When you purchase a home with less than 20% down payment it is called a high ratio mortgage.
The “high-ratio” part refers to the ratio of the loan to the purchase price, also known as loan-to-value.
If there is less than 20% down payment on a purchase, an insurance premium is required.
The insurance premium gets added to the mortgage amount and paid over the life of the loan. Mortgage Insurance is there to protect the lender and not the client.
In Canada, there are three insurers that lenders use to offer high-ratio mortgage insurance and they are CMHC, Genworth, and Canada Guaranty.
An insurance premium is based on the loan to value so the lower the down payment, the higher the premium.
A high ratio insured mortgage in Canada can only be amortized to a maximum of 25 years. Uninsured mortgages (mortgages with 20% down payment or more) can have the amortization extended to 30 years.
Amortization is the total amount of time required to pay off the mortgage.
High-ratio mortgage example:
Let’s say you’re buying a $500,000 home. With a down payment of 10%, here are the numbers that matter:
Property Price (value): $500,000
Down payment: $50,000
Mortgage amount (loan): $450,000
In this example, your loan to value ratio is 9 to 10 (90%) which is considered a high-ratio mortgage.
The insurance premium added to the mortgage amount would be based on a 90% loan to value.
low-ratio mortgage example:
Let’s take the same example, but with a larger down payment of 25%.
Property Price (value): $500,000
Down payment: $125,000
Mortgage amount (loan): $375,000
Our new loan-to-value ratio is 3 to 4 (75%) which is considered a low-ratio mortgage.
Interest Rate: There is a difference in interest rates between insured high ratio mortgages and uninsured mortgages. Insured mortgages come with a lower interest rate.
This is because the lender feels the mortgage loan has less risk since the insurer will pay out the mortgage to the lender should there be a default.
A conventional mortgage, when a borrower has a higher down payment and less financing from the lender. You would think it would be less risky for the bank, however, should there be a default, the lender incurs all the expenses to foreclose while trying to collect their funds from the borrower.
With the latest rule changes from CMHC recently announced, here are some of the highlights:
• The Gross Debt Service (GDS) ratios must be under 35% of your gross income, down from 39%, no matter the credit score
• Total debt service (TDS) ratios must be under 42, down from 44
• Borrowers credit score must be at least 680, up from 620
• The borrowed down payments will no longer be allowed
Luckily, the other two insurers have decided not to follow CMHC’s new rule changes. This means those with a lower credit score still have an opportunity to buy a home.
Currently, Genworth Canada and Canada Guaranty offer GDS (Gross Debt Service) ratios of 39% to those with a credit score of 680 or higher and 35% for those less than 679.
Gross Debt Service (GDS) is 39% of your Gross Income used to qualify for a mortgage while Total Debt Service of 44% of your total income must include your mortgage payment, heat, property taxes, and other debts.
The bottom line
As with any changes to the mortgage application process, the best thing for you to do is understand the impact on your personal situation. For assistance, the best person to speak to is a mortgage professional, such as a mortgage broker.
Brokers are independent experts that can assess your situation to give you personalized, up to date advice and explain high ratio mortgages.