Owning a home comes with a lot of expenses. Mortgage payments, utilities, property taxes and maintenance are just some of the things you’ll need to budget for. Since adjusting to these costs can take some time, you need to be prepared from the start. But some new homeowners are caught off guard by how a high-ratio mortgage can affect their monthly expenses.
What is a high-ratio mortgage?
A high-ratio mortgage is a loan with a down payment of less than 20% of the purchase price of the home you’re buying. The term “high ratio” refers to the spread between the mortgage amount (the loan) and the purchase price (the value). This spread is more commonly known as the loan-to-value ratio.
Conversely, you’ll have a low-ratio (or conventional) mortgage when you have a down payment of 20% or more of the purchase price.
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High-ratio mortgages require mortgage loan insurance, which is an extra premium that is added to your regular mortgage payments and protects your lender in the event you default. The total cost is typically between 0.6% to 4.50% of the amount of your mortgage.
Since high-ratio mortgages must satisfy the requirements of mortgage loan insurance, they all share the following features:
- A home with a purchase price that is less than $1,000,000. Mortgage insurance is not available for homes that cost $1,000,000 or more because homes like these require a minimum down payment of 20%.
- A self-funded down payment. To qualify for mortgage insurance, you need to save for the down payment on your own or receive it as a gift from your family. You can’t borrow money for the down payment.
- An amortization period of 25 years or less. The maximum amortization period for high-ratio loans is 25 years. If you want more time to pay your loan, you’ll need to get a conventional mortgage, which can be amortized for up to 35 years. Just remember, while a longer amortization period means smaller payments every month, you will likely pay more interest over time.
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What are the mortgage loan insurance premiums?
All high-ratio mortgages require mortgage loan insurance, and how much you’ll pay depends on your down payment.
For example, the Canada Mortgage and Housing Corporation (CMHC) charges:
- 4% of your mortgage amount if your down payment falls between 5% and 9.99% of the purchase price.
- 3.10% of your mortgage amount if your down payment falls between 10% and 14.99% of the purchase price.
- 2.80% of your mortgage amount if your down payment falls between 15% and 19.99% of the purchase price.
As you can see, the premium is lower if you have a bigger down payment. You can choose to pay the insurance premium upfront as a lump sum, but most people have it rolled into their mortgage so it’s part of their regular payments. CMHC is the largest mortgage default insurance provider, but your mortgage might instead be backed by Sagen or Canada Guaranty Mortgage Insurance Company, which are private lenders.
Pros and cons of a high-ratio mortgage
Although you may not have a choice when it comes to getting a high-ratio mortgage, you should still understand how it affects you.
- You can become a homeowner sooner. Before mortgage loan insurance was introduced, you needed a larger down payment just to qualify for a mortgage. With mortgage loan insurance, you can buy a home with only a 5% down payment.
- Lower interest rates. As weird as it sounds, lenders offer better interest rates to homeowners with high-ratio mortgages. That’s because lenders are protected if you default, so they can give you lower rates to entice you to borrow from them.
- Mortgage loan insurance is required. With high-ratio mortgages, you’ll need to pay up to 4.5% of your mortgage amount in mortgage loan insurance.
- It’ll cost you more money in the long run. Since you’re borrowing more money than you would with a conventional mortgage, you’ll pay more interest over the term of your mortgage.
- Amortization period cap. High-ratio mortgages have a maximum amortization period of 25 years, whereas conventional mortgages can be amortized over 35 years.
Alternatives to high-ratio mortgages
Although whether you get a high-ratio mortgage is based on the size of your down payment, you may have a few options, depending on your situation.
- Save a bigger down payment. Once you have a down payment of at least 20% of the purchase price, you’ll qualify for a conventional mortgage. If delaying your home purchase by a few months or adding a side hustle could help you save the extra cash, it might be worthwhile.
- Buy a cheaper home. If your home’s purchase price is lower, the down payment you’ve saved up will cover a greater percentage of the price. A more affordable home could help get your down payment over 20%.
- Use the Home Buyers’ Plan. If you’re a first-time homebuyer, you can withdraw up to $35,000 from your Registered Retirement Savings Plan (RRSP) as part of the Home Buyer’s Plan.
High-ratio mortgages cost more than conventional mortgages, but they’ve become quite common in Canada due to rising real estate prices. If you need to get one, don’t worry too much about it — they were created to help people with smaller down payments buy homes. If they make it possible for you to buy a home, they’re doing their job.
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Mortgage default insurance protects lenders against defaulting borrowers. Mortgage protection insurance pays mortgages in the event of death or disability.