Why smaller down payments can lead to better mortgage rates

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It doesn’t make much sense, but a skimpy down payment on a home might  actually get you a better mortgage rate in today’s market.

Blame the government subsidy known as mortgage default insurance, which  ultimately makes it less risky to lend money to someone who has only 5% down  compared to someone with 20%.

Consumers with less than 20% down must get mortgage default insurance in  Canada if they are borrowing from a federally regulated bank. The cost is up to  2.75% of the mortgage amount upfront on a 25-year amortization but that fee  comes with 100% backing from the federal government if the insurance is provided  by Crown corporation Canada Mortgage and Housing Corp.

It’s already happening secondary lenders are now offering rates that are 10 to 15  basis points higher for a closed five-year mortgage for uninsured consumers.

The crackdown on mortgage insurance announced by Jim Flaherty, the federal  Finance Minister, could exacerbate the situation. Mr. Flaherty, who mused to the  Financial Post editorial board in May 2012 about getting CMHC out of the mortgage  insurance business, has placed the agency under the authority of the country’s  banking regulator, the Office of the Superintendent of Financial  Institutions.

Mr. Flaherty also put in new rules on bulk or portfolio insurance. The banks  had been paying the insurance premium on low-ratio mortgages – loans with more  than 20% down – because it was easier to securitize them.

However, Mr. Flaherty says those loans will no longer be allowed in the  government’s covered bond program.

“You are seeing an interesting phenomenon where if you go to get a  mortgage today, you are oftentimes quoted a higher rate on a conventional  mortgage. Presumably you have less risk because you have more equity.”

It all depends on the lender. For now, the Big Six banks have kept consistent  pricing between low-ratio and high-ratio mortgages.

Farhaneh Haque, director of mortgage advice and real estate-secured lending  at Toronto-Dominion Bank, says competition among the Big Six banks is keeping  rates down and stopping any of them from raising rates for conventional  mortgages.

“When we can’t securitize a deal, there is a different cost of funds but the  bank continues to offer the same rate,” said Ms. Haque, adding her bank did  charge a premium for stated income deals, which usually means self-employed  people, but removed the difference last week. The premium was 20 basis  points.

“Looking at the competitive landscape, it was a disadvantage,” she says. “We  were aiming to target pricing that was specific and for the risk appetite for  that deal itself. We didn’t want one [deal] compensating for the other.”

But the banks have bigger fish to fry than just your mortgage. Those with the  larger equity position in their homes may be a costlier mortgage to fund, but  they also could be a future line-of-credit customers. There’s also the potential  for other business such as RRSPs and TFSA, so losing a few basis points might  make more sense in the long run.

Peter Routledge, an analyst at National Bank Financial, says he wouldn’t want  to be an investor in a bank that approached its business any other way, though  he did acknowledge there is a cost to keeping those conventional mortgages.  “It’s in effect a subsidy,” Mr. Routledge says.

While banks may be eating some of the costs for people who are not eligible  for a subsidy, if they continue down that road they might not be able to match  the rates some of the secondary lenders are able to offer with insured  mortgages.

It doesn’t sound like much, but the difference between, say, 3.14% and 3.29%  on a $500,000 mortgage amortized over 25 years would be about $3,500 extra in  interest on a five-year term.

It’s true that those people getting the better rate pay a hefty fee up front  in insurance premiums, but they also represent a greater risk to the taxpayer.  Do they deserve a better rate?



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About Sky Financial

We incorporated The Mortgage Centre-Sky Financial Corp. in August 1992 in Edmonton Alberta. Furthermore we opened offices in Fort McMurray, Cold Lake, Grande Prairie, Red Deer, Stettler, Saskatoon, Moose Jaw and Prince George BC.

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