Andrej Miletic

Picture this: You spend 15 or 20 years slaving to pay down your mortgage. You’ve built up 80 per cent equity in your home and you have just five years left until it’s free and clear.

After all that effort, after all that built-up equity, you deserve the lowest mortgage rate around, right?

Perhaps, but that’s not how it works in our mortgage market. The people rewarded with the lowest rates are the ones with big, fat six-figure mortgages, and there are two main reasons for it. The first one won’t surprise you, but the second one might.

The No. 1 reason that lenders covet monster loans is profit. If you’ve got a giant mortgage, banks and credit unions figure you’ll have more assets to invest with them, more savings to rot in their 1-per-cent savings accounts, more purchases to put on their credit cards and credit lines, more appetite for insurance and so on.

That’s why it’s easier to grind down a bank’s mortgage specialist on a $700,000 loan than one for $70,000. (One exception is when you have a small mortgage, plus a large amount of non-mortgage business with that lender, and you threaten to leave them.)

Brokers are the same way. They earn commissions just like bankers. And the bigger the mortgage, the bigger the commission.

That’s why some of the best deals on rate-comparison websites say things such as: “For mortgages of $300,000 or more.” Mortgage minimums are becoming more and more common.

For most brokers, one $300,000 mortgage is better than doing six for $50,000. Of course, six $50,000 clients means six potential referral sources instead of one. But it also means exerting six times the effort to close those mortgages, and time is a scarce resource for brokers.

The second reason small-time borrowers do worse in the rate department is risk. It’s one of the most counterintuitive things in the mortgage industry, but someone with a puny 5-per-cent down payment often gets a better rate than someone who’s been pounding down his or her mortgage for decades.

“That’s crazy,” you may say. “Isn’t my mortgage less risky if I have a huge amount of home equity?”

Technically, yes. But if you’re dealing with a lender who sells mortgages to investors, that’s not always reality. Mortgage investors prefer the safety of insured mortgages. Those are mortgages where an insurer, backed by the Government of Canada, guarantees to pay off the balance if the borrower defaults.

There’s a cost for this insurance, and when the mortgage is less than 80 per cent of the property value, the lender must typically cough up this fee. By comparison, when the “loan-to-value” ratio is more than 80 per cent, it is the borrower who pays that insurance premium. For lenders who sell their mortgages to investors, avoiding the cost of insurance lets them offer slightly lower rates – usually about one-tenth of a percentage point lower.

Quick tip: If you’re renewing a mortgage that you paid to insure, you’ve built up 20 per cent equity or more and you’re switching lenders, provide your insurance policy number to your new lender or broker. Keeping your default insurance in force costs you nothing and gives you a wider selection of lenders and rates when you renew the next time.

So, where can diligent borrowers go for a deal on a mini-mortgage? Most people just renew with their existing lender. Saving one-tenth of a per cent interest on a $50,000 mortgage with a five-year term and amortization is only about $130. Unless you need to refinance or add a secured line of credit, the trivial savings don’t offset the hassle of reapplying elsewhere, collecting your documentation, getting your home appraised (which you must often pay for), meeting with a lawyer or closing agent, paying your lender’s discharge fee and so on.

None of this should stop you from trying to better your rate. At the very least, use competitors’ rate quotes as a bargaining chip, either with your existing lender or with a broker who doesn’t have a mortgage minimum. And if you have loads of other business with your bank or credit union, definitely use that as leverage. There are always other lenders who would welcome all of your banking business with open arms.

Published Thursday, Nov. 19, 2015 5:54PM EST

Last updated Friday, Nov. 20, 2015 8:04AM EST

We could cool the housing market in a minute by raising the minimum down payment to 10 per cent.

That’s too extreme a measure right now because prices in many cities outside Vancouver, Toronto and Hamilton are either rising at a moderate pace or falling. So let’s do this instead: Urge all first-time buyers to unofficially regard 10 per cent as the minimum. In fact, let’s suggest a 10/10 rule: Put 10 per cent down and plan to stay put for 10 years.

If you buy a house today, you have to be prepared for the possibility of a pullback in prices. Canada Mortgage and Housing Corp. warns that house prices have run ahead of the underlying economic fundamentals in 11 of 15 major markets, and that Toronto, Winnipeg, Regina and Saskatoon are of particular concern. The 10/10 rule is how you play defence in this kind of a market.

Risks posed by falling real-estate prices were highlighted last week by the Canadian Centre for Policy Alternatives in a report about the impact on young homeowners. The CCPA estimates that a 20-per-cent decline in real-estate prices would put 169,000 households of 20- and 30-year-olds under water, which means they would owe more than the value of their home. That is equivalent to about one in 10 homeowners in this age group.

Twenty per cent is the midpoint between the Bank of Canada’s estimate that house prices are overvalued by 10 to 30 per cent. Sound too extreme? Even a small drop could hurt someone who makes the current minimum down payment of 5 per cent.

Introducing the Gottabuys, a nice young couple that put the minimum $20,000 down on a $400,000 home and was charged $13,680 in mortgage default insurance premiums. The premiums are added to the couple’s mortgage principal, thereby increasing their debt to $393,680 and lowering their equity to 1.6 per cent.

Over the next year or so, the housing market weakens and the Gottabuys find that their home has fallen 10 per cent in value. Even after building equity through their regular mortgage payments, they are now under water. If they want to move, they will have to pay their lender the difference between the lower value of their home and their mortgage balance.

Okay, so they stay put. Since they have never missed a mortgage payment, their lender will almost certainly not bother them about topping up their equity to get back to 5 per cent. “As long as you’re paying as agreed, then the odds are that you can ride it out,” said Robert McLister, a mortgage planner at IntelliMortgage and founder of RateSpy.com.

Things get more complicated at mortgage renewal time. The couple can’t shop their mortgage around for the best rate unless they top up their equity with enough cash to get back to 5 per cent. Oh well. At least they can still expect a competitive rate from their current lender, right?

Maybe not. Mr. McLister said mortgage lenders, particularly the big banks, have access to reams of data about the housing market. If housing prices are declining in the area where the Gottabuys live, their lender may recognize that the couple’s options for getting a better deal are extremely limited.

“If we’re in that scenario, I would not be surprised in the least that lenders become a little less competitive on renewal rates,” Mr. McLister said.

Putting at least 10 per cent down on a house offers some protection against price declines. So does staying put in a house you buy for at least 10 years, which should be long enough for house prices to recover from any price declines after you buy. Also, owning for a decade will give you a chance to build equity the quiet way, by simply making your mortgage payments and not getting help from price gains.

A hot housing market may no longer be a national story: Vancouver, Toronto and Hamilton are still surging, and that’s about it. But playing defence in the housing market makes sense no matter where you plan to buy. Remember the 10/10 rule, or hold off on buying. The oldest defensive housing strategy in the book is renting.