Conventional and Non-Conventional Mortgages

Conventional mortgages are those where the lender provides no more than 75% of the pre-purchase appraised value of a property or the purchase price, whichever is less. In addition to the limit on the mortgage amount, individual lenders determine what form of property is acceptable for a conventional mortgage. For example, a home without a poured concrete foundation, or a very small home, may not meet the lender’s criteria for a conventional mortgage, even if the borrower needs to finance less than 75% of its value.

A non-conventional, or high ratio, mortgage exists where the borrower makes a down payment of less than 25%, so that the mortgage amount provided by the lender is more than 75% of the property’s appraised value or its purchase price, whichever is less. Borrowers who do not have sufficient assets to make the necessary down payment on a home need to find another source of funds or apply for a high ratio mortgage. In Canada, high ratio mortgages are insured by Canada Mortgage and Housing Corporation (CMHC). Since the chances of default are greater for mortgages of a high value relative to the value of the home, borrowers are required to purchase CMHC insurance, which adds to the cost of the mortgage. The cost of the insurance increases as the percentage to be financed increases, up to about 3.75% of the mortgage amount.

For borrowers who choose a high ratio mortgage, the CMHC insurance is an additional cost that must be paid. Many mortgage lenders arrange to have the insurance premiums added to the mortgage and amortized over the life of the mortgage, rolling the insurance premiums and mortgage payments into one convenient monthly payment. However, this adds greatly to the interest costs, since the amount paid for the premium is substantially higher when amortized over 20 or 25 years. The borrower may decide to pay the CMHC insurance fee up front, saving thousands in interest costs.

Alternatively, borrowers without the necessary 25% down payment may use a personal loan for the difference between the available down payment and the requisite 25%. Provided that the borrower has sufficient income to assume a personal loan and meets the credit criteria, the benefits are twofold. First, the mortgage insurance is saved, a cost which is never recovered by the borrower. Second, a personal loan will amortize the remainder of the required down payment over a relatively short period of time, such as 3 or 5 years. This will save thousands of dollars in interest, even on a relatively small mortgage, as the debt is repaid over a shorter amortization period than if it had been part of the mortgage.

Of course, the disadvantage of using a personal loan is the increased level of personal indebtedness. Since the purchase of a home entails often unexpected expenses and cash outlays, the additional debt burden may be prohibitive. If this is the case, the financial planner should not overlook private sources of funds, such as parents, single siblings, or other family members.

Some employers provide home relocation loans to employees who are required to move as a result of their jobs. The CCRA provides some relief to the tax consequences associated with these loans, and this may be an interesting alternative for individuals moving as a result of employment. A low interest or zero interest relocation loan should always be requested as part of the compensation package when an employee is asked to move to another location for work.