It doesn't make much sense, does it? Why would the buyer with the smaller down payment (and therefore the riskier borrower) would benefit from lower rates?
And the answer is: You probably know that borrowers with less than 20% down payment must purchase mortgage default insurance – commonly referred to as “CMHC insurance”. CMHC stands for Canada Mortgage Housing Corporation. There are two other mortgage insurers – Genworth Canada and Canada Guaranty.
So when this insurance is purchased, there is almost no repayment risk to your mortgage lender.
But when the mortgage is not insured, the lender assumes the risk you could default.
And this insurance premium is no small thing. If you have less than ten percent down payment, it’s four percent of your net mortgage amount.
So if you buy a condo for $400,000 and you put down $20,000 – you will pay a bit over $15,000 in one time insurance premium. To make things even more interesting, you pay 8% PST on this premium, so another 1200 bucks come from your own pocket, and not included in the mortgage, it is added to your closing costs.
Since the mortgage default premium gets added to your mortgage loan, you would start out with a mortgage of 395,000 against a home with a market value of $400,000. Is this risky?
Okay so that’s not too complicated to understand after all, is it? Where it might get confusing is that some mortgages are insured even when borrowers make more than 20% down payment.
A good example might be a self employed borrower who cannot verify their income in a traditional manner, and therefore relies on other set of underwriting guidelines to get approved for a mortgage. The lender will insure this mortgage even up to a 35% down payment, and the borrower will pay this premium.
The cherry on top would be another scenario where the borrower has a down payment anywhere from 20% to 35%, and the lender chooses to insure the mortgage and absorbs the cost of the mortgage insurance premiums. They buyer is almost not aware of this since there is no additional cost to the borrower.
What if you already have a mortgage and need to access your home equity or consolidate debts into your mortgage? Refinances can no longer be insured. So we go back to a higher rate structure in these scenarios, because the lender will bear the risk of the buyer defaulting – no matter how small that risk may be.
If you’ve read this far - Great Job! Is your head spinning? I’m here to answer any questions you may have - email me at email@example.com or give me a call at 647-893-2535.
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