Why do low down payment mortgages sometimes get better rates?
Posted on Aug 17, 2012 in Mortgage Market Updates and News
The news about getting better mortgage rates with a lower down payment has been in the news recently -- if you have a down payment of only 5% and your credit is good, then you could get a rate up to 20 basis points better than if you had a higher down payment. For example, instead of 3.59% on a 5-yr fixed rate you could pay 3.39%.
It may seem counterintuitive and just plain unfair if you're sitting with the higher down payment, but there is method to this interest rate madness. It comes down to two things: insured risk and capital.
Let's face it, bank lenders like sure things and try to reduce their risk as much as possible. When a mortgage is insured, which is the case in high-ratio or low down payment mortgages; it requires the bank to hold less capital against it. Since there is a cost to capital -- both a direct cost as well as an indirect cost, lenders want to apply capital to the areas that will yield the highest return. So, less capital equals less cost, which translates into better rates for insured mortgages. The high-ratio risk is transferred through default insurance from the lender to the insurer. This, despite the fact there may be less risk from clients with more equity.
"It's a conundrum of default insurance," explains Grant MacKenzie, CEO of Canadiana Financial Corp. "Sometimes the toughest credit profile gets the best rates."
Until recently, some low ratio mortgages were bulk insured by Canada Housing and Mortgage Corporation (CMHC) but when its insurance cap of $600 billion dollars hit $541 billion dollars, it became more difficult to continue to offer portfolio insurance.
"All Mortgages that are not on a lenders balance sheet - are usually securitized. In Canada, one way we do that is through the Canada Mortgage Bond (CMB)," MacKenzie said. "Lenders have been paying the insurance premium on low-ratio mortgages as it was necessary to securitize them and, lenders can decide whether to add a premium to the rate to cover the increased costs."
"Also, lenders need a balanced portfolio of purchases, refis, Alt-As and rental mortgages," MacKenzie added. "So a premium applied to rates on certain products can effectively speed up or slow down the volume of that mortgage product."
For now, big lenders will likely cover the increased costs with no direct effect on the consumer said John Bordignon, Executive Vice-President of Strategic Development for Paradigm Quest. "Most big banks have stayed away from adding a premium but it will be a big deal over time," he said. "Lenders will eventually want a higher spread and that will be passed on to the consumer."
Bordignon also said that some deals may be harder to fund because of the increase in costs. "All insurers have dollar limits, so it's up to them to decide which products to insure. Since limits have been reduced, money becomes scarcer, which drums up the costs."
However, competition between banks and lenders has kept the interest rates consistent between high and low ratio mortgages, but some monoline lenders have added a rate premium to its conventional business. The industry has already seen premiums added to stated income products. A few bank lenders added the premium then removed them, opting to cover the spread themselves and for very good reasons. Those with large equity positions are potential customers for other business such as lines-of credit, TFSA's, and RRSPs.
"As time progresses, lenders will want to cover those increased costs and we'll likely see consistency in all rates across all lenders," Bordignon said. "The entire market will move that way and costs will be passed onto the consumer, but camouflaged in slightly higher rates."
As always, speaking to a mortgage broker will present you with all the options for your mortgage transaction and help you find the best rate and product for your personal situation.
-TMG The Mortgage Group Canada Inc
Contact your TMG Mortgage Professional, Sharie Marie Francoeur, today for more information