What is a high-ratio mortgage?
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“You need at least a 20% down payment to purchase a home in Canada.” You’ve likely heard this before and might even believe it yourself. Spoiler alert: It’s not true.
I don’t know where that myth started or why it’s persisted, but I’ve had that conversation a handful of times with friends and family members wanting to purchase a home. It’s just too much to save 20% for a home, especially in pricey markets like Toronto, they say. And so many people go on with their lives renting, believing homeownership is nothing but a dream.
Well, I’m here to tell you that you can purchase a home with as little as 5% down in Canada with what is called a high-ratio mortgage. So, what is a high-ratio mortgage?
A high-ratio mortgage is a home loan greater than 80% of a home’s value. A conventional mortgage, which requires at least 20% down, is a loan of less than 80% of a home’s value (since you’re fronting 20% or more, which becomes your initial equity).
To put it in simpler terms, a high-ratio mortgage is a home loan you can get to purchase a home with as little as 5% down. That’s right, you can purchase a home with as little as 5% down. Read on to learn all about it.
Key components of a high-ratio mortgage
Loan-to-value ratio
Every mortgage has what’s called a loan-to-value (LTV) ratio, a simple measure of the percentage of a home that’s mortgaged (loan) compared to the overall value of the home (value).
It’s simple to calculate: Just divide the amount of your mortgage by the value of your home. So, if your home is worth $500,000 and your down payment is $50,000, you would have a loan-to-value ratio of 90%. You can calculate the LTV when purchasing a home and anytime after, as you make payments. Assuming the home value stays the same or increases, your loan-to-value ratio will shrink over the lifetime of your mortgage. And that’s a good thing – because it means you’re building equity.
It’s particularly important to understand LTVs when purchasing a home with a high-ratio mortgage. The nature of these types of mortgages (buying a home with a smaller down payment) means your LTV will be higher than if you were to purchase a home with a conventional mortgage. This means you’ll end up paying more interest over the life of the mortgage, since you’ve taken out a higher loan amount, than if you’d chosen to get a conventional mortgage.
CMHC insurance
CMHC (or the Canada Mortgage and Housing Corporation, if you want to get technical), is the federal housing agency for Canada. It provides mortgage insurance for high-ratio mortgages, among other things.
CMHC insurance (or another type of mortgage default insurance – more on that in a bit) is required for all high-ratio mortgages. What it does is insure the lender in the event the home buyer defaults on their mortgage payments. This is because high-ratio loans are considered riskier than conventional mortgages because homebuyers have less equity in their homes at the time of purchase.
To qualify for CMHC insurance, buyers need a minimum of 5% down, a good credit rating, stable income and low debt-to-income ratios. The home being purchased must also cost less than a million dollars and the amortization period must be no longer than 25 years.
Interest rate
The good thing about high-ratio mortgages is that its rates are typically lower than conventional mortgages, since it’s insured.
However, you’ll have to pay mortgage default insurance, which is typically lumped into your regular mortgage payments and paid off over the course of your mortgage. You can also pay the amount up-front, but coming up with that lump sum can be difficult for some buyers.
Using our earlier example of a $500,000 home purchased with a 10% down payment of $50,000, CMHC insurance would cost $13,950.
You can speak with a broker to compare high-ratio and conventional mortgages, but know that generally you’ll get a better rate with a high-ratio loan.
Mortgage type
For the most part, high-ratio borrowers can qualify for the same types of mortgages as conventional borrowers, with some small differences. You can get a high-ratio mortgage for all the different mortgage terms, ranging from 1-year to 10-years – your term is the contracted time you agree to a mortgage rate and its terms. A key difference, though, is that high-ratio mortgages only qualify for mortgage amortizations – the entire life of the mortgage – of up to 25 years. Conventional mortgages, meanwhile, can be amortized for up to 30 years.
Only you can figure out which mortgage is right for you. I recommend speaking to your financial planner about your financial situation and a mortgage broker to help you find the best loan for you.
Monthly payment
It’s a great idea to calculate your monthly payments before buying a home. Not all of us are math wizards, though, and if you’re like me you can barely add two plus two. Luckily, you can use our handy mortgage calculator to give you a hand.
Here are a few different scenarios for a $500,000 home.
| Home price | Down payment | Amortization period | Mortgage rate | Frequency | Payment amount |
|---|---|---|---|---|---|
| $500,000 | 5% | 25 years | 4% | Monthly | $2,507 |
| $500,000 | 10% | 25 years | 4% | Monthly | $2,375 |
| $500,000 | 20% | 25 years | 5% | Monthly | $2,338 |
| $500,000 | 20% | 30 years | 5% | Monthly | $2,147 |
Your monthly payment will depend on a few factors, including the amount you put down, the amortization period and the mortgage rate. Sometimes, with high-ratio mortgages, you’ll end up with higher mortgage payments even with a better rate – that’s because you’ve taken out a larger loan and are paying mortgage default insurance.
It’s important to play around with various mortgage options in the calculator before choosing a mortgage. Revisit your budget and see how much mortgage you can afford each month – that could help you decide whether a high-ratio or conventional mortgage makes more sense.
Mortgage payment remaining
Mortgages are a long-term commitment and each payment helps chip away at the principal amount you owe on the loan. At the end of the amortization period (more on that in a bit) you’ll own your home outright – yeah, you!
Before you get there, though, you’ll have to make a number of mortgage payments. Like, a lot. You may want to sit down for this one.
Let’s say you find your perfect home. You arrange your financing, get a great rate, close without a hitch and move in. A month later, your first mortgage payment is taken out of your bank account. Yep, things just got real.
It may not be top-of-mind when you first purchase a home, but there will be a lot more payments where that one came from.
Say you chose a high-ratio mortgage with an amortization period of 25 years. You’ve chosen to pay your mortgage monthly, since that’s what makes the most sense with your budget. That means you’ll be making 12 payments a year over the course of 25 years. Some quick math tells you that paying off your home will require 300 mortgage payments.
Now, before you panic, there are some things you can do to cut down on those payments. You can make additional payments over and above your monthly payments (though you’ll need to confirm with your lender if they allow prepayments – most mortgages allow them, but some don’t).
And, as you chip away at the mortgage, you’ll have fewer and fewer payments remaining.
After the first 10 years in your home, you’ll have 180 payments remaining. A better way of looking at it is that you’ll have made 120 payments so far!
And after 20 years, you’ll be down to just 120 payments left.
I dunno, did that make you feel any better? Probably not. But homeownership doesn’t come free, that’s for sure. And many people believe it’s better to make payments on your own mortgage than to rent and pay the mortgage payments for someone else. But, it’s a big decision to make – which drives home the importance of weighing the pros and cons not only of the type of mortgage you should get, but if homeownership is really even for you.
Comparison with conventional mortgages
High-ratio mortgages
The major difference between high ratio and conventional (low ratio) mortgages, is the amount of down payment required. With low-ratio mortgages, you can qualify for a loan with just 5% down. With a conventional mortgage, you’re required to put at least 20% down.
Both have their advantages and their disadvantages. Let’s take a look.
Pros
-
Lower interest rates
-
Lower down payment requirements – as little as 5% down
-
Allow you to enter the housing market sooner
Cons
-
Require CMHC insurance
-
Lower amortization
-
Not all properties qualify (must cost less than $1 million)
Conventional Mortgages
A conventional mortgage will require a larger down payment than a low-ratio mortgage. However, you can purchase pricer homes with a conventional mortgage and can take longer to pay your loan off.
Pros
-
Longer amortization periods
-
No CMHC insurance required
-
Can be used to purchase homes that cost more than $1 million
Cons
-
Higher interest rates
-
Higher down payment requirements – require 20% down
-
May delay your home purchase
Mortgage insurance
Default insurance
As mentioned, mortgage default insurance is required for all high-ratio mortgages. It’s a type of insurance that protects lenders by guaranteeing that they will receive the outstanding balance of the mortgage loan if the borrower defaults and the property is sold at a loss.
It’s paid for by the borrower – though it’s important to note that it offers no protection for the borrower, just the lender.
The cost is based on the size of the mortgage and is offered by three companies in Canada.
Mortgage insurance providers
There are three mortgage default insurance providers in Canada: CMHC (which we’ve already covered), Sagen and Canada Guaranty. All offer the same type of insurance, though CMHC is the most popular. The main difference is that CMHC is government held, while the other two are private. Whichever you choose, your lender will arrange mortgage default insurance for you. If you’re unsure which one is right for you, your broker can give you some direction.
Factors affecting high-ratio mortgages
Purchase price
The purchase price of a home is an important factor when considering between a high-ratio and conventional mortgage. That’s because high-ratio mortgages are only available for homes that cost less than $1 million. If you’re interested in purchasing a home that’s listed for more, you’ll either have to offer less than the asking price, choose a conventional mortgage or find a different home.
Every home purchase is negotiable, so don’t be afraid to speak to your real estate agent for advice on making an offer below asking – assuming you’re dead set on a high-ratio mortgage and the home you’re looking to buy comes close to the $1 million threshold.
Amortization period
The amortization period is the amount of time it takes to pay off an entire loan. Don’t confuse it with the mortgage term, though: The term is the amount of time you agree to a certain set of lending terms (like the mortgage rate).In Canada, the most popular mortgage term is five years; the most popular amortization period is either 25 years or 30 years. A simple way to think about it is that the amortization period is made up of a number of different mortgage terms.With high-ratio mortgages, the maximum amortization period is 25 years. With a conventional mortgage, you can choose to take longer to pay the loan off since the maximum amortization period is 30 years. There are advantages and disadvantages to longer amortization periods, such as lower mortgage payments (since you can spread the loan out). However, keep in mind that you might have to pay more in interest for a longer loan.
Conclusion
That was quite the crash course in high-ratio mortgages, wasn’t it? I’d say you’re now a certified know-it-all – or, at the very least, have a better idea if you’re better suited for a conventional or high-ratio mortgage loan.
Remember, the best thing you can do before buying a home is to speak to your financial advisor (if you have one), update your budget and crunch the numbers of a potential home purchase with a mortgage calculator. Good luck and happy house hunting.
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