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The rising real estate market has made buying property, especially in pricey places like Canada, harder to achieve.
However, with just an initial amount of money (less than 20% of the property’s purchase price), you can still acquire your dream house through mortgages, specifically high-ratio mortgages.
Understanding mortgages is important. Understanding the complexities of these deals is crucial before diving in. This comprehensive guide on high-ratio mortgages enables you to make informed choices when investing.
What is a High-Ratio Mortgage?
A high-ratio mortgage refers to a home loan where the borrower’s down payment is less than 20% of the property’s purchase price. In other words, the mortgage amount is more than 80% of the property’s value.
High-ratio mortgages are a common feature in the Canadian real estate market, particularly for first-time homebuyers who may not have saved enough for a larger down payment.
However, it’s worth noting that high-ratio mortgages come with their own set of rules and complexities.
One of the most critical aspects is the requirement for mortgage default insurance, a policy that protects the lender if the borrower fails to make their mortgage payments.
How to Calculate Loan-to-Value Ratio (LTV)
The Loan-to-Value ratio (LTV) holds significant importance in classifying a mortgage as high-ratio. It gauges the loan size against the property’s value and is calculated as follows:LTV Ratio = (Home Price – Down Payment) / Home Price
If this ratio exceeds 80%, the mortgage qualifies as high-ratio. For properties under $500,000 in Canada, a minimum down payment of 5% is mandatory, leading to an LTV ratio of 95%.
Pros and Cons of a High-Ratio Mortgage
Like any financial product, high-ratio mortgages come with their own set of advantages and disadvantages.
Greater Accessibility: High-ratio mortgages enable homebuyers with limited savings to access the housing market faster.
Lower Interest Rates: Due to insurance, these mortgages often come with reduced interest rates compared to standard loans.
Mortgage Insurance Requirement: High-ratio mortgages mandate mortgage insurance, increasing the overall loan expenses.
Higher Long-Term Costs: With larger loan amounts and added insurance costs, these mortgages tend to be more expensive over time.
Amortization Limit: Unlike conventional mortgages that can span up to 35 years, high-ratio mortgages are capped at a maximum of 25 years.
Cost Implications of a High-Ratio Mortgage
The main added cost associated with high-ratio mortgages is the mortgage default insurance premium. This is calculated as a percentage of your loan amount and varies based on the LTV ratio.
For instance, when the LTV ratio reaches up to 95%, the insurance premium might hover around 4% of the total loan amount.
This premium can either be paid upfront or added to your mortgage amount. However, adding it to the mortgage amount means you’ll be paying interest on it, thereby increasing your overall cost.
Alternatives to High-Ratio Mortgage
If you’re not enthusiastic about the additional costs associated with a high-ratio mortgage, there are alternatives. The most notable is the conventional or low-ratio mortgage.
High-Ratio vs Low-Ratio Mortgage
A conventional or low-ratio mortgage, unlike a high-ratio one, demands a down payment of 20% or higher, resulting in an LTV ratio below 80%.
The key benefit of this type of mortgage is avoiding the need for mortgage default insurance, which could lead to considerable savings throughout the loan period.
However, the hurdle of saving for a sizeable down payment can be a challenge for many, especially first-time homebuyers.
Strategies to Avoid a High-Ratio Mortgage
If you prefer to avoid the extra costs associated with a high-ratio mortgage, consider these strategies:
Saving a Larger Down Payment: Delaying your home purchase to save a larger down payment may qualify you for a conventional mortgage.
Purchasing a Less Expensive Home: Choosing a less expensive property can make it easier to achieve the 20% down payment mark.
Utilizing the Home Buyers’ Plan (HBP): First-time homebuyers can use up to $35,000 from their Registered Retirement Savings Plan (RRSP) through the HBP to bolster their down payment.
Choosing the Right Mortgage for You
Choosing between a high-ratio and a conventional mortgage depends largely on your individual financial situation and long-term goals.
While a high-ratio mortgage can help you get into the housing market sooner, a conventional mortgage can save you money over the long run.
Impact of High-Ratio Mortgage on the Canadian Housing Market
High-ratio mortgages have played a significant role in the Canadian housing market, providing an opportunity for many Canadians to enter the real estate market.
However, their prevalence has also contributed to the increasing household debt levels in Canada.
The Role of Canada Mortgage and Housing Corporation
The Canada Mortgage and Housing Corporation (CMHC) is a government agency that provides mortgage default insurance for high-ratio mortgages.
The CMHC insurance is not free, and you need to pay premiums based on your mortgage’s loan-to-value ratio.
Mortgage Rate Implications
High-ratio mortgages come with insurance, lowering the risk for lenders. That’s why lenders typically offer lower interest rates compared to traditional mortgages.
But remember, the expense of mortgage insurance might cancel out those lower rates.
What is a high-ratio mortgage?
A high-ratio mortgage is a home loan where the borrower’s down payment is less than 20% of the property’s purchase price.
What’s the difference between a high-ratio vs low-ratio mortgage?
A high-ratio mortgage requires a down payment of less than 20%, while a low-ratio or conventional mortgage requires a down payment of 20% or more.
Do I need high-ratio mortgage insurance in Canada?
If your down payment falls below 20%, buying mortgage insurance in Canada becomes necessary. This safeguard ensures the lender is covered if you can’t keep up with mortgage payments.
In summary, grasping the details of a high-ratio mortgage is vital before making a decision. Buying a home is a major financial step, so making informed choices that match your financial plans and capacities is key.
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