When it comes to finances, most Canadians have the same two goals: buy a home and get out of debt. And it can feel like working towards one of those goals makes the other even harder to reach.
That’s where a high ratio mortgage often comes into play. In simple terms, a high ratio mortgage is one you have less than 20% equity in your home. High ratio mortgages are also referred to as “insured” mortgages.
What is a high ratio mortgage?
In Canada, if you have less than 20% as a down payment for a house purchase, you’ll need a high ratio mortgage. For example, let’s say you found the perfect home for your family and it’s priced at $450,000. You have $67,500 saved for a down payment, which is 15% of the purchase price. You’ll need a high ratio mortgage.
Lenders consider a high ratio mortgage risky. If the homeowner stops making mortgage payments, and the lender forecloses (takes back ownership of the house), the lender might not be able to re-sell the house for the amount of the mortgage, and they risk taking a loss.
Mortgage default insurance
In Canada, home buyers with high ratio mortgages must purchase mortgage default insurance as part of the home buying process. Typically, insurance protects the purchasers. When you buy car insurance or health insurance, it protects you from unexpected costs. Mortgage insurance is different.
Mortgage insurance protects the lender—not the home buyer—from losses in case of default and foreclosure. That’s why it’s also called mortgage default insurance. There are three institutions you can purchase it from: Canada Mortgage and Housing Corporation (CMHC), Genworth, and Canada Guaranty. CMHC is the biggest and best-known mortgage insurance provider.
If you are offering less than 20% as a down payment for a house, you must apply for insurance when you apply for a mortgage. The lender cannot approve your application without it. Just like making monthly payments on your car insurance, you can include the payments for your mortgage loan insurance in your total mortgage payment.
Advantages of a high ratio mortgage
A high ratio mortgage allows individuals and families the chance to own their own home and step onto the property ladder with less money down. With this mortgage, you can buy a property starting at 5% down, and not necessarily pay a higher interest rate than someone putting 25% down. Considering the price of property, it’s often the only way a family can afford to buy a home.
And, there are ways to reduce the amount you have to pay in mortgage loan insurance. The greater the amount of the down payment, the less the amount of the insurance. This is set by CMHC. For example, if you put 5% down on a $500,000 house, your mortgage insurance is $19,000. But if you put 10% down, that insurance drops to $13,950.00.
Another way to pay less mortgage loan insurance is to purchase an energy efficient home. If the home meets efficiency standards, or if you will build or renovate a home to meet these standards, you can receive a premium refund of 15% to 25%. That puts thousands of dollars back in your pocket—in addition to the savings you’ll see from the costs of heating and cooling your efficient home!
High ratio mortgages can also have lower rates than conventional mortgages. This is because mortgages that have default insurance provide more assurance to the lender that they’ll get their money back, allowing the lender to give you a lower rate.
Disadvantages of a high ratio mortgage
A big disadvantage of a high ratio mortgage is that it can cost more over the long run. In our example above with the $500,000 purchase, the additional cost is $19,000. That’s a lot of money, especially since people who take this option are choosing it because of the difficulty in saving more for a down payment. And you’ll be charged tax on your insurance, which you must pay out right when you pay your closing costs.
High ratio mortgages also put personal assets at risk. Unlike a conventional mortgage (with a down payment of 20% or more), if someone with a high ratio mortgage defaults, the lender can pursue any assets the home buyer has to recoup the full value of the loan.
If you have a high ratio mortgage and you sell your home for less than you bought it, you may not have enough money to repay the mortgage—especially once all the selling fees add up. Some sellers try to avoid this by assigning the current mortgage to the new owner. If this mortgage includes a high ratio mortgage, both parties (the seller and the buyer) can be pursued by the lender if the new owner defaults. This power even reaches to legally separated spouses.
While a high ratio mortgage allows people to purchase a home they might otherwise never be able to own, it comes at a cost that you should be mindful of.