Even if you don't have a big enough down payment for a conventional mortgage, you may still be able to buy a home.

Conventional mortgages require a down payment of 25 percent of the home's appraised value.  If you are looking at a house with a price tag of $200,000, that mean you need to come up with $50,000 of you own money.  but if you don't have that much saved, you may still be able to purchase that property.

There are two basic alternatives if you can't meet the requirements for a conventional mortgage:

1. Obtain what is known as "high-ratio financing" from you bank, trust company, or credit union.  High-ratio mortgages can be obtained from many lenders if you have a minimum of 10 percent of the purchase price.  (If you are a first-time buyer, you may be able to put down as little as 5 percent under a special CMHC program, depending on the area in which you live).
2. Get a second mortgage.  This means taking out a traditional (or first) mortgage for the first 75 percent, and then arranging a second mortgage for the remaining amount you need to borrow.

High-Ratio Mortgage

First, let’s look at high–ratio financing. These loans must be insured by the federal Canada Mortgage and Housing Corp. (CMHC). The protection is for the lender, not for you. Mortgage insurance is expensive: it can range up to 2.5 per cent of the value of the loan. You have to insure the entire loan, not just the amount that is above 75 per cent of the purchase price. That means the insurance premium for a $140,000 mortgage would be $3,500. Most lenders will let you roll the insurance premium into your mortgage. If you do, though, you’ll end up paying a good deal of interest on the insurance fee as well.

One advantage to this type of financing is that CMHC–insured mortgages become open after three years. All that’s required to pay off your mortgage at that point is to pay a penalty of three months’ interest. (An open mortgage means you can pay it off or refinance at current rates at any point.)

CMHC's 5 Percent Down Program

If you are a first–time buyer, you can put as little as 5 per cent down with an insured mortgage — provided you earn enough income to qualify. The amount of money you can borrow under this plan depends on where the house is located. Contact CMHC for more information about your specific situation and location.

These loans must be insured, and while you can choose any term you wish, your income must be able to meet the payments required under a three–year term.

Second Mortgages

Now let's consider a second mortgage.  In general, you have to go to a mortgage broker to find secondary financing.  You'll probably have to pay the broker a fee for arranging the load.  The interest rate on the money you borrow on a second mortgage will also be higher that the rate on your first mortgage and you must pay the cost of drawing up a second mortgage document.

Which Alternative is Better?

Despite the higher interest rate a second mortgage may turn out to be cheaper than high-ration financing, provided you repay it quickly.  Consider the following comparisons:

The Smiths buy a house for $250,000.  They put $40,000 down, get a conventional first mortgage of $187,500 at 8 percent, and get a second mortgage of $23,100 at 10 percent with a three-year term. (That amount includes $600 in fees for the second mortgage).

based on a 25-year amortization, the monthly payments on the first mortgage are $1,431.   The monthly payment on the second mortgage is $206.63 for a total of $1,637.66 a month.

Each year on the anniversary of the second mortgage, the Smiths prepay $6,000 towards their second mortgage.  They make a final payment of slightly less than that when the second mortgage term ends in three years.

The Jones family buy the house next door at the same price, but opt for a $210,000 high-ration mortgage at 8 percent.  The insurance premium is 2 percent, or $4,200, plus an administration fee of $75, bringing the size of the loan to a total of $214,200.

They make monthly payments similar to the Smiths' - $1,634.80 - as well as the same annual lump-sum payments.

In the end, the Smith's second mortgage option costs them a total of $244,612 in interest, while the Jones' high-ration mortgage costs them $276,240 in interest.  In addition, after three years, the Smiths' outstanding balance is $179,353, a good deal less than what is outstanding on the Jones' high-ration mortgage - $183,842.  the reason is the high up-front cost of mortgage insurance.

As you can see, for the second mortgage to work, the couple must pay down the loan within three or four years, otherwise, the higher interest payments will tip the balance back the other way.

A variation on the second mortgage theme could make it a hands-down winner.  You could ask the seller of the house to help you finance its purchase by taking back a second mortgage at the same interest as a first mortgage.  This way, you same both the higher financing costs on the second mortgage and the broker's fee.

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