The lowdown on low down payments – Mortgage insurance a must for those with high-ratio loans

Hot markets and cold feet might keep some people out of the housing market, but a lack of upfront cash doesn’t have to be an obstacle. While it’s long been the convention in the industry to start with a 20% down payment, the availability of mortgage default insurance means ownership is still possible with as little as 5% down, as long as the buyer meets industry standards of income and creditworthiness.

“What mortgage insurance allows people to do is to get into the market with today’s prices, with today’s low interest rates, once they have determined that home ownership is right for them,” says Mary Stergiadis, principal for Ontario business development at Canada Mortgage and Housing Corp. The insurance repays lenders if a homeowner defaults on payment.

People with insured mortgages can take advantage of the same interest rates as those taking out conventional mortgages, she says. And the insurance doesn’t cost as much as some people think.

Here’s how it works: With 5% down, the insurance premium is 2.75% of the mortgage. On a $400,000 property with $20,000 down, the mortgage insurance premium would be $10,450. That would bring the total being borrowed to $390,450. Assuming a fiveyear closed at 3.75% amortized over 25 years, the monthly payment would be about $2,000, including less than $55 a month for the insurance. The same property with 20% down would have a monthly payment of $1,640.

“What consumers have to ask themselves is what $60,000 means to them in terms of savings,” Ms. Stergiadis says, referring to the amount needed to reach a 20% down payment for this property. “How long would it take to save that additional down payment? Where will home prices be within that time? Where will interest rates be?”

(But note that the tax on the premium – 8% in Ontario – cannot be amortized and is due on closing.) The insurance rate goes down as the down payment goes up. For buyers with 10% down, for instance, the premium is 2%; with 15% down, it’s 1.75%.

A popular misconception is that this insurance applies only to the primary residence of the borrower. But it is also available for a second property, such as a home or condo in the city to cut a commute or to house an aging parent or a student. CMHC does not, however, insure recreational properties.

Private mortgage insurers, such as Genworth Canada and Canada Guaranty, also insure high-ratio mortgages. The rates offered match those of CMHC; consumers usually aren’t aware of differences, as lenders apply directly to the insurers once an offer has been made and accepted on a property.

Genworth estimates about 30% of Canadian mortgages are insured, down from historical levels of as high as 40%. That percentage tends to be lower in the GTA, says Jason Neziol, Genworth’s regional vice-president of sales for Ontario and the GTA. That’s because higher prices mean more people make larger down payments in order to quality for mortgage loans.

Mr. Neziol says private insurers play an important role in the market by providing more choice for lenders and helping to educate the public about options. “It gives options to consumers,” he says. “It’s good for lenders to have a choice in terms of what insurance providers would do.”

You don’t have to be a first-time buyer in order to qualify. Plus, even conventional mortgages, those with 20% or more down, can be insured. This can happen if a loan is slightly outside of a lender’s usual parameters.

And there can be a rental component. A buyer can purchase a duplex with 5% down, for instance, but must live in one unit. A 10% down payment is the norm for three-and four-unit properties, where one unit is owneroccupied and the others are rented out. The point, Mr. Neziol says, is to be aware of the many options available.

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Mortgage 101: Where to start – The numbers behind the home

You’re 29 years old. You’ve been in a solid job for a couple of years and your partner has a good job, too, giving you a gross household income of $125,000 a year.

The housing market has recovered after the dip caused by tougher lending rules and prices continue to rise, so it might be time to act and leave renting behind. Interest rates are holding steady at still-low rates. And your parents are ready to gift you a healthy down payment.

Now it’s time to determine how much you can afford. Online mortgage calculators, of which there are many, will provide a rough idea. And this is where many people start. You could click on RBC Royal Bank’s calculator and punch in the numbers, which include your income and debt information. Other sites may ask for slightly different numbers, but the process is generally the same.

Your magic number for buying is $505,000. With a down payment of $75,000, a 25-year amortization and a five-year locked-in rate of 4%, your monthly mortgage payment will be $2,310.

While this may seem doable, mortgage professionals highly recommend more work be done before heading out to find that dream home. And they caution against jumping right to the maximum mortgage potential.

“We don’t want to put someone into a house just because it’s their maximum,” says Jennifer Bissonnette, a mortgage specialist at RBC. “You want to leave some wiggle room. You don’t want to live just to pay your mortgage.”

Online calculators are good tools, but they aren’t always realistic, agrees Laura Parsons, a financial expert at BMO Bank of Montreal. “It’s good to go there and have an idea. But there are many other components to consider.”

A chat with a mortgage professional will help put things in perspective. You might be asked about your plans to start a family, how much you are contributing to your RRSP, what your career goals are, how old your cars are.

This conversation will get you thinking about whether you really want to borrow $439,000, which includes the mortgage principal and mortgage default insurance. You should also consider the ramifications of rates rising in the future.

“Maxing out your borrowing is not always where you want to be,” Ms. Parsons says. “You can’t see into the future, but you have to have some idea of what to prepare for.”

There will be property taxes, homeowner’s insurance, utilities and regular maintenance. There may be emergencies, such as a leaking roof, a broken furnace or a flooded basement. There could be landscaping, snow removal costs or condo fees. All this needs to be rolled into the budgeting process. “You may have to buy a lawnmower,” Ms. Parsons says with a laugh. “A lot of people don’t think about these things.”

Mary Stergiadis, principal for Ontario business development at Canada Mortgage and Housing Corp., explains some guidelines for determining a target home price.

There’s total shelter costs, which include month-ly payments for principal and interest, taxes, heating and half of a condo fee, if there is one. (According to industry standards, half of the fee is seen to represent true shelter costs, while the other half includes things like condo maintenance.) This total is divided by monthly gross household income. As a general rule, the total monthly housing costs should be no more than 35% of gross household monthly income.

Then there is the total debt-servicing-ratio calculation, which adds other monthly debt payments to shelter costs. This total is divided by gross monthly income. Again, as a general rule, servicing these costs should be no more than 42% of gross household income.

CMHC has a suite of online calculators to help homebuyers crunch the numbers. “If they are over the ratios that are allowable within the industry, they would have to look at lowering the mortgage,” Ms. Stergiadis says.

At this point, you might think a less expensive property might be more reasonable. But it sometimes happens, though less often, that people find they qualify to borrow more than they expected. Once a target price has been established, it’s time to apply for a pre-approved mortgage.

A pre-approval will help you refine the process and know exactly what you have to work with when you find the right place and are ready to make an offer. A pre-approval entails a credit check and information such as the rate being offered (usually locked in for 120 days), as well prepayment options. Ask for details about such closing costs as land transfer taxes and legal fees.

A word of caution: A preapproval is not a final approval, so make sure you know what the condi-tions of getting final approval are and that you can meet them. If you go out and lease a new Mercedes before closing, you could end up with a nasty surprise about your ability to qualify. And don’t forget to save a little for that new lawn mower.


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Pondering merits of low-rate mortgage financing? Crunch the numbers when deciding whether to convert from variable

With today’s unprecedented low interest rates, homeowners may be wondering if it’s a good time to refinance or lock in their variable-rate mortgages.

The Bank of Montreal last week introduced a 2.99-per-cent five-year mortgage — believed to be the lowest five-year fixed mortgage rate ever.

Although BMO’s low-rate mortgage has some restrictions — including a maximum 25-year amortization and limited prepayment options — it could potentially save a lot of money for homeowners who qualify.

After BMO announced the new mortgage, some other banks followed suit, announcing similar low-rate products, but none we found that match the five-year term. TD and RBC announced 2.99-per-cent mortgages for four-year terms.

“In today’s environment, it’s an extremely competitive rate at about [.5 of a percentage point] off what most financial institutions have posted right now,” said Carolyn Heaney, area manager for specialized sales, BMO. “People are very interest-rate savvy, so a 2.99 has caused a lot of inquiries.”

BMO introduced its low-rate mortgage product in March 2010; the product’s previous low was 3.29 in December 2011.

Richmond mortgage broker Chris Pughe said just one of the lenders she deals with, AGF, is offering 2.99 for a five-year fixed mortgage, but several are close.

“There are some with a four-year at 2.99 and a lot of the lenders are at 3.19 or 3.29 right now [for five years],” Pughe said.

Any decision to refinance or lock in will depend on what a person has already committed to — term and interest rate — and what penalties will have to be paid. At BMO, mortgage penalties are whichever is greater: three months’ interest or an interest rate differential, which is a calculation based on what the bank will lose in interest if you pay your mortgage off early and renew at a better rate.

But penalties vary from one financial institution to the other, Pughe said. She gave the example of a five-year mortgage at Vancity, where for the first three years an interest rate differential penalty will apply, but in the last two years the penalty will only be three months’ interest.

Pughe said it only takes a mortgage broker or banker about 10 minutes to figure out if breaking your existing mortgage and renewing at these low rates makes financial sense.

Most people who locked in about five years ago are at about 5.09 to 5.49 now, Pughe said. If they locked in three years ago, in late 2008, rates were 5.0 to 5.5 and in early 2009, they were a bit lower at 4.24 to 4.5. Today, the equivalent rate is about 3.29.

Although 5.29 is the regular posted five-year rate at BMO, the rate charged is usually less because banks offer discounts based on their relationship with a customer.

The 5.29 rate is close to the lowest posted five-year rate BMO has offered in the past 20 years, which was 5.25 in April 2009.

But it’s still anybody’s guess whether this will be the bottom, if rates will drop further, or go up.

“I remember when rates dipped in 2004-05, the best rate was 4.3 and we all thought we’d seen the bottom,” Pughe said.

As far as variable-rate mortgages go, Pughe said if you’re lucky enough to have one with a good discount, it’s probably a good idea to hang onto it.

“The best discount you’re able to get right now with a variable-rate is prime minus two, which is 2.8 per cent,” Pughe said “That has shrunk in the past two or three months because we were able to get prime minus [.8 or .75 of a percentage point] not that long ago.”

Most people taking new mortgages are going with fixed rates, Pughe said.

“It depends on people’s personal risk tolerance,” Pughe said. “There are people who hear on the news that interest rates are going up, then they call you at 11 at night. Those are the people who shouldn’t be in variable rates.”

Even though BMO is promoting its 2.99 mortgage, Heaney said most people opt for a 30-year amortization rather than 25.“Everyone stretches out and that’s not bad advice,” Heaney said.

“One suggestion is to go out to the maximum and then you can control, as the consumer, how you want to pay that back.

“People are more conscious of their debt today, and they want to pay their mortgages off as quickly as possible, but they don’t want to be house poor, where they can’t do anything.”

Heaney said the decision about whether to lock in a variable rate is a matter of how well you will sleep at night.

“It’s always a gamble when you go into a longer-term rate because you don’t know what the future rate will be, but a five-year at 2.99 is pretty much unprecedented,” Heaney said.

For Pughe, the bottom line is if you have a variable mortgage with prime minus .75 or .8 of a percentage point, leave it, because there’s no pressure on prime to go up.

“But if you’re in a fixed term, and if you’re paying a three- month interest charge penalty, it makes a load of sense to make a phone call.”

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