Why a bigger down payment can result in a higher rate

One reason your rate may be higher is the down payment size. This is understandably counter-intuitive for most clients. You would think that being a good saver would show you are financially responsible, and that you could be rewarded with a lower rate. The reason is default insurance.

Canadian Banks:

By federal regulation, the big banks in Canada need to hold approximately $1500 in capital for every $100,000 they lend in mortgages. The smaller the down payment, the more capital they must hold to remain solvent. Except, of course, if the Government guarantees the mortgage. If the mortgage is guaranteed, they need to hold virtually no capital. All mortgages with less than 20% down must be insured. Therefore, banks end up charging higher rates on mortgages with over 20% down to offset the requirement to hold the extra capital.

Mortgage Finance Companies

Mortgage Finance Companies (Monoline lenders) don’t have the same capital as Big Banks, so their structure is slightly different. Without the required capital, any mortgage that a Mortgage Finance Company funds must be backed by the Canadian Government with default insurance. This doesn’t mean that Mortgage Finance Companies can’t do mortgages for clients with more than 20% equity in their home, 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 rates being offered will be increased to cover the offset.

This insurance cost is not the same for all mortgages. The expense of the insurance decreases as there is more equity in the property. That means for those who have a mortgage between 70%-80% loan to value (20%-30% down payment) has the highest cost for the lender, whereas mortgages at 0-60% have the least. That cost is generally tiered and includes factors other than just the loan to value such as credit score, property location, mortgage size, amortization, etc.

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