What Is a High Ratio Mortgage?
What Is a Ratio Mortgage?
In the context of conventional and high ratio mortgages, the ratio mortgage refers to the relationship between the size of the mortgage loan and the amount of the down payment the investor is willing to place when purchasing a property. It is also known as the loan-to-value ratio.
The down payment is the first initial payment you will make towards purchasing your future home. The required amount can range from a minimum of 5% up to 20%, depending on the property’s purchase price. Though saving up a lump sum of money may not always be easy, as unexpected situations in life often happen, a down payment must be paid from the funds currently in your possession.
It is important to note that the size of your down payment will determine your mortgage ratio.
Weighing Various Mortgage Options
When starting on your journey to purchase the home of your dreams, you will inevitably have to learn about mortgages and the various types offered. This may be overwhelming when you are thrown different mortgage option terms such as fixed vs variable, open or closed, convertible, and now possibly high ratio vs conventional.
A ratio mortgage is the ratio between the down payment and the mortgage loan. Usually expressed as a percentage, a high ratio mortgage is when the mortgage loan is over 80% of the purchase price and a conventional mortgage is 80% or less.
In this article, we will cover what a ratio mortgage is, the differences between a high-ratio mortgage and a conventional mortgage, and how this ratio will affect your mortgage plan.
High Ratio Mortgage Vs. Conventional Mortgage
A high ratio mortgage is when you make a down payment of less than 20% of the purchase price of the property you wish to purchase. As the minimum down payment is 5%, it is then possible to have a mortgage loan of up to 95%.
On the other hand, a conventional mortgage is when a larger down payment has been made, and the loan amount is 80% or more.
High ratio mortgages may be more appealing to first-time home buyers looking to enter the housing market as the minimum down payment is only 5% of the purchase price, but there is more to ratio mortgages that you should consider.
Since high ratio mortgages allow buyers to borrow more than 80% of the principal loan, you will be required to purchase mortgage insurance from a regulated source, such as Canada Mortgage House Corporation (CMHC), for their mortgage loan insurance. Mortgage insurance is necessary to protect lenders against default mortgage payments, also known as mortgage default insurance.
Understanding Ratio Mortgages and the Loan-to-Value (LTV) Ratio
As 80% or more of a property purchase that usually costs hundreds of thousands to millions of dollars is a significant amount of money to loan, the lender will set a loan-to-value (LTV) ratio when reviewing your mortgage application. Think of this as a risk assessment done by the lender where the higher the LTV ratio, the higher the risk of default payments.
A loan-to-value (LTV) ratio is a percentage that expresses the amount of a mortgage loan compared to the purchase price of the property. This percentage is calculated by dividing the total mortgage amount by the appraised value of the property. This implies the LTV ratio will directly influence whether a mortgage loan requires mortgage insurance, the cost of the insurance, and if the mortgage is considered a high ratio or conventional ratio.
For example:
Two partners decided to buy a home together. After finding their dream home for $1,000,000, they decide to purchase it and split a down payment of $150,000. In this case, they would pay a down payment of 15%, and the LTV would be 85%, which would be considered a high-ratio mortgage.
A high ratio mortgage of 85% would require the partners to purchase mortgage insurance and make higher monthly payments than if they had made a larger down payment.
Ratio Mortgages Vs. Interest Rates
You might then wonder why a high ratio mortgage might equate to a larger monthly payment. The answer is in two words: interest rates. Though there are also various types of interest rates, generally, the higher the principal loan given by the lender, the higher the interest rate will be. The interest rate is always calculated based on the amount of money owed.
On the positive side, purchasing the required mortgage default insurance for high ratio mortgages typically results in being offered lower interest rates. This is due to the lenders’ assurance of receiving a payout in the event of a defaulted mortgage payment. Thus, it can be viewed as a lower risk.
How Does the Ratio Mortgage Affect the Amortization Period?
Another factor the ratio mortgage can affect is the mortgage’s amortization period. The amortization period is the set length of time over which the entire debt will be repaid, typically over a set period of time through regular payments.
A conventional mortgage can extend the amortization period up to 35 years, whereas a high ratio mortgage can limit the repayment period to only 25 years. In addition to the higher mortgage payments, interest rates, and mortgage insurance costs, a high ratio mortgage will require paying the total amount within a shorter timeframe.
However, effective as soon as August 1st, 2024 lenders will begin to offer 30 year amortization periods on high ratio mortgages to eligible first time homebuyers purchasing newly constructed homes. Newly constructed condominiums that have had an interim occupancy period will be included.
Key Insights
We have covered that although a high LTV ratio mortgage may let a first-time home buyer purchase a home quicker, they may be paying more, including the cost of mortgage insurance, over a shorter period of time. All this will depend on the amount of the initial down payment towards the purchase and your mortgage ratio.
It is always recommended that you thoroughly research and consider all the available options when budgeting your mortgage plan so that you can make confident, well-informed decisions about purchasing your dream home.
