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High-ratio mortgages

When it comes to mortgages, conventional wisdom is often still the best advice.

If you can afford to make a down payment of 25 percent without sentencing yourself to living like a monk for the next 25 years, you'll be suitably rewarded with low interest rates.

But that advice dates back to the 1950s, when the average selling price of a home in Canada hovered around $13,000. Trying to save a 25 percent down payment today, when the average national selling price is $217,298 and still climbing, according to the latest figures from the Canadian Real Estate Association, is a much trickier feat.

That's why many home buyers choose to forego years of monastic living just to save enough for a conventional mortgage and opt to get into the housing market sooner with a high-ratio mortgage instead.

As its name suggests, a high-ratio mortgage is one in which the loan-value to home-value ratio is higher than in traditional mortgage situations.

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Unlike a conventional mortgage, for which buyers have to put down 25 percent, a high-ratio mortgage lets buyers put down as little as 5 percent of the purchase price.

For Toronto buyers, who live in a city in which the Canadian Real Estate Association says the average home sold for $301,612 in November 2003, it means the difference between a down payment of $15,081 and $75,403.

High ratio means high level of flexibility
Besides lowering the savings requirement of home-buying, high-ratio mortgages also provide buyers with greater flexibility. Even if you have enough cash socked away to make a down payment of 10, 15 or even 25 percent, high-ratio mortgages mean you don't have to break the bank if you don't want to.

That was an important factor for Jason Graham, 31, a freelance art director whose film credits include "X-Men" and "Bollywood Hollywood." When he said farewell to renting in February 2002 and bought his first home, a one-bedroom condominium in downtown Toronto, he chose to make a down payment of 5 percent, even though he had the resources to put down almost twice that amount.

"I could have completely depleted my RRSP and made a bigger down payment, but I would much rather that money stay in my RRSP, just in case," says Graham, who, at the time, was nearing the end of a job contract. "Being in the world of freelance, you're never really sure where your money will come from."

Even though he started a new contract shortly after moving in, Graham says he was still glad to have the extra money at his disposal, since it enabled him to make renovations on his condo, including installing hardwood laminate floors and painting.

How it works
With conventional mortgages of 75 percent or less, lenders insure the loans themselves, says Cara MacKillop, mortgage development manager at VanCity, Canada's second-largest credit union, in Vancouver. But the less money buyers put down, the greater risk lenders assume.

"If anything drastic happens, like a job loss, there's more of a risk than if you had put 25 percent down, because you don't have as vested an interest in the property," explains MacKillop.

So, to protect themselves against the increased risk, lenders require buyers with down payments of less than 25 percent to buy default insurance from a third party.

This insurance is the key to high-ratio mortgages. Without it, few major lenders will let you put down less than the standard 25 percent. Unlike life or accident insurance, when you buy mortgage insurance, you are paying to protect your lender's interests, not your own.

Although your mortgage broker or bank loan officer will take care of the details, it's good to understand how it works.

In Canada, mortgage insurance is offered by two organizations. The Canada Mortgage and Housing Corporation is an agency created by the federal government agency in 1946 to help meet the housing needs of World War I veterans. Today, it is dedicated to helping all Canadians buy quality, affordable housing.

The other insurer, GE Mortgage Insurance Canada, is the domestic arm of the largest mortgage insurer in the world and the only private-sector supplier in Canada.

Who can qualify
Until the late '90s, only first-time home buyers purchasing properties worth $250,000 or less could qualify for CMHC mortgage insurance and be eligible for a high-ratio mortgage. Since then, MacKillop says CMHC has changed its eligibility requirements, removing the cap on housing prices and extending eligibility to all qualified home buyers.

"The whole mentality is to help people get into homes sooner," she says. "Everyone should put down 25 percent. But realistically, a lot of people can't, so you have to decide if it's worth it to pay the premium and get into the market sooner, and start paying your mortgage instead of someone else's."

Today, both the CMHC and GE use similar qualification guidelines. As with any type of mortgage, a good credit rating and two or more years of job stability are essential. Here are other requirements to keep in mind:

  • The home you're buying must be your principal residence and located in Canada. So, summer cottages on the Bay of Fundy and time-shares in Florida don't qualify.
  • You need a down payment of at least 5 percent of the purchase price (or 7.5 percent for a two-unit property in which you will occupy one of the units). Borrowing money from your RRSP through the Canada Customs and Revenue Agency's Home Buyers' Plan or using a cash gift from an immediate relative are acceptable if you don't have the required cash on hand.
  • In addition to your down payment, you also need to prove you can pay closing costs equivalent to 1.5 percent of your new home's purchase price.
  • Your home-related expenses, or gross debt service, must not exceed 32 percent of your gross monthly household income. Home-related expenses include monthly mortgage payments, property taxes, heating costs and condo fees.
  • Similarly, your total monthly debt load can't exceed 40 percent of your gross monthly household income. Debts include your monthly mortgage payments plus any personal loans, car loans and credit card debt.

What it costs
Mortgage insurance has two components. The first is an underwriting fee of between $75 and $185 that varies according to the complexity of your mortgage.

The second is a one-time insurance premium that can either be added to your mortgage and paid off as part of the loan or paid in a lump sum. Generally, it costs between 0.5 percent and 3.25 percent of your mortgage's value.

Exactly how much the premium costs varies according to the size of your mortgage and the type of interest rate. Generally speaking, the costs are the same with CMHC or GE. Below are the general premium fees the two organizations charge on fixed-rate or capped variable-rate mortgages:

Size of mortgage (as a percentage of total property value)
Loan insurance premium (as a percentage of mortgage value)
Up to and including 65 percent
0.5 percent
65.01 to 75 percent
0.65 percent
75.01 to 80 percent
1.0 percent
80.01 to 85 percent
1.75 percent
85.01 to 90 percent
2.0 percent
90.01 to 95 percent
3.25 percent

To determine how much insurance costs, multiply the amount of your mortgage by the corresponding premium listed above. For example, if you bought a $180,000 home with 5 percent down ($9,000), the insurance on your mortgage of $171,000 at a premium of 3.25 percent would be $5,558.

Having a high-ratio mortgage does mean you'll incur the extra cost of default insurance, which might otherwise be used to buy a bigger home. But many home buyers, especially young people or first-timers, say it's worth it to get into the housing market early and start building equity in their own home.

Bruce Gillespie is a freelance writer and editor in Simcoe, Ontario.


-- Posted: Sept. 20, 2004
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