Why a bigger down payment can result in a higher rate

You'll still save money over the long term. Here's how your down payment and interest rate are intertwined.

Jun. 11, 2020

It seems counter-intuitive that a higher down payment may increase your rate.

So you've saved and saved, and have 20% or more for your down payment. You're probably thinking that as a good saver, you should be rewarded with a lower rate. That sure sounds right, but it doesn't quite work that way.

With a higher down payment, your mortgage doesn't require default insurance, and therein lies the rate snag.

How do banks handle your rate with a bigger down payment?

By federal regulation, the big banks in Canada need to hold a certain amount in capital for every $100,000 they lend in mortgages. The smaller the down payment, the more capital they hold to remain solvent. That's why high ratio mortgages (less than 20% down for a Loan-to-Value (LTV) of 80% or greater) are legally required to carry default insurance. This guarantees the mortgage, meaning banks don't need to hold as much capital, and can offer lower interest rates. But for conventional mortgages (20% or more down payment), there is typically no insurance coverage, so banks charge higher rates to offset their extra capital requirement.

How do Monoline Lenders treat your bigger down payment?

Monoline Lenders (Mortgage Finance Companies) don’t have the same capital as the major banks, so their structure is slightly different. Without the required capital, any mortgage that they fund must be backed by some kind of default insurance. However, this doesn’t mean that these lenders can’t do conventional mortgages (20% or more down payment) for clients. It just means that when they do, they must now bear the cost of that default insurance behind the scenes. Since the lender now has this added cost, the offered rates may be a bit higher to cover the offset.

The costs change with the size of your down payment.

For high ratio mortgages, the expense of default insurance decreases as there is more equity in the property, until it reaches a 78-80% LTV. Mortgages with a LTV of 70%-80% (30%-20% down payment) have the highest capital cost for the lender, whereas mortgages at 0-60% LTV actually have the least. Both insurance and capital costs are generally tiered and can include other factors, such as credit score, property location, mortgage size and amortization.

Despite a higher rate, you can save more over the long-run.

Even though you may get a higher mortgage interest rate with a larger down payment, you'll still likely save more money over the long term. That includes not needing to pay mortgage insurance premiums, and having better access to options with the increased equity in your home.

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