If you plan to buy a home, you’ll need to come up with a down payment to get approved for a mortgage.
Considering the cost of homes these days, your down payment will cost you tens or even hundreds of thousands of dollars. Fortunately, minimum down payment amounts are accepted, which may help make homeownership more attainable. In fact, you may even be able to secure a lower interest rate despite the lower down payment amount.
But why would a smaller down payment (i.e. high ratio mortgages) result in lower interest rates?
Key Points
- Mortgages with a down payment lower than 20% are called high-ratio mortgages.
- High-ratio mortgages require mortgage default insurance.
- Mortgage default insurance can result in lower mortgage interest rates, as the added insurance protects the lender’s investment and reduces their risk.
- Offering a smaller down payment can not only help secure lower interest rates but make it easier to buy a home with less time spent saving.
Do Smaller Down Payments (High-Ratio Mortgages) Qualify For Lower Mortgage Rates?
Although it may sound counterintuitive, a small down payment (one that is less than 20%) can help you qualify for lower mortgage rates.
While a high-ratio mortgage (i.e., a mortgage with a down payment of less than 20%) carries more risk for the lender, this risk is offset by the mortgage default insurance borrowers must add to the mortgage.
As such, despite high-ratio mortgages being more risky, lenders are willing to offer lower rates due to the added mortgage default insurance.
It’s worth mentioning that you can typically get the same low interest rate of an insured mortgage by putting 35% down.
| Note: That said, while a lower mortgage rate may lead to money saved on interest, it is often offset by the premiums paid on the mortgage default insurance. |
Learn more: Your Guide To Mortgage Down Payments In Canada
What Is Mortgage Default Insurance?
Mortgage default insurance—commonly referred to as CMHC Insurance—is a premium borrowers pay when their down payment is between 5% and less than 20%. It can cost between 2.4% and 4% of the mortgage amount, though the exact rate depends on the down payment.
Typically, the lower your down payment, the higher your CMHC cost will be. It may also be higher if you’re borrowing your down payment, or if you opt for a 30-year amortization.
CMHC insurance can be paid upfront in one lump sum, or you can opt to pay it with your mortgage.
Learn more: Mortgage Default Insurance (CMHC Insurance)
How Does Mortgage Default Insurance Lead To Lower Mortgage Rates?
As mentioned, mortgage default insurance is a premium you pay when your down payment is less than 20%. But what does it do?
Essentially, mortgage default insurance protects the lender from borrowers who default on their mortgage. The risk lenders take when lending money is significantly reduced when borrowers pay the mortgage default insurance premium. It covers lenders of any loss they may incur due to borrowers defaulting on their mortgage.
For example, let’s say a borrower stops making payments and the lender is forced to seize the property and resell it to recoup the lost funds. If the lender is unable to sell the property for the amount that is still owed on the mortgage, the insurer will reimburse the lender for the loss they incur.
As such, when a mortgage is insured, lenders are able to provide the mortgage at a lower cost, which is usually shown in the form of a lower mortgage interest rate.
| Can You Get A Lower Interest Rate With No Down Payment? Generally no. Lenders usually offer lower interest rates for high-ratio mortgages, which are mortgages with down payments between 5% to less than 20%. With zero down payment, you’d be considered a higher-risk loan, which may lead to higher interest rates. Mortgage lenders usually prefer at least a 5% down payment because it reduces their overall risk when lending large amounts of money. Moreover, as mentioned, mortgages with down payments of less than 20% also require mortgage default insurance which further protects the lender. |
Pros And Cons Of Making A Smaller Down Payment
A smaller down payment might be easier to save for, but there are some downsides to it as well that you should be aware of.
Pros
The benefits of making a smaller down payment are as follows:
- Money Can Be Invested Elsewhere – If you sink all your money into a down payment, you’ll have little left over to invest in other investment vehicles. By making a smaller down payment, you can open up your pool of available funds to be invested somewhere else.
- Lower Interest Rate – As mentioned, a smaller down payment often means a lower interest rate. That’s because the lender is protected with mortgage default insurance and can pass some of those savings on to you in the form of a lower rate.
- Takes Less Time – Saving tens of thousands of dollars or more for a down payment can take a lot of time and effort. But with a smaller down payment, you may be able to realize your dreams of homeownership sooner rather than later.
Cons
The downsides of making a smaller down payment include the following:
- Larger Amount Required – A smaller down payment means a higher loan amount. That means you’ll owe more, which can take a lot longer to pay off your mortgage.
- CMHC Mortgage Insurance Fees – If you don’t make at least a 20% down payment, you’ll be slapped with additional fees in the form of mortgage default insurance premiums. This can offset any savings you may have realized with a lower interest rate.
- Higher Monthly Payment – The smaller the down payment, the higher the loan amount, as mentioned. And in turn, that means higher monthly mortgage payments, especially if you choose a shorter amortization period.
- More Interest Paid – While you may be able to secure a lower interest rate in many cases with a smaller down payment, you’ll end up paying more in interest over the life of the loan because of the higher loan amount you’re stuck paying.
What To Consider Before Making A Small Down Payment
When deciding on the size of your down payment size, consider the following factors:
Long-Term Costs
A smaller down payment is easier to save up for and can get you into the housing market sooner than later. But it can also mean more money spent on interest over the life of the loan.
Financial Goals
You may have other investments that you might want to park your capital in rather than commit a bigger chunk of your finances in a down payment. In this case, be sure to weigh the potential return on your investments to see if they outweigh the costs associated with the added interest costs and mortgage insurance fees that tend to come with a smaller down payment.
Emergency Fund Requirements
It’s a good idea to have an emergency fund available in case of an urgent last-minute expense. You may want to avoid draining your savings in the name of making a bigger down payment.
What Are Insured vs. Uninsured Mortgages?
In Canada, mortgages are either insured or uninsured:
| Insured Mortgages | Uninsured Mortgages | |
| Down Payment | Less than 20% | 20%+ |
| Home Price Limit | Under $1.5 million | No limits |
| Interest Rates | Lower | Higher |
| Amortization | Up to 30 years* | Up to 30 years |
What Are Uninsured Mortgages?
Uninsured mortgages are used when the down payment is at least 20% or more. With no mortgage default insurance in place, the lender assumes more risk, which can result in higher interest rates. There is no home price limit for uninsured mortgages.
What Are Insured Mortgages (High Ratio Mortgages)?
Insured mortgages require mortgage default insurance when the down payment is less than 20% of the purchase price. Borrowers are required to pay insurance premiums, though lenders are the ones who are protected in case of loan default. The maximum purchase price for an insured mortgage is $1.5 million.
Learn more: High Ratio Mortgages
What’s The Difference Between Insured Vs Uninsured Mortgage Rates?
Insured mortgage rates are generally lower because the loan is backed by mortgage default insurance. This reduces the lender’s risk. Uninsured mortgage rates are typically higher because there’s no mortgage default insurance, so the lender assumes more risk.
Final Thoughts
There’s no getting around a down payment when it comes time to take out a mortgage to buy a home. But you may be able to get approved with a smaller down payment without having to get slapped with a high interest rate. Just keep in mind all the other fees that may come with a minimum down payment amount.
