Down Payment and Mortgage Default Insurance - Explained
By Nick Holloway -
One of the first steps of considering a mortgage for the purchase of a owner-occupied property, is the amount of funds available to make the purchase. Commonly referred to as a down payment, this is a percentage of the purchase price required for completing the purchase, with the remaining portion as the principal balance of the mortgage loan. There are primarily two distinct categories of down payment in Canada, a down payment of between 5% and 20%, defined as a high ratio or insured mortgage. Alternatively, with a down payment greater than 20%, this is defined as a conventional mortgage, which is further categorized as either an insurable or uninsurable mortgage. You may alternatively see the amount of the down payment expressed as a loan to value (LTV) ratio, in which case an LTV between 80% and 95% is classed as high ratio, and an LTV less than 80% is classed as a conventional mortgage.
Should the borrower require a high ratio mortgage, it would be necessary for the borrower to pay a mortgage default insurance premium. There are currently three mortgage insurers in Canada - CMHC, Genworth and Canada Guaranty, who effectively guarantee the repayment of the mortgage to the lender, in case of default by the borrower. It is primarily for this reason that you see the most competitive mortgage rates offered in this space. There are several specific guidelines for all insured mortgages, most notably the current regulations state an insured mortgage cannot have an amortization period of more than 25-years and the property price must be under $1 million. The premium which is charged to the borrower is tiered depending on whether the down payment is up to 5%, 10% or 15% of the property price. Specifically looking at the premium for a 5% down payment, the mortgage default insurance premium is currently 4% of the total mortgage amount and this amount can be added, or capitalized, into the mortgage amount.
To run some numbers, on a $400,000 property with a 5% down payment and a fixed 5-year term at a rate of 2.69% over a 25-year amortization period, the mortgage would total $380,000 and results in an insurance premium of $15,200 giving a mortgage amount totalling $395,200. The good news is that after around 16-17 months of repaying the scheduled interest and principal payments, the borrower should expect the contributed principal payments to have paid off the mortgage default premium in full (i.e. remaining principal of around $380,000), and by the end of the 5-year term, the remaining principal is reduced further to a balance of $335,760 from the original total mortgage amount. If we assume a modest appreciation in the property of say $20,000 over the same five-year period, the resulting LTV is under 80% at this moment in time.
With a conventional mortgage, most mortgages fall into an insurable bracket, which means the mortgage can be default insured and is required to follow similar insurer guidelines mentioned above. However, the difference is the lender has the option to purchase mortgage default insurance in the back end, commonly referred to as bulk or portfolio insured. With the lender purchasing the applicable insurance, this provides the lender the ability to securitize their mortgage loans which can be sold to investors, therefore reducing default risk which in turn lowers funding costs and those savings are passed to the borrower. The rate offered on insurable mortgages are typically higher than the insured mortgage, however, rates offered by a number of lenders are tiered based on LTV and become more favourable with a lower LTV ratio. This may provide the borrower a good opportunity to switch, or transfer, their existing mortgage to a new lender at the end of their term, to find a lower rate at the time of mortgage renewal.
The final mortgage to consider is the uninsurable mortgage which doesnt fit any of the above criteria, such as a purchase with an amortization of over 25 years or property value in excess of $1 million. In addition, should the borrower decide to either refinance or extend the amortization period of an existing insured or insurable mortgage, either or both actions would make the new mortgage uninsurable under current guidelines. A refinance, also referred to as an equity take out (ETO), occurs when a borrower withdraws equity from their property and increases the remaining principal of their mortgage. This differs from the definition of a switch/transfer mentioned above, where there is no material change to the mortgage amount or repayment duration.
In summary, it is important to seek the counsel of a mortgage professional who is best positioned to assess the specific needs of your circumstances and will help to advise you on the best course of action for both your initial mortgage, as well as subsequent mortgage renewals and overall debt considerations for the lifetime of the remaining loan.
Mortgage Qualification Rate is reduced from 5.34% to 5.19%, why is this important?
By Nick Holloway
Following anannouncementby the Bank of Canada, the Mortgage Qualification Rate (MQR) will be reduced by 0.15% from 5.34% to 5.19%, or 2% above contract mortgage rate (whichever isgreater). This is the first reduction we have seen in the MQR since it was last increased in May 2018.
To provide a brief recap, the MQR was introduced as part of the B20 guidelines with the express intention of diminishing the amount home buyers can qualify for in respect of mortgage financing. This was initially rolled out for high ratio mortgages (down payments less than 20%) effective from October 17, 2016, and later revised to include conventional mortgages (down payment more than 20%) effective from January 1, 2018. The net effect of these changes for all federally licenced lenders was widely reported to reduce purchasers buying abilities by approximately 20%, in comparison with previous qualification rates - which would have been based on the mortgage contract rate at the time of securing the borrowers mortgage commitment.
How is the Mortgage Qualification Rate calculated?
The Bank of Canada release the benchmark posted 5-year rate every Wednesday, which is based on the mode average of the big 6 (chartered) banks posted 5-year fixed mortgage rates. Whilst the mode average is currently split equally at 5.19% and 5.34% respectively, the Bank of Canada took a view on the overall asset changes in aggregate and determined the 5.19% was a more appropriate rate to prevail.
Why does it seem the chartered banks are permitted to determine the mortgage qualification rates?
This isan interesting question as towhy the regulators decided to use these rates to determine a qualification benchmark at the outset of setting the new mortgage rules. First we should look to understand the reasons why the chartered banks require a 5-year posted rate in the first place, when the reality of what most borrowers receive byway of a closed 5-year fixed mortgage rate is generally far lower than the comparable 5-year posted mortgage rate. We should consider that often the first time a borrower is likely tosee their chartered banks posted rateis when they find they needto break their closed fixed rate term mortgage early for whatever reason.The borrower is then required to pay apre-payment penalty based on an Interest Rate Differential (IRD) calculation, which is generally not calculated from the borrowers actual mortgage rate, butthe elevated posted rate (or using the discount received from the banks posted rate) which typically has the effect of amplifying the penalty the borrower must bear in favour of the chartered bank.
What isthe effect of a 0.15% reduction in MQR for mortgage qualification?
For borrowers who find themselves at the limit of qualifying, this will increase the amount they can qualify for. In the same way that the 2% increase in mortgage qualification mentioned earlier had the net effect of reducing a borrowers purchasing power by around 20%, here we can apply the same logic in reverse. Areduction in the MQR of 0.15% translates to an increase of a borrowers purchasing power of1.5% -in other words, home buyerscan qualify for around 1.5% more property.However, it poses the questionwhether this goes far enough considering we have recently seen far greater decreases in rates offered on fixed term mortgages, which have not been reflected equally in the chartered banks posted rates.
Nevertheless, a small victory is a victory after all.
Bank of Canada holds Policy Interest Rate at 1.75% at April 24th 2019 meeting
By Nick Holloway
As had been widely expected, the Bank of Canadas latest monetary policy statement was released today with no change to the overnight lending rate. The overnight rate remains at 1.75% after Canadas central bank last made an increase in October 2018 from 1.5%. The Bank also lowered the neutral overnight rate from 2.5%-3.5% to 2.25%-3.25%.
Accompanying the announcement, the Monetary Policy Report was issued which provides some of the key figures the Bank of Canada is tracking. The first being inflation, which remains close to the target of 2%, with a dip in CPI inflation predicted for the 3rd Quarter. The Real GDP figures forecast growth in 2019 of 1.2%, and around 2% in 2020 and 2021.
So, whats causing this pause in interest rate increases, and is there any scope based on the current figures for the Bank of Canada to increase stimulus to the economy by making a cut in the overnight rate. One area to monitor is the Overnight Index Swap Futures which is traded on the Montreal Options Exchange. This is a tradable instrument and by way of its pricing, it provides an indication in real time of what the probability is for an increase or hold decision of the overnight rate at the next Bank of Canada meeting. Having watched this market for some time, the indications have remained at zero for some time now, and this seems to be a broadly shared sentiment by many of the other global central banks which we should take the time to observe.
Arguably the most important central bank for the interests of the global economy is the US Federal Reserve Bank, primarily due to the nature of the US dollar being the largest reserve currency in the world. The Federal Reserve have indicated that they dont foresee any further increases in 2019, as they are looking for the global economy to be firing on all cylinders to justify removing monetary policy stimulus by way of increasing the Federal Funds Rate from its current level of 2.5%. Why is the Federal Reserve Bank so important in respect of the global economy? We need to take some time to understand the impact of increasing interest rates in the US in respect of debt and currency held by emerging economies. A number of emerging economies rely on debt denominated in US dollars, so the increase of interest rates in the US can have the effect of increasing the cost of carry for this debt, and this can also be further compounded by the currency effect of an increase in the exchange rate, as a higher interest rate tends to have the effect of strengthen the home currency which can in turn make it harder for emerging economies to repay this debt based on a stronger US Dollar.
To look at other developed economies, they tend to be more reliant on their own central banks to provide guidance on investment decisions as any debt instruments tend to be denomination in their respective currencies. The Bank of England currently maintain the official bank rate at 0.75% after increasing from 0.5% in March 2018, while the European Central Bank (ECB) key interest rate is currently at 0.00% where it has remained since March 2016. There are many factors which are paring back growth prospects in Europe which are causing these low interest rates, but it is worth noting a significant divergence from the North American economies who have over the past couple of years found a greater opportunity to exert a level of tightening by way of increases to their overnight rate up to now.
In conclusion, it is worth keeping all these factors in mind when you are making investment decisions as individuals or collectively. For many households, the biggest investment they will make in their lifetime is real estate and its important that they are able to make an informed decision with all the tools that are available to them at the time.