What is a High Ratio Mortgage?

You shouldn’t even think about signing your first mortgage until you have a firm grasp on the different types of mortgages and the unique requirements that come along with each of them. Some types of mortgages will require additional mortgage insurance, some will influence the interest rates you’re offered, and some will allow you to seek out a condominium for a larger purchase price, among many other variable traits that each carry their own pros and cons.

Right now, we’re going to focus specifically on high ratio mortgages for people who can only afford a down payment of less than 20 percent of the total price of the condominium. Having a lower down payment isn’t ideal, but it’s also pretty common and certainly not something that should scare you away from an investment, since it’s still usually advantageous over renting, in just about any scenario.

Let’s take a look at mortgages for people who can’t make a down payment of 20% of the purchase price, how it can impact mortgage payments and mortgage rates, interest rates, and more.

What is a high ratio mortgage?

A high ratio mortgage is a type of mortgage where the buyer has a down payment of less than 20% towards the purchase price of a condominium. This equates to a loan to value ratio of more than 80%. A lower ratio would be when the buyer can put down a larger down payment, which makes the loan “safer” from the lender’s point of view.

What is default insurance for a high ratio mortgage?

From the lender’s perspective, high ratio mortgages can be risky. This is because borrowers who purchase a condominium at the top of their budget will take longer to build up equity (meaning the lender is responsible for more of the loan for a longer period of time), and they are statistically more likely to default on the loan.

If the lender has to foreclose on the condominium, they have to hope that the property has maintained enough resale value for them to be made whole. With house prices often rising, this isn’t necessarily a huge risk, but it factors in nonetheless. The condominium could need repairs, could take time to sell, and there are always additional fees associated with selling a property. If they auction it off quickly, they might not get top market value, either. These are all factors that contribute to the overall risk of a loan.

To help counteract this, it is a requirement for borrowers to purchase special insurance when applying for a high ratio mortgage. The goal of this insurance is to provide protection to lenders in the event that the borrower is unable to make their mortgage payment. 

This insurance can be costly since it’s enabling condominium buyers to purchase property that may otherwise be unattainable for them. Since they’re in a higher risk category, and the insurance company could end up being responsible, the costs go up accordingly.

What is the minimum down payment required for a high ratio mortgage?

The amount of the down payment required for a mortgage is based on a percentage of the purchase price of the property. Since the property is used as collateral on a mortgage, having less of a down payment means you don’t own as much of the house initially, which means the risk is higher for the lender. The minimum down payments can vary around the world, but they tend to be similar.

There are federal housing administration loans for borrowers with great credit that can require a down payment as low as 3.5%. Generally speaking, a down payment of less than 20% of the cost of the real estate is considered to be a high ratio mortgage, which will require additional insurance.

The good news is that you can refinance your loan once your equity has surpassed that minimum, and you will no longer require mortgage insurance. This is a good goal to work towards and something to keep in mind when choosing the initial terms of your mortgage.

Why do high ratio mortgages have lower rates?

Lenders can offer lower rates on high ratio mortgages because borrowers are legally required to pay insurance for this type of loan. Since lenders are protected through insurance, they have less to lose by offering a low rate than they do for uninsured (or conventional) mortgages, which carry the risk of the borrower defaulting with no protection for the lender.

As a condominium buyer, this insurance can be quite costly, so while you may get a slightly more generous interest rate, you aren’t necessarily going to come out on top. Furthermore, since people with high ratio mortgages are more likely to have trouble making their payments and defaulting on their loans, that’s another way in which this type of mortgage can be costly.

Do you want a high or low mortgage rate?

When it comes to choosing a high or low mortgage rate, it really depends on your financial situation. If you have less equity available but you have significant income available each month to pay for your mortgage, a higher mortgage payment rate might make more sense for you.

If you have more money saved up when shopping for your loan, buying down your mortgage rate by paying for some expenses upfront might be a better decision in the long run. Typically, a low mortgage rate throughout the duration of your loan means you’ll pay less interest overall but that doesn’t mean it’s a good decision for everyone. 

What is a 5 year closed high ratio mortgage?

Typically you can choose between an open or closed mortgage when applying for your high ratio loan. Closed mortgages offer a fixed rate that lasts the duration of your term (in this case, 5 years) but they come with certain stipulations.

While you have the comfort of knowing what your interest rate will be for the next 5 years, you may face penalties if you put extra money towards your mortgage payment than originally agreed upon. This might seem odd, but your lender makes money from the interest paid on your loan, so they don’t want you to pay the balance too quickly (at least, not without extra penalties.)

Most lenders will allow a certain amount of “pre-payments” per term, but it’s up to you to read the fine print to ensure you don’t go over that amount. Otherwise, your lender will charge a significant penalty to help recoup the costs lost by overpaying on your mortgage. You’ll have to run the numbers to determine whether or not these extra fees are worthwhile for you.

Final Thoughts on High Ratio Mortgages (Pros and Cons)

There are pros and cons to taking out a high ratio mortgage. The pros include the potential of paying a lower interest rate and being able to buy a more expensive property than you might otherwise be able to afford if you were required to put down a larger down payment. For people who couldn’t otherwise afford a large down payment, it gives more housing opportunities, and a chance to build equity instead of continuing to rent. When used responsibly, and to buy a condominium within your means, this is a great tool.

The cons are that you’ll be required to pay for expensive mortgage insurance and that it will take you longer to own your condominium. This also increases the risk of being in a position to sign a mortgage that you may have difficulty paying should your finances take a turn for the worse down the road, if you use this to purchase a condominium outside of your means. As previously mentioned, mortgage default insurance is required since people with high ratio mortgages are more likely to default on their payments and lose their properties. That doesn’t mean it will happen to you, but it’s still important to acknowledge the possibility and to have plans to ensure it doesn’t happen.

You can wait to save up a larger down payment, but putting your goal property ownership on the backburner for too long means you’re also putting off building equity with your monthly housing payments, too.

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