With home prices growing every year, more and more Canadians are looking for ways to make buying a home more affordable. If you’re looking to get into the market and require mortgage financing, you will likely have come across the idea of high ratio and low ratio mortgages. There are many considerations to make when applying for a mortgage and the mortgage ratio is one that can play a big role in how much you pay. In this article, we will explain what a high ratio mortgage is and the benefits and downsides of choosing one over a low ratio mortgage.

What makes a mortgage high ratio?

When you apply to a lender for mortgage financing, they will expect you to come to the table with some amount of money in the form of a down payment. When looking at the overall price of your home, your loan-to-value ratio is essentially the difference in size between your contribution and your lender’s contribution.

In Canada, a conventional down payment is 20%. This means that 80% of the home is paid upfront by your lender which then becomes the mortgage principal that you pay off with interest.

Since homes are expensive and down payments can take a long time to save for, homebuyers can decide to provide a lower down payment than the standard 20%. These are known as high ratio mortgages because the loan-to-value ratio is higher than the conventional 20%. The opposite of this is a low ratio mortgage, where the loan-to-value ratio is less than 80%.

Mortgage ratios are not to be confused with another important mortgage factor: debt ratios, which measure how much of your income goes towards servicing debt.

How high can my mortgage ratio be?

In Canada, the lowest legal amount you are able to pay for a conventional mortgage is 5% down. It is possible to pay an even lower ratio if you are able to borrow money for the down payment. This is not a very common choice and puts a higher financial burden on the borrower. You would have to find a lender willing to agree to this kind of mortgage.

It’s worth noting that while the loan ratio may be 5%, you will likely end up needing more than that to secure your home. After factoring in the closing costs and insurance premiums (if you choose to pay them upfront) you will find the amount of money you need at the bare minimum will be closer to 10%.

The minimum depends on the purchase price

You should also know that the minimum of 5% down only applies to homes costing $500,000 or less. For a home between $500,000 and $1 million, you will need to pay 5% on the amount below $500,000 and 10% on any value above that. For homes above $1 million, the minimum is 20% down.

Low ratio mortgages

If you are on the other side of things and want to take out a mortgage with a ratio lower than 80%, you can do this as well. Like high ratio mortgages, this is a less common option but can be a way to help you own your home faster or have lower monthly payments.

What are the benefits of a high ratio mortgage?

The idea of paying less down for your mortgage is an appealing one and the benefits have led to it being an increasingly popular choice in recent years. Here are some of the benefits for buyers who choose to use a high ratio mortgage :

Getting into the market sooner
For one, a low ratio mortgage allows you to simply buy your home sooner as saving a high down payment can take a long time. Another benefit of getting your home sooner, especially with the rapid price escalations we have seen recently, is that you are able to buy at a lower price point than if you waited and saved.

Many options available even with a high ratio mortgage
Another reason to consider a low ratio mortgage is that mortgage loan terms are not too restrictive or different from what you could get with a conventional mortgage. Choosing to go with a high ratio mortgage does not significantly impact your buying choices and mortgage terms, though there are some caveats that we will discuss later on.

Lower interest rates
High ratio mortgages actually tend to have lower interest rates than a low ratio mortgage. Since insured mortgages are protected against default, the lender also takes on less risk for a high ratio loan. They are also able to charge interest on an overall higher principal amount which makes up for the lower rates.

Overall, when it comes to price, high ratio mortgages can be comparable to conventional mortgages in the total amount paid, and in the best circumstances, can vary by only a few thousand dollars in lifetime costs. However, in general, high ratio mortgages end up paying more.

What are the downsides?

Though a high ratio mortgage may seem appealing, there are some downsides you need to keep in mind if you choose to go with this option :

Mortgage default insurance
To account for potentially higher risk levels, all high ratio mortgages are required to have mortgage default insurance from the Canada Mortgage and Housing Corporation (CMHC). This insurance is designed to protect lenders in the event of a mortgage default but is paid by the borrower.

The value of your insurance premiums will depend on how high your loan-to-value ratio is. With a loan-to-value ratio of 95%, you will need to pay 4% of the home’s cost for insurance premiums on top of your mortgage principal. This can either be paid upfront or added to the mortgage principal to be paid overtime. However, in some provinces, the insurance premiums will also be subject to sales tax and this will always need to be covered up front.

Less choice for homes
One very important aspect of CMHC insurance is that it is only available for properties below $1 million. This means that for any property above this price, as is increasingly common in today’s market, you will be unable to use a high ratio mortgage at all and will need to put the full 20% down.

Amortization period
You should also know that a high ratio mortgage has a maximum amortization period of 25 years. In order to attain a longer amortization period, you will need to opt for a conventional 20% down mortgage. This means you may end up paying less interest over time than with a longer mortgage, however, you will also be required to make higher regular monthly payments. This is an important consideration when looking at how much you can afford for a home based on your income.

Is it right for me?

Deciding on whether or not to get a high ratio mortgage is an important decision many homebuyers face. Broadly speaking, it’s difficult to say that either a high or low ratio mortgage is the better choice. Rather, the decision will need to take into account many factors such as your ability to save, the home you want to purchase, and general market conditions.

A conventional mortgage with 20% down will offer you the most options. You will be able to opt for a longer amortization period if you wish and will have options for homes above $1,000,000. You will also not need to pay the price of mortgage insurance, saving you thousands of dollars on your purchase.

If you would prefer a conventional mortgage, you have a few options such as waiting a while longer to buy while you save for a higher down payment, or looking at lower-priced homes in order to reach that 20% threshold.

If you are considering a high ratio mortgage, you should carefully consider what is affordable for you and what the best terms will be. For example, in a market where prices are rising quickly, it may be more worth your while to take out a high ratio mortgage before prices rise too high, depending on how quickly you can save. If the interest on a high ratio mortgage is low enough, the difference in total interest paid over time compared to a conventional mortgage can end up costing you only a few thousand extra. In other cases, this can be much higher.

You should also consider your income level. Though high ratio mortgages cost less upfront, you may also find yourself paying higher regular mortgage payments. Depending on your ability to save money and how much disposable income you would like to have once you borrow for your mortgage, you may want to decide on a high or low ratio. This can also play a role for those who have been gifted enough for a low down payment but can’t easily save for a higher one.

Overall, high ratio mortgages are a very good option for some home buyers, but not in all cases. To be sure, you should consult a mortgage broker who can help you identify the best options for you.

What is A High Ratio Mortgage? by Corben Grant | Canadian Real Estate Wealth