example, suppose you need mortgage financing for $450,000 for a home after putting down $40,000.
In that case, you’d determine your mortgage insurance premium as follows:
LTV ratio: $450,000 / $490,000 = 91.83%
Applicable insurance premium rate based on LTV ratio: 4.00%
Mortgage loan insurance premium: $450,000 x 4.00% = $18,000
Mortgage loan insurance providers charge the highest premiums for a zero-down payment mortgage.
Pros of a High Ratio Mortgage
There are numerous benefits associated with a high ratio mortgage.
Less Money is Needed for a Down Payment
Saving for a down payment can take a long time, and for some homeowners, amassing a vast sum of money isn’t financially feasible.
If this describes you, opting for a high ratio mortgage is more sensible.
Even if you managed to stockpile a hefty sum of cash, it might be more prudent to invest a portion of it in assets like stocks and bonds.
These investments may yield lucrative returns over the long run.
For example, suppose you’ve accumulated $95,000 to put toward a home with a selling price of $475,000, meaning you’d need financing for $380,000.
You choose a five-year fixed-rate mortgage at 1.90% over 25 years.
However, let’s say you also have the option of putting down 5% ($23,750) and allocating the excess funds to an investment that earns 2.5% annually.
Here’s how the two scenarios play out after 25 years:
|High Ratio Mortgage||Low Ratio Mortgage|
|Down Payment||$23,750 (5%)||$95,000 (20%)|
(including CMHC insurance)
|Total Interest Costs||$93,461 (1.5%)||$97,251 (1.9%)|
|Invested instead of using for Down Payment||$71,250||$0|
|Investment Value after 25 years
(2.5% earn rate)
As you can see, investing your funds instead of putting 20% down can prove to be a valuable strategy over an extended period of time.
In both cases you own the home and benefit from 100% of it’s appreciation in value.
You Can Purchase Your Home Sooner
By contributing a down payment of as little as 5% of your property’s purchase price, you can settle into your ideal home sooner rather than later.
Closing a property deal with a small down payment will enable you to get a head start in building up valuable home equity.
Access to Lower Rates
Since high ratio mortgages come with mortgage default insurance, your lender will generally offer you a lower interest rate.
As a result, you’ll realize savings in interest charges over the life of your mortgage.
Cons of a High Ratio Mortgage
Despite how tempting a high ratio mortgage can be, there are some drawbacks to ponder over, as well.
Mortgage Loan Insurance
Mortgage loan insurance accompanies all high ratio mortgages – there’s no way to bypass this extra expense.
You can choose to pay for the insurance premium upfront or combine it with your mortgage principal and pay it off over time through your regular payments.
While the amount may seem trivial, adding this extra item to your mortgage increases your total payments, even if you secure a low-interest rate.
Here’s an example that shows the difference in interest costs over 25 years on a home purchased for $475,000.
|High Ratio Mortgage (5% down payment)||Low Ratio Mortgage (20% down payment)|
|Five-year fixed interest rate||1.50%||1.90%|
|Total interest costs||$93,462||$97,251|
As you can see, the interest savings amount to only $3,789.
Expensive in the Long Run
While a high ratio mortgage allows you to acquire your home earlier, a larger mortgage with a CMHC premium at a lower interest rate may negate any savings you think you may be getting at the lower rate.
Limited Amortization Options
The maximum amortization period permitted in Canada for a high ratio mortgage is 25 years.
Conversely, lenders can approve low ratio mortgages with amortization schedules spanning 35 to 40 years.
A longer time frame enables you to pay down your principal over more years, providing you with flexibility in managing your monthly cashflow.
Frequently Asked Questions
- Why are high ratio mortgages cheaper?
High ratio mortgages offer favourable interest rates because they require the borrower to purchase default insurance.
The presence of default insurance alleviates much of the default risk a lender assumes when they issue a mortgage. Thus, with lower risk, they offer lower interest rate to borrowers.
- What is considered a high ratio?
A high ratio mortgage applies to home purchases where the borrower submits a down payment of less than 20%.
- Is it better to get a high ratio mortgage?
There’s no right or wrong answer when choosing between a high or low ratio mortgage. It depends on your personal and financial goals.
A high ratio mortgage is ideal if you’re keen on acquiring a property soon, but your financial circumstances preclude you from saving for a sizeable down payment.
While you’ll likely secure a lower rate on a high ratio mortgage, keep in mind that the larger mortgage and added expense of mortgage default insurance may offset much of the cost savings of the lower interest rate.