What is a High Ratio Mortgage?

In Canada, a high ratio mortgage is a home loan where the borrower makes a down payment of less than 20% of the property’s purchase price. High ratio mortgages require mortgage insurance to protect lenders in case of default, which adds an additional cost for borrowers. Despite the insurance requirement, high ratio mortgages offer opportunities for Canadians to enter the housing market with a smaller down payment. This guide explores what a high ratio mortgage is, how it works, and the benefits and considerations for Canadian homebuyers.

1. Understanding High Ratio Mortgages: Definition and Requirements

A high ratio mortgage refers to a mortgage where the loan-to-value (LTV) ratio is over 80%. This means the borrower finances more than 80% of the home’s purchase price through the mortgage, with a down payment of less than 20%. Here’s what qualifies as a high ratio mortgage:

• Down Payment Requirement: For a mortgage to be classified as high ratio, the borrower’s down payment must be less than 20% of the home’s price.
• Mortgage Insurance Requirement: Canadian federal regulations require borrowers with high ratio mortgages to obtain mortgage insurance, typically through the Canada Mortgage and Housing Corporation (CMHC), Sagen, or Canada Guaranty.
• Lender Protection: Mortgage insurance protects the lender by covering potential losses in case the borrower defaults. Although the borrower pays for this insurance, it reduces lender risk, making it easier for more Canadians to secure home financing.

High ratio mortgages make homeownership accessible for those who may not have a large down payment, with the trade-off of added insurance costs.

2. How Mortgage Insurance Works for High Ratio Mortgages

In Canada, mortgage insurance is mandatory for high ratio mortgages and is provided by approved insurers. Here’s how it works:

• Insurance Premiums: Borrowers pay an insurance premium, calculated as a percentage of the mortgage amount. The premium rate depends on the down payment size; smaller down payments result in higher premiums.
• Payment Options: The insurance premium can be added to the mortgage and paid off over the mortgage term or paid upfront. Most borrowers choose to add the premium to their mortgage to avoid paying a large upfront cost.
• Protecting the Lender, Not the Borrower: It’s important to note that mortgage insurance protects the lender, not the borrower. If the borrower defaults, the insurer covers the lender’s losses, while the borrower still faces financial repercussions.

This insurance enables lenders to offer financing to borrowers with smaller down payments, contributing to greater housing accessibility across Canada.

3. Benefits of a High Ratio Mortgage

While high ratio mortgages come with additional costs, they also offer several benefits for homebuyers:

• Accessible Homeownership: High ratio mortgages allow Canadians to enter the housing market sooner without waiting to save a full 20% down payment. This can be advantageous in competitive markets where property values rise quickly.
• Lower Initial Costs: With a smaller down payment requirement, homebuyers can allocate funds toward other expenses, such as closing costs, moving expenses, or home improvements.
• Increased Borrowing Power: Mortgage insurance makes it possible for buyers to finance a larger portion of the home’s price, giving them more flexibility in choosing a property.

These benefits make high ratio mortgages attractive for first-time homebuyers and those who want to take advantage of rising real estate markets.

4. Considerations and Costs of High Ratio Mortgages

Although high ratio mortgages make homeownership more accessible, there are important factors and costs to consider:

• Insurance Premium Cost: The cost of mortgage insurance adds to the total mortgage amount, increasing the overall cost of the loan. Depending on the down payment, insurance premiums can range from 2.8% to 4% of the mortgage.
• Higher Monthly Payments: Because the mortgage amount includes the insurance premium, high ratio mortgages often result in higher monthly payments compared to conventional mortgages with a 20% down payment.
• Limitations on Property Type: High ratio mortgages are typically available only for properties intended as primary residences. Vacation homes, investment properties, and properties over a certain value may not qualify for mortgage insurance.

Understanding these costs helps homebuyers make informed decisions and prepare for the financial commitment of a high ratio mortgage.

5. Qualifying for a High Ratio Mortgage in Canada

Qualifying for a high ratio mortgage involves meeting both lender and insurer requirements. Here are some key criteria:

• Credit Score: Lenders look for a good credit score, typically above 600, to approve high ratio mortgage applicants. Strong credit history can also help secure better interest rates.
• Income and Employment Verification: Lenders require proof of income and stable employment to ensure the borrower can manage mortgage payments.
• Debt-to-Income Ratio: Lenders assess the borrower’s debt-to-income (DTI) ratio, which compares monthly debt obligations to monthly income. In Canada, lenders typically look for a DTI ratio below 44% to qualify for a high ratio mortgage.
• Stress Test Requirement: Canadian homebuyers must pass a stress test, demonstrating they can afford mortgage payments even if interest rates rise. The stress test is based on the higher of the mortgage contract rate plus 2% or the Bank of Canada’s benchmark rate.

Meeting these requirements is essential for borrowers to secure a high ratio mortgage and manage their financial obligations.

6. High Ratio vs. Conventional Mortgages: Key Differences

The primary difference between high ratio and conventional mortgages lies in the down payment and insurance requirements:

• High Ratio Mortgage: Requires a down payment of less than 20%, involves mandatory mortgage insurance, and is often chosen by first-time homebuyers or those with limited down payment savings.
• Conventional Mortgage: Requires a down payment of 20% or more, does not require mortgage insurance, and typically comes with lower monthly payments since the loan amount is lower.

The choice between these options depends on the borrower’s financial situation, down payment availability, and preference for managing insurance costs.

Frequently Asked Questions About High Ratio Mortgages

• How much is the mortgage insurance premium for a high ratio mortgage?
  The premium varies based on the down payment percentage. For example, a 5% down payment typically incurs a 4% premium, while a 10% down payment incurs a 3.1% premium.
• Can I avoid mortgage insurance on a high ratio mortgage?
  No, mortgage insurance is mandatory for high ratio mortgages in Canada. To avoid insurance, a borrower must make a down payment of at least 20%.
• Is it harder to qualify for a high ratio mortgage?
  Qualifying for a high ratio mortgage requires meeting credit, income, and stress test requirements. However, it’s not necessarily harder to qualify; in fact, mortgage insurance may increase the likelihood of approval since it protects the lender.

Conclusion

A high ratio mortgage provides Canadian homebuyers with an opportunity to purchase a property with a smaller down payment, helping them enter the housing market sooner. While this type of mortgage requires additional insurance costs, it offers flexibility and accessibility for individuals who may not have the resources for a 20% down payment. By understanding the benefits, costs, and qualifications, homebuyers can make informed decisions and confidently approach the Canadian real estate market.