High-ratio mortgage

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High-ratio mortgage
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High-ratio mortgage is one of the mortgage loan option that requires from the borrower to place down the payment of less than 20% of the property's price. In other words, high-ratio mortgage is a loan to value ratio of more than 80%. The exception here is applied when the borrower is self-employed- in such a case he/she needs to pay beforehand less than 35%. High-ratio mortgage is widely known in Canada. To compare, the opposite option to the high-ratio mortgage is called conventional or low ratio mortgage- this is the situation, when the borrower needs to put down the payment of more than 20% (35%- in case of self employed) of the initial value[1].

A high-ratio mortgage insurance

Most high-ratio mortgage are required by law to have mortgage default insurance, which is provided by either CMHC, Canada Guaranty or Genworth. The borrower needs to pay a premium for this insurance. The insurance premium for a high ratio mortgage is determined by the down payment amount (less than 20% and 35%). For high ratio mortgages, the default mortgage insurance premium is added on top of the initial amount, and the payment is one with the mortgage payment. The purpose of such insurance is to protect the lender in case the borrower is not able to make the payments[2].

The main benefit of mortgage loan insurance is the stabilization of the housing market. During economic slumps when down payments may be harder to save, it ensures the availability of mortgage funding.

The cost of such insurance is calculated as the percentage of the mortgage, based on the size of the down payment. Firstly, the lender pays an insurance premium on mortgage loan insurance. After which the lender will likely pass this cost on to the borrower. There are two ways to pay off this obligation[3]:

  • pay it in a lump sum
  • add it to the mortgage (include in the further payments).

Differences between conventional and high ratio mortgage

Conventional (low-ratio mortgage) mortgage is the type of the loan where the down payment is equal to 20% or more of the property's value/purchase price. A low-ratio mortgage does not normally require mortgage protection insurance. As an alternative, a high ratio mortgage is useful for those who have less than a 20% down payment. High ratio mortgage allows to buy a home with less than 20% of the purchase price as down payment. However the special insurance needs to be included as the factor protecting against default.

Advantages and disadvantages of high ratio mortgage

The benefit of such loan option is the fact that the borrower is able to purchase the property with as little as 5% to 19.99% down payment. It is the excellent opportunity for first-time home buyers to allow them to own a home assuming they have good credit and steady income (without a big down payment).

When it comes to the disadvantages of the high ratio mortgage, one of the main here is the fact that borrower will incur the additional insurance cost. What is more, the borrower will need to pay the insurance premium amount, as part of their closing costs[4].

Footnotes

  1. Gray D, Mitham P (2010)
  2. Ioannou T, Ball H (2010)
  3. MiniCram (2019)
  4. Charupat N, Huang H (2012)

References

Author: Weronika Włodarska