Hi, Aleem here – Mortgage Specialist Vancouver.
Loan Mortgage Down Payment, Canada – I’d like to address something that has come up in my conversations with other experts in the industry, that being the topic of interest rates and their relationship with down payment.
Although, it doesn’t make a whole lot of sense, what is happening is a lower down payment on a home might actually get you a better mortgage rate in today’s market.
The reason behind this is the government subsidy known as mortgage default insurance, which ultimately makes it less risky to lend money to someone who has only 5% down compared to someone with 20% available.
The government requires that consumers with less than 20% down obtain mortgage default insurance in Canada if they are borrowing from a federally regulated bank. The cost of an insurance premium is up to 2.75% of the mortgage amount on a 25-year amortization but this fee comes with 100% backing, or guarantee if you will, from the federal government if the insurance is provided by Crown corporation Canada Mortgage and Housing Corp (CMHC).
Non institutional, mortgage only lenders, also referred to as monolines are already offering rates that are 10 to 15 basis points higher for a closed five-year mortgage for uninsured consumers.
When we dig a little deeper, something else that may also be a catalyst is the crackdown on mortgage insurance announced by Federal Finance Minister Jim Flaherty. Flaherty has placed CMHC under the authority of the country’s banking regulator, the Office of the Superintendent of Financial Institutions, which by the way has been visiting all of the banks and grilling them on their lending practices and scrutinizing their mortgage portfolio over the past 8 months.
Flaherty has also put in new rules on bulk or portfolio insurance. Many banks had previously been paying the insurance premium on low-ratio mortgages – loans with more than 20% down – because it was easier to securitize them. Now Flaherty says those loans will no longer be allowed in the government’s covered bond program.
The long and short of it is that this is going to have a push up effect on rates to some degree. leading to a very interesting phenomenon where if you go to get a mortgage today, you are oftentimes quoted a higher rate on a conventional mortgage which seems counter intuitive as presumably you are less of a risk because you have more equity.
For now, the Big Six banks have kept consistent pricing between low-ratio and high-ratio mortgages but there is a question on whether they will continue doing that or raise rates overall to compensate for higher conventional mortgage costs.
There is a lot going on on the back end that most of us don’t even realize. Right now it is competition among the Big Six banks that is keeping rates down and stopping any of them from raising rates for conventional mortgages.
There is a higher cost of funds when a deal cannot be securitized but the bank continues to offer the same rate.
These institutional lenders, however, have an advantage over their monoline counter parts who deal strictly in mortgages. If you look at everything a little more closely, you begin to realize that bank have more of an interest in you than just your mortgage.
Those customers with the larger equity position in their homes may be a costlier mortgage to fund, but they also could be future line-of-credit customers. There’s also the potential for other business such as RRSPs and TFSA, so losing a few basis points on the mortgage side might make more sense for the Big Six in the long run.
While banks may be eating some of the costs for people who are not eligible for a subsidy, if they continue down that road they might not be able to match the rates some of the monoline lenders are able to offer with insured mortgages.
An article was published recently where an example was used:
“That might not sound like much, but the difference between, say, 3.14% and 3.29% on a $500,000 mortgage amortized over 25 years would be about $3,500 extra in interest on a five-year term.
But what about that extra and not to mention hefty up front fee in insurance premiums? Well 2.75% of 500,000 amounts to $13,750. So are you really getting a better deal?
Most people don’t have this kind of money, especially here in BC where they have to come up with the property transfer tax, so they opt to add the insurance premium to the mortgage.
In the same example as above, adding the premium to the mortgage makes the total mortgage, 513,750. So in reality the consumer is paying 3.14 for 25 years on 513,750 vs 3.29 on 500,000. The difference in interest is still greater with the higher rate and lower mortgage amount, but by about $1,550 dollars, not $3,500.”
So the conclusion:
You do pay less interest over the term when you put less down. These consumers also represent a greater risk to the taxpayer.
Less money down does mean a lower rate, and more importantly a lower overall interest cost on the term. Does this really add up?
Mortgage Specialist Burnaby, I’m Aleem Peermohamed
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