A conventional mortgage is a type of loan that can be obtained from any financial institution and paid back in installments over a set period. It is a loan that is secured by a piece of real estate. According to section 418.1 of the Bank Act, a bank in Canada is prohibited from lending money to purchase, renovate, improve, or refinance a residential property if the combined amount of the loan and any existing mortgage on the property exceeds 80% of the property's value at the time of advancing the loan.
Section 418.2 introduces some exceptions allowing for LTV greater than 80%. Specifically, Canadian banks can offer a mortgage with a loan-to-value (LTV) ratio above 80% if the excess amount of the loan is insured by a superintendent of Financial Institutions approved insurer. This restriction is also included in the Cooperative Credit Associations Act, Insurance Companies Act, and Trust and Loan Companies Act. Consequently, the 80% LTV limit is the dividing line between conventional and insured mortgages.
Lenders prefer insured mortgages because they can be packaged and sold to investors. As a result, lenders often choose to purchase insurance for conventional mortgages as well. The main difference is in who pays for the insurance premium. With insured mortgages, the borrower covers the cost of mortgage default insurance, while with conventional mortgages, the lender is responsible for paying the mortgage default insurance.
This is reflected in the mortgage rates, with conventional mortgage rates typically higher than those for insured mortgages. For example, at the time of writing, according to WOWA’s mortgage rate comparison table, the average of the four lowest insured mortgage rates is 4.36%. In comparison, the average of the four lowest conventional mortgage rates is 4.63%. In general, you can expect a discount of between 0.2% and 0.3% on a conventional mortgage rate if you opt for an insured mortgage.
It would be instructive to compare the cost of an insured mortgage with a conventional mortgage. Let us consider the purchase of a $600k house, which is close to the average home price in the Canadian housing market. We use WOWA’s mortgage payment calculator to make the following table.
|House price||Down Payment||Rate||Monthly payment||Total Mortgage Cost||Mortgage Insurance||Mortgage Type|
The 20-30 basis points discount offered on insured mortgages can easily offset the cost of the mortgage insurance premium, making insured mortgages more cost-effective and cheaper. However, there is a drawback when it comes to early mortgage repayment. The mortgage insurance cost is paid when the mortgage is advanced, but the benefit of a lower interest rate is received throughout the entire amortization period. So if you pay off your mortgage early, you will have incurred all the costs while only receiving part of the benefit of mortgage default insurance.
The result is quite counterintuitive. A loan with a lower down payment is riskier, but it can be cheaper. The reason is that the Canada Housing and Mortgage Corporation (CMHC) buys Canadian mortgages with default insurance from mortgage lenders. Because insured mortgages always have a buyer, it is far cheaper for a lender to fund an insured mortgage than an uninsured mortgage.
With a conventional mortgage, you are borrowing less money than with a high ratio mortgage. This means your monthly mortgage payments will be lower for a period with the same term.
In an emergency, you can tap into your home equity for cheap cash. This is because the higher down payment can be borrowed in the future. However, you should save this money for emergencies only. You can use secured lending options such as a low-interest home equity line of credit (HELOC), or a second mortgage.
You’ll end up paying less money in interest throughout your mortgage with a higher down payment. Additionally, high-ratio borrowers need to pay extra for mortgage insurance. This can add on 2.80-4.00% to your mortgage, as shown by WOWA’s CMHC calculator. Conventional mortgages do not need to pay for this insurance.
Your down payment provides a safety cushion to the lender in case you default. If you declare bankruptcy, the bank can sell your house at market value to get their money back. With a lower down payment percentage (higher LTV), the bank could risk losing money if they sell your property during a market dip. A higher LTV generally means the lender is taking on more risk. Different types of mortgages have different risks for lenders too. For example, a construction loan is riskier than a conventional mortgage. As a result, the mortgage rate is higher.
Due to the risk of high LTV mortgages - otherwise known as high-ratio - the Canadian government introduced mortgage default insurance through the Canada Mortgage and Housing Corporation mortgage rules. In Canada, mortgage default insurance is required by law to protect lenders against mortgage default.
The main difference between these three types of mortgages in Canada is the percentage of your down payment.
|Down Payment||Between 5-19.99%||20-35%||More than 35%|
A high ratio mortgage has a down payment of less than 20% (LTV greater than 80%). You may also be able to use down payment assistance programs to increase your down payment amount. You will need to pay an extra 2.8-4.0% fee for mortgage default insurance.
A conventional mortgage has 20-35% down payment (65-80% LTV). Yet it has income and credit requirements similar to insured mortgages. Thus both insured and conventional mortgages are prime mortgages. A conventional mortgage will have a lower monthly mortgage payment because the bank is lending you less money.
A low-ratio mortgage has the highest down payment at more than 35%. You should also have the lowest monthly mortgage payment because you are borrowing the least amount of money.
In general, your lender has two goals when qualifying you for a conventional mortgage. Initially, they want to see if you can handle your monthly mortgage payments.
Lenders use the gross and total debt service ratios to determine your mortgage payments aren't too high. They will also conduct a mortgage stress test to ensure you can afford an increase in mortgage interest rates. You will also need to meet a minimum credit score to qualify.
Secondly, your lender will verify that you can handle the down payment along with other upfront costs such as closing costs. To prove you can handle these expenses, your lender will typically ask to see the following required mortgage documents:
For proof of income, you may have to provide:
Your lender will want to see your pay stubs and may contact your employer to ensure that you are employed and earning sufficient amounts of money. Borrowers should also have documentation to show any additional income, such as spousal support or bonuses.
Your lender or mortgage broker in Canada may request recent financial statements from bank accounts or investments. This will assist them in determining whether you have the required down payment.
If you get money from a friend or family member to help with the down payment, you'll need gift letters that state that it's not a loan and has no required repayment. These documents will frequently have to be notarized.
Your debts or financial obligations might include your monthly payments for:
Your lender may need a copy of your driver's license for proof of identification. Additionally, they may want your Social Insurance Number to check your credit score.
Lenders will reward you with the best conventional mortgage interest rate if they see you as a low-risk candidate. Some of the best ways to prove this to them are through the following factors.
A higher credit score demonstrates your history of paying back your loans. The best mortgage terms are reserved for those with a credit score over 740. However, to qualify for a conventional mortgage, you'll want a minimum credit score of 600.
A low debt service ratio means your financial obligations (including your future mortgage payments) will only take up a small percentage of your income. This demonstrates to lenders that you are at a low risk of bankruptcy because you can easily pay your monthly debts.
Ideally, your total debt service ratio should be around 32% and no more than 44%. In other words, you should spend less than 32% of your monthly income on debt repayments.
Higher down payments lowers risk for the lender. As a result, you'll have more negotiation leverage when determining your mortgage rates.
Overall, a conventional mortgage means a mortgage with a down payment between 20-35% with a credit-worthy borrower. The main benefits are a lower monthly payment and more home equity. Conventional mortgages are often advanced by federally regulated financial institutions. These lenders are legally required to observe the regulations set by the Office of the Superintendent of Financial Institutions (OSFI). OSFI has issued Guideline B20, which outlines how a financial institution should make its mortgage lending decisions. For example, the stress test is a requirement imposed by OSFI.
Few lenders only offer their mortgages directly to home buyers. Some lenders offer their mortgage products only through mortgage brokers, and some lenders offer their products both via brokers or directly. The good point about brokers is that you don’t pay for their services, as lenders would pay them a commission. So you should take the best mortgage for your situation, and it does not matter if you are getting it directly from a lender or via a broker.
In general, those who are just starting their career, persons with more debt than usual, and people with a low credit score have difficulties qualifying for typical loans.
Each lender has its own residential mortgage underwriting policy (RMUP). So if one lender rejects your mortgage application, another might accept it. But if your application is rejected because it does not satisfy the requirements of Guideline B20, then no federally regulated financial institution will give you a mortgage. In that case, you might be able to get a mortgage loan from a provincially regulated financial institution like a credit union. If even they reject your application, that means you can’t get a prime mortgage and should consider alternative lenders.
In the US, a conventional mortgage is a mortgage which is offered by a private institution and does not involve any government agency. The most common non-conventional mortgages in the US are FHA mortgages.