How do you know if you need a high ratio mortgage?

If you’re buying a home, you’ve likely heard the term “high ratio mortgage”. Are you wondering whether it applies to you, and what it means financially?

Look at your down payment

Simply put, a mortgage is usually considered to be “high ratio” if your down payment is less than 20% of the purchase price of your home.  You can potentially get a mortgage for up to 95% of your home’s price. Any mortgage that’s more than 80% of the purchase price is a high ratio mortgage.

So, what is the financial implication of going high ratio?

If you have less than 20% down, your mortgage lender will require you to get mortgage default insurance.  This type of insurance is to protect the lender.  Basically it provides the lender with additional security. So, if you can’ t pay the mortgage at some point, the lender gets the mortgage paid back by the insurer. This security allows lenders to offer home buyers excellent interest rates, even though smaller down payments mean the mortgage is riskier, since there’s less equity in the property.

Is there a cost for a high ratio mortgage?

Yes, there is.  If you have less than 20% down, you’ll need to pay the premium to the default insurer.  It’s based on a sliding scale – the lower your down payment, the more expensive your insurance will be.  You can check out the premium tables at CMHC, Sagen, and Canada Guaranty, Canada’s three default insurers, to get the latest breakdown.

How does the default insurance get paid?

The premium for the default insurance gets added to your mortgage; you don’t have to pay it up front.  Your mortgage payment will increase a bit.  For example, if you’re buying a $500,000 home, and have a five year rate of 2.59% on your mortgage, here’s how it plays out:

If your down payment is $25,000, or 5% of the purchase price

• Insurance premium is 4% of the mortgage amount
• Monthly payment increases by approximately $77 per month

Your down payment is $50,000, or 10% of the purchase price

• Insurance premium is 3.1% of the mortgage amount
• Monthly payment increases by approximately $48 per month

If your down payment is $75,000, or 15% of the purchase price

• Insurance premium is 2.8% of the mortgage amount
• Monthly payment increases by approximately $35 per month

(Note: all of the above examples are based on a 25 year amortization, which is the maximum allowed for high ratio mortgages at this time.)

Should you wait to save up a bigger down payment?

That depends.  I believe it’s important to fully explore your mortgage plan and financial resources, so that you can understand whether you should buy now or wait.  In the Toronto market, waiting to buy, over the last few years, has meant more for your home for each year you wait.  According to the Toronto Real Estate Board, the average price of a condo in Toronto increased by 7.6% in April 2016 versus April 2015; prices for townhomes, semi-detached and detached homes went up even more.  In that scenario, waiting to save up a bigger down payment to avoid paying 2.8% – 4% for default insurance may not make sense, since instead you may have to pay more for the home you want, each year you wait.

Obviously, no one can predict whether the Greater Toronto Area real estate market will continue to grow at these levels.  So, when I discuss this with my clients, the question we explore is:

Are you financially ready for home ownership?

You need to understand what the financial scenario looks like, if you buy now, versus waiting to buy in a year or longer.  That way, you can be comfortable that you are making an informed choice, either way.

More questions?

Feel free to get in touch with me – I’m happy to help!

Photo [c] sasirin pamai for vecteezy.com

Downpayment