Date Posted: November 10, 2017
Consider two couples looking to purchase the same house at 456 Maple Lane with a purchase price of $400,000. Both sets of clients have excellent credit history and great job stability. Bob and Barbara are looking to put a down payment of 5%, giving them a loan to value of 95% which is a high ratio mortgage. Shawn and Steve will be putting a down payment of 20%, giving them a loan to value of 80% which is a conventional mortgage. In terms of who gets the better rate, Bob and Barbara with less down payment and a high ratio mortgage will get the lower rate of the two couples.
Wait... WHAT?! Shouldn’t the couple with more down payment get the better rate?
The mortgage rule changes in the Fall of 2016 have made a significant difference to the way mortgage interest rates are determined. Those changes made a number of mortgage categories not eligible for default insurance (CMHC), including non-owner occupied rentals, refinances, mortgages with amortizations greater than 25 years, and homes over $1,000,000. Almost all mortgages end up being insured at some point. Banks and large deposit holders insure their mortgage portfolios with default insurance for the purpose of securitization (to move the mortgages as assets into investments such as mutual funds). Other mortgage lenders obtain their funds through investors who often require the mortgage portfolio to be insured for the same reason. In these last scenarios, the mortgages are insured through what is called “bulk insurance”. This is insurance paid by the lender for the insurance coverage provided, but at a reduced rate to the premiums that borrowers pay. In cases where the insurance is already paid (such as homeowners with less than 20% down payment), the lender does not have to incur the cost of insuring the portfolio. In that case, many of the non-bank lenders pass the savings on to home owners in the form of a reduced interest rate for mortgages with less than 20% down payment.
Let’s take a look at a few other scenarios with couples that have large down payments and more equity that will obtain higher rates for their mortgages.
Purchase Price/ Home Value
|Bob & Barbara||$400,000||$20,000||95%||$380,000||Lowest|
|Shawn & Steve||$400,000||$80,000||80%||$320,000||Higher|
|Mary & Martin (Rental)||$400,000||$100,000||75%||$300,000||Highest|
|Peter & Patricia (Refinance)||$400,000||$200,000||50%||$200,000||Highest|
|Tom & Tracey||$1,200,000||$1,000,000||17%||$200,000||Highest|
As you can see, the same house, with customers who have the same profile, excellent credit, good income, great job stability, can all have different rates dependent on the type of mortgage and amount of down payment.