What is Conventional Mortgage in Canada?

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Bank of Canada 5-year conventional mortgage rate:4.79%For date: Fri Dec 03 2021

What you Should Know:

  • A conventional mortgage is a mortgage with a 20% or more down payment.
  • You won’t need to apply for mortgage default insurance (CMHC) with a conventional mortgage.
  • In general, you will have a smaller monthly mortgage payment because you are borrowing less money.
  • As with any mortgage, to qualify for a conventional mortgage you'll need to prove you can handle the monthly mortgage payments and the down payment.

What is a Conventional Mortgage in Canada?

conventional mortgage explained

A conventional mortgage means you pay a down payment of 20% or more of the property value. When you pay a 20% down payment, the lender provides you with a property loan equivalent to 80% of the purchase price. This ratio is known as the loan-to-value (LTV).

However, there are different regulations on the mortgage you receive depending on your loan-to-value (LTV). For example, a mortgage where the lender provides you with a 95% LTV will differ from a 65% LTV. Continue reading to learn everything about conventional mortgages in Canada.

Benefits of a conventional mortgage

Lower mortgage payments

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.

Emergency home equity

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 options such as a low-interest home equity line of credit (HELOC).

Pay less interest

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. Conventional mortgages do not need to pay for this insurance.

Understanding lender risk

protect house from falling wooden

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.

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, CMHC insurance is required by law to protect lenders against mortgage default.

Comparing high-ratio, conventional, and low-ratio mortgages

The main difference between the three types of versions is the percentage of your down payment.

High-ratioConventionalLow-ratio
Down PaymentBetween 5-19%20-35%More than 35%
CMHC FeeYesNoNo
Monthly PaymentsHighestMiddleLowest

High Ratio

A high ratio mortgage typically has a down payment between 5-19% (81-95% LTV). You will need to pay an extra 2.8-4.0% fee for mortgage default insurance.

Conventional

A conventional mortgage has 20-35% down payment (65-80% LTV). A conventional mortgage will have a lower monthly mortgage payment because the bank is lending you less money.

Low Ratio

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.

How to qualify for a conventional mortgage

mortgage affordability

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 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;

1. Proof of income & employment

For proof of income, you may have to provide:

  • A letter expressing your present salary or hourly wage rate (for example, a recent pay stub)
  • Amount of time employed by current company
  • Your employment position
  • Self-employed workers need to provide notices of assessment from the CRA for the past two years.

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.

2. Assets

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.

3. Debts or financial obligations

Your debts or financial obligations might include your monthly payments for:

  • car loans
  • lines of credit
  • student loans
  • credit card balances
  • child or spousal support
  • any other debts

4. Other Documentation

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.

Getting the best interest rates on a conventional mortgage

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.

High credit score

credit-score-ranges

A higher credit score demonstrates your ability to pay back a loan. 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 score of 680-700.

Low debt-to-income

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.

Increase your down payment

Higher down payments create less risk for the bank. As a result, you'll have more negotiation leverage when determining your mortgage rates.

The bottom line

Overall, a conventional mortgage means a mortgage with a down payment between 20-35%. The main benefits are a lower monthly payment and more home equity. If you want to qualify for a conventional mortgage, keep in mind that your potential lender will likely go through several steps before they determine your eligibility.

FAQ

Is a conventional or high-ratio mortgage better for me?

That depends on your situation. If you can afford the higher down payment, you may qualify for a lower mortgage rate when getting a conventional mortgage than when taking out an insured high-ratio mortgage. High-ratio mortgages are better if you have little money saved for a down payment or less than perfect credit.

Where can I get a conventional mortgage?

All big five Canadian banks offer conventional mortgages. However, they have the strictest lending criteria. Other lenders that offer conventional mortgages are smaller financial institutions such as credit unions or private lenders.

Should I use a mortgage broker or individual lenders when applying for a conventional mortgage?

A mortgage broker will save you time on a mortgage application and may provide you with access to better interest rates. They can leverage their network to find you exclusive mortgages. Additionally, they can benefit your credit score by only requiring one credit inquiry. Whereas applying to multiple banks will result in many credit checks.

Who may not qualify for a conventional mortgage?

In general, those who are just starting in life, persons with a little more debt than usual, and people with a low credit score have difficulties qualifying for typical loans.

What should I do if I'm turned away from a conventional mortgage?

If you are declined for a mortgage, ask for the bank's reasons in writing. You may be eligible for other assistance that will help you get approved for a mortgage. For example, you may qualify for a private mortgage lender or a high-ratio mortgage.

How do lenders determine the best interest rate on my loan application for me?

Lenders will review your credit report and loan application to determine the interest rate on your loan. These factors, such as your debt-to-income ratio, can help lenders predict whether you can afford mortgage payments and whether they're at a high risk of a debt default if you take out a loan.

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