Common sense, from a risk perspective, would dictate a lower interest rate for a larger downpayment when buying a home or investment property. Afterall, the greater the capital the applicant has invested into the property, the less "risky" the mortgage would be from a lending perspective, right? Wrong!
Ever since the 2008 credit crunch, common sense lending is pretty much a thing of the past. Insured mortgages, downpayment less than 20%, have lower interest rates than conventional, downpayment with more than 20%!
Why Are Insured Mortgages Offered At A Lower Interest Rate?
Typically lenders bulk insure mortgages . This allows the banks to sell off these mortgage as investments. Without getting into the complexities of securitization:
- Mortgages with less than 20%: Applicants pay for the insurance premium (CMHC, Genworth or Canada Guarantee).
- Mortgages with 20% or higher downpayment: Lenders pass on the cost of the insurance premium via a higher interest rate
Example: fully featured mortgage with less than 20% downpayment is offered at 2.49%, where as a conventional mortgage is offered at 2.59%
What About Investment Properties?
From a lending risk perspective, investment properties financing is riskier than an owner occupied property for the following reason: if the applicants encounter lifestyle changes such as loss of income, they are more likely to do what it takes to keep their home mortgage up to date than keeping the investment property mortgage up to date. Hint: Buy a positive cash flow investment property. Some lenders limit the number of properties an applicant can finance where others limit the total dollar amount lent to an applicant. Example: no more than 2 rental properties financed by the same lender or no more than $1.5 million in mortgages lent to one client.
Investment properties require a minimum of 20% downpayment and in certain cases 25% downpayment depending on the applicants' credit worthiness and the property details.
True Cost of CMHC Insurance Premium
Here is a case study of $500k purchase with 20% downpayment vs 15% downpayment:
20% Downpayment: Mortgage $400k amortized over 25 years at 2.59%, $1809.84 monthly payment.
15% Downpayment: Mortgage $432,650 ($7,650 insurance premium added to the mortgage) amortized over 25 years at 2.49%, $1935.97 monthly payment.
Payment difference: $1,935.97 - $1,809.84 = $126.13 x 60 months (5 year term) = $7,567.20 which is roughly the insurance premium amount capitalized into the mortgage.
Mortgage balance at renewal: $339,163 vs $366,112, a difference of $26,949.
Net difference: $26,949+$7,567.20-$25,000 (difference in additional downpayment) = $9,516.69 in 5 years only. Over the life of the mortgage, the number grows.
What's the point I'm conveying? The lower interest mortgage doesn't payoff in the long term due to the added insurance premium (compounded interest over 25 years) and be nice to your parents or siblings who might consider gifting the difference in downpayment to get you to 20%! The overall cost of financing is more important than just looking at mortgage rate.
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