Why Is Your Rate Higher When You Have Equity?
It seems counter intuitive that a person with 5% down be offered a lower rate than someone with 20% down. Clearly the second person appears to be much financially stronger. Either they have sold an asset like a home or they have saved extra funds or through some other means they have 20% or more to put down. Or maybe this is existing equity already in place after years of mortgage repayments. This savvy consumer goes to apply for a mortgage after having researched the lowest rates only to be told when they get the approval that those very low rates are only for people with less than 20% down. That seems ridiculous really as the person with more skin in the game, so to speak, is less likely to default on their mortgage and lose that substantial equity stake. It is true nonetheless so let’s take a look at why.
Back in October of 2016 you likely heard in the news that the federal government had deemed it prudent to make some additional changes to the mortgage rules. The one which seemed to get the most press was the fact that the qualifying rate was now significantly increased and as of today sits at 4.64%: so when the rates start to rise, we know that people will be able to afford the higher payments. This is just the latest in an 8 year run of mortgage rule changes designed to keep our economy strong. The government is interested in this area especially as they have pledged to cover the loans in case of the worst case and mass defaults ensuing.
What didn’t get as much press was another issue. They also decided that they would no longer allow mortgages with less than 80% loan to value to be insured. What you may not have known is that for a number of years these conventional mortgages were being insured at the lenders expense. Why? Basic answer is this. There are 2 ways to lend mortgage money if that is the business you are in. The first is from the balance sheet of liquid assets you hold. There are rules about how much can be lent out based on how much is held in deposits. The downside with this system is that you have to wait until the loan is repaid before you can relend. The second is known as securitization. The mortgage lender does the due diligence and offers a loan. Once the loan funds they sell a group of mortgages off to an investor which means they can turn around and relend the money. Rest assured that at no time ever were the Canadian mortgage lenders as reckless or ‘creative’ as those in the US. Our lending policies have been prudent the whole time.
The investors are groups of people, such as teacher pension funds, looking for a secure place for their investments. Prior to October, the groups of mortgages were all insured. Our government was pledging to cover the losses if default occurred which made the mortgage backed securities a very safe place to invest their money. After taking a look though, the government decided that this was not what mortgage insurance was intended for in the first place. That it was meant to help Canadians get into a home with less than 20% down.
What this all means now is that the mortgage lenders have to have the necessary liquid assets in the bank, on their balance sheet if you will, which increases the cost of lending to them and therefore to you through higher interest rates.
So the days of what is your best 5 year fixed rate is a thing of the past I’m afraid. Mortgages are now more complex than ever and they were plenty confusing before. As always, talk to a well-qualified mortgage professional to help you navigate this process.