For example, a high ratio borrower today can score a five year fixed rate mortgage for 2.99%, very easily. While a buyer whose mortgage is not insured will see her rate quotes starting at 3.39%.
Similarly, our high ratio buyer can score a five year variable rate mortgage for 2.3% quite easily, whereas the uninsured borrower may be quoted rates starting at 2.70%.
It seems counter intuitive that the buyer with the smaller down payment (and therefore the riskier borrower) would benefit from lower rates, doesn’t it?!
You probably know that borrowers with less than 20% down payment must purchase default insurance – commonly referred to as “CMHC insurance”. CMHC is short for Canada Mortgage Housing Corporation, a branch of the federal government.
CMHC is not a monopoly however. There are two other mortgage insurers – Genworth Canada and Canada Guaranty. Most lenders align to one or two of these three.
So when this insurance is purchased, there is no repayment risk to your mortgage lender. No matter what happens – even if you do a runner, they WILL get paid.
But when there is no insurance component, your lender assumes the risk you could default; albeit it’s a very small risk – Canadians are very reluctant to walk away from their homes.
This insurance premium is no small thing. If you have less than ten percent down payment, it’s four percent of your purchase price! So if you buy a condo for $500,000 and you put down $25,000 – you will pay $20,000 in one time insurance!
This gets added to your mortgage loan so in fact you would start out with a mortgage of $495,000 against a home with a market value of $500,000. Yes, you can see why this is risky.
On top of the insurance cost, you also pay PST on the premium, and that comes from your own pocket, and is not included in the mortgage. At 8%, that is another $1,600 added to your closing costs.
Here is a link to CMHC’s insurance premium tables
Okay so that’s not so hard to understand after all is it? Where it might get confusing is that some mortgages are insured even when they are not high ratio!
A good example might be a self employed borrower who cannot verify her income in a traditional manner, and thus relies on other measuring criteria to determine the suitability of the mortgage. Her lender will insure this mortgage even up to a 35% down payment, and the borrower will typically pay this premium.
With an even larger down payment, the mortgage might still be insured, but chances are the borrower is oblivious to this since lenders almost always absorb the insurance cost themselves when the buyer has this much “skin in the game.”
Refinances can no longer be insured. So we go back to a higher rate structure in these cases, because the lender will bear the risk of the buyer defaulting – no matter how small that risk actually is.
There you have it. Whether you are a dreamy-eyed first time buyer, up-sizer or down-sizer, it pays to know how every cent of your down payment factors in.