HIGH RATIO MORTGAGE – What You Need to Know?
Before we jump into everything that you need to know about a high ratio mortgage, some background history on mortgages is important to understand/ be familiar with.
Mortgages originally started in England when people did not have the resources to purchase land in a one swoop transaction. Sellers would lend buyers money directly – no banks or outside parties were involved. Purchasers were only allowed to take possession of the land once the entire amount of the loan was paid off. Unlike today where you can take possession and make payments while living on the land, before you would not be able to set foot on the land until you paid off your loan in full. And if purchasers missed even one payment, they would forfeit their right to the land and lose any prior payments that they made to the seller.
By the 1900s most mortgages were formalized and involved long-term loans where only monthly interest was paid while the borrower saved towards repayment of the original sum. So inn other words, interest only payments, but borrowers were still expected to set aside additional funds to make a lump sum payment for the original amount of the amount borrowed.
Major events like the Great Depression of the 1920s and WW1 and WW2 saw many borrows struggle to make their interest payments let alone set aside any money to pay off the principal amount of the loan. This led to the introduction of long- term fully amortized mortgages that included principal and interest payments each month and the maximum amortization of 25 years.
The Canada Mortgage and Housing Corporation (CMHC) was created in 1946, and its primary role was to administer and enforce the National Housing Act. Today, CMHC sells mandatory mortgage loan insurance when the buyer is putting less than 20% of the price of the home they are purchasing as a down payment. This insurance is to protect the lenders if a borrower defaults on their mortgage loans. The borrower pays for the insurance, and the insurance backed by the government will cover any losses that the lender faces in the event of the borrower being unable to continue to make payments. The thought process behind high ratio mortgages, essentially is that they are higher risk – there is less skin in the game for the borrowers as they have to come up with less of their own original money for the down payment.
Today, there are 2 other companies that provide mortgage insurance for high ratio financing, Canada Guaranty (CG) and Sagen – formerly called Genworth.
Inflation rose to unprecedented numbers in the 1970s and this led to changes to mortgage offerings and products that we see today. We no longer saw 20 to 30 year terms, and the most common term became the 5 year fixed with a 25 year amortization. In the United States however, we still continue to see 30 year terms, and the terms usually equal the amortization of the mortgage.
In 1992, the Home Buyer’s Plan was introduced. Under this plan Canadians can withdraw money from their RRSPs for the purpose of putting down towards their purchase without incurring any tax implications, so long as they followed a repayment schedule and met other criteria
What is a High Ratio Mortgage?
We have already defined a high ratio mortgage in the history lesson above, but we will dive in a little bit deeper here, to make sure that you are clear on the definition.
A mortgage is considered a high ratio mortgage when there is less than 20% down payment. These mortgages are considered a higher risk for the lenders, as there is less of the borrowers own funds in relation to the value of the property going towards the purchase. An insurance premium is charged to the borrower, and in the event of default, a third party default insurance provider, CMHC, Sagen or Canada Guaranty, will compensate the lender. The maximum amortization for a high ratio mortgage is 25 years.
High ratio mortgages offer competitive interest rates and terms, and can be the best option for buyers who want to purchase a home but don’t have the funds for a large down payment. If you’re interested in getting a high ratio mortgage, here’s what you need to know:
The ‘high-ratio’ part of the name refers to the ratio between the mortgage amount (the loan) and the total purchase price (the value), also known as the loan-to-value ratio, or LTV for short. A conventional mortgage is one that has 20% or more down payment, thereby reducing the loan to value.
For example if you purchased a home for $300,000 and put $15,000 down payment your loan would be 95% loan to value – high ratio. On that same purchase amount if you put down $60,000 your loan to value would be 80% and therefore, a conventional mortgage. II you would like more information on everything that yo need to know about Conventional Mortgage financing, click here LINK TO CONVENTIONAL MORTGAGE PAGE HERE
Interested in learning more about high ratio mortgages? Keep reading! We will cover everything you need to know about these types of mortgages, including eligibility requirements, interest rates, and terms. We’ll also discuss some of the benefits of choosing a high ratio mortgage over other types of loans. So whether you’re just starting your home buying process or you’re already approved for a loan but are considering your options, this page should have all the information that you need!
Qualifying for High Ratio Mortgage Financing
Many people in Canada have the dream of buying a home but, unfortunately do not have enough of a down payment for conventional financing. Are you someone that wants to buy a home but you don’t have 20% down?
Don’t worry – there are many different types of mortgages available, and one of them may be perfect for you, here we are discussing high ratio mortgages.
Most home buyers would prefer to not take out a high ratio mortgage as there is an insurance premium attached to this type of mortgage, mortgage default insurance that we discussed above. This default insurance protects the lender if the borrower defaults on the mortgage payments ending in a foreclosure sale. The client pays for this ‘risk’ factor. This is a federal requirement and in Canada we have 3 companies providing this insurance to lenders. Only one is backed 100% by the Government however, and that is the Canada Mortgage and Housing Corporation (CMHC). The other two are Canada Guaranty and Sagen, formerly known as Genworth.
The premium is paid upfront at the time of funding your mortgage, you have the option of paying the premium in a lump sum payment or adding it on to your mortgage. Most people choose to add the premium into the mortgage and repay through their regular mortgage payments. The cost of the premiums depend on your loan to value (LTV) and are generally between 2% and 4% of the mortgage. Of course, the higher the loan to value the higher the premium.
Here is a link to CMHCs site that breaks down the percentages depending on the LTV CMHC mortgage loan insurance costs
You can refer to CMHC for a premium calculator to figure out how much your premium could be. Your mortgage broker will also provide this information for you as well.
Why Do We Need High Ratio Insurance
If mortgage default insurance didn’t exist, mortgage lenders would be far less willing to shoulder the risk of low-equity mortgages. The result would be a sharp decrease in home affordability in Canada, with lenders demanding larger down payments on all home purchases. The good news is in most cases you only need to do this as a first time home buyer if you don’t have a 20% down payment. Typically when you purchase your second home you will have the equity in the home that you already own to put down the minimum 20% for a conventional mortgage. At this point, the mortgage is considered conventional. The default insurer is no longer involved, and the lender assumes 100% of the mortgage loan risk. Of course, when a home buyer is putting that much skin in the game, the odds of default decrease significantly.
Note * there are certain circumstances where insurance premiums are required even with 20% (or more) down payment / skin in the game. Such things such as remote areas and unique properties play a factor in this. Always best to have a quick chat with your mortgage broker if you are looking at an unconventional property.
When you apply for a high ratio mortgage, your application must be reviewed and approved by two parties: your mortgage lender, and the insurer. There are specific criteria that must be met to qualify for a high ratio mortgage:
- A maximum mortgage amortization period of 25 years
- 10% down payment on the mortgage amount between $500,000 and $999,000. (5% on the first $500,000, and 10% on the remaining balance).
- Home purchases over $1,000,000 are not considered eligible for high ratio insurance, they require at least 20% down payment.
- Debt servicing ratios are limited to 39% for GDS and 44% for TDS
Here is a table with the premium rates for a high ratio mortgage.
- Up to and including 80% 2.40%
- Up to and including 85% 2.80%
- Up to and including 90% 3.10%
- Up to and including 95% 4.00%
What are GDS and TDS?
Gross debt service ratio (GDS) is the maximum amount of money you can afford to pay for housing each month. It is one of the tools your lender uses to determine whether you can afford a mortgage or a loan. Definition and Example of Gross Debt Service Ratio (GDS). You can determine your GDS by taking your total housing costs divided by your gross monthly income. This is capped at 39% for a high ratio mortgage.
The total debt service (TDS) ratio measures how much of your gross income is being used to cover your housing costs and other debt payments. This ratio is used with the GDS to evaluate your loan application. TDS cannot exceed 44%. When you hear people talking about debt servicing ratios this is what they are referring to.
From a mortgage lender’s perspective, a high TDS ratio indicates that you may have trouble paying your bills and making your mortgage payments. Most lenders do not like to see maxed out GDS and TDS ratios. This could indicate the borrower may end up defaulting on their household expenses including their mortgage payment. Because you can afford it on paper doesn’t mean you should.