The term conventional mortgage refers to a mortgage that does not carry any form of high-ratio or lender insurance premium
The Bank Act of Canada controls many facets of the finance industry, and the mortgage industry is not immune to its effect.
As a law, no chartered bank or is able to offer mortgage financing without insurance beyond a certain percentage of the value of the property. This limit used to be 75 percent, but was changed on April 20th, 2007 to 80 percent for most residential single-family mortgages.
A high ratio mortgage exceeds 80 percent of the property value, and must therefore be insured by CMHC, Genworth or AIG (the newest mortgage insurer in the industry). The price of the insurance premium IS added directly to the mortgage amount, going on TOP as an insurance premium vs. being deducted like a lender fee in trust company or private mortgages.
As conventional mortgages do not exceed this 80 percent maximum of the property’s value, an ample cushion of 20 percent remains. As such, the basic principle is that the financial institution is insulated enough from risk in order to provide such a loan without any 3rd party insurance coverage.
By insuring a mortgage loan, Canadian banks are able to reduce the capital allocation required on a per dollar basis as a result of reduced capital requirements due to the insurance component.
Let’s say you want to purchase a $200,000 house. To qualify for a conventional mortgage, you will have to put up at least $40,000 as a down payment. Paying anything less than 20 percent as a down payment, down to about 5 percent of the total purchase price of the home, means that you will need a high-ratio mortgage rather than a conventional one.
Benefits and drawbacks of a conventional mortgage
The most significant benefit to buyers with a conventional mortgage is the fact that they have more equity in the home right away because of the larger down payment. This equity gives homeowners greater access to useful financing tools, such as HELOCs.
Homeowners indeed save money on the insurance payments necessary for a high-ratio mortgage; however may lose out in other ways. Although the higher the down payment a buyer pays, the more equity the lender has access to in the event of a default, lenders typically do not benefit from insurance with conventional mortgages.
In this sense, some borrowers can obtain a lower interest rate with a high-ratio mortgage than a conventional one given that lenders see the added insurance as reducing overall risk. This is why it’s extremely important you speak with a mortgage professional about your specific situation before making a decision.
As high-ratio insurance companies have an important say on any mortgage loans approved above 80 percent, conventional mortgages can sometimes be arranged for those with less than perfect credit or income situations. CMI’s mortgage brokers have increased negotiating power in situations where at least 20 percent equity is available.
Despite the various ways that you (and your lender) can benefit from a conventional mortgage, there are certain things you will need to consider. Coming up with 20 percent of a home’s value for a down payment is sometimes not feasible for prospective homebuyers.
Even if you could save enough for this down payment over time, you may have to put off your dream to purchase a home for several years. In the meantime, you will likely have pay a monthly rental rate that’s comparable to a mortgage without gaining any ownership of the unit in which you live.
You also must consider that a lot can change in just a few years. If the market you are buying in is on the rise, you may find that real estate prices have skyrocketed by the time you can actually afford a 20 percent down payment.
Selecting the right mortgage option for you
Even though conventional mortgages tend to be the most typical option, they are by no means the only one. Mortgages come in a variety of different forms. Choosing the right one is important to ensure a successful home-buying process.
There are fixed-rate mortgages, variable-rate mortgages, convertible mortgages, bridge mortgages. hybrid mortgages, closed mortgages, among many others. Although understanding each of these mortgage term types fully may take a significant amount of research, it’s more than worth it to ensure you approach the mortgage application process with strong background knowledge to best inform your choices.
Ultimately, a conventional mortgage is a lower risk transaction for lenders since the additional equity in the property serves as a buffer from potential losses in the event of a loan default. Single family conventional home loans are typically cheaper, in that the cost of added insurance is avoided.
In the case of multifamily property loans, often conventional mortgages are more expensive as a result of the additional risk component, and high amount of capital required for non-insured deals. CMHC insured multifamily loans are also available through CMI’s commercial mortgage division.
The most important thing to remember is that every person is different, and the “right” choice will vary depending on the specific circumstances that apply to your situation. Whether purchasing a home is a long-term goal of yours or you wish to buy a piece of property as soon as possible, you should never neglect doing your research.
Take the time to consider your situation, crunch the numbers and work directly with a mortgage professional. This will allow you to proceed through the mortgage process with confidence and move into your dream home.
Ultimately, it is best to speak with a qualified mortgage professional about the pros and cons of conventional mortgages, and which option is best for you. Even mortgages as low as 50 percent can be insured, and thus are conventional by definition but still carry an insurance premium to reduce the rate.