Large Mortgage Loans and the Sliding Scales Used to Underwrite Them

For a lender, bigger is not always better.

The larger a mortgage gets, the greater the lender’s potential loss if the borrower defaults.

Additionally, the higher the purchase price of a property, the fewer potential buyers it has. That makes its price more vulnerable to market corrections, and makes it more difficult it is to unload if it has to be sold under foreclosure or Power of Sale proceedings.

In the world of lending, the return of capital always takes priority over the return on capital. As such, large mortgage loans are subject to greater scrutiny.

Lenders mitigate the increased risk that is inherent in larger loans with some variation of a sliding-scale policy, which reduces a loan in proportion to the subject property’s value when it exceeds a certain dollar amount.

For example, if you in or near a major urban centre, lenders typically consider properties in the $2.5 million to $3 million purchase-price range to have increased risk. (That range will be lower, sometimes dramatically so, for properties located in smaller population centres and/or rural areas.)

Today’s post will explain how these sliding scales work and will offer some suggestions to help ensure that you get the full bang you deserve for your higher-than-average-size mortgage buck.

Let’s start with an example where the purchase price of a property is above $1.5 million, which is the maximum for borrowers with down payments of less than 20%, but below the lender’s sliding-scale threshold.

In such cases, borrowers will be required to make a down payments of at least 20% of the purchase price.

While it may seem counterintuitive at first, these types of mortgages (referred to as conventional loans) are actually riskier for lenders than loans with down payments of less than 20% (which are called high-ratio loans). That’s because high-ratio loans must be insured against default, and once they are, a lender’s potential for loss is effectively zero.

For that reason, conventional loans with down payments of 20% are the riskiest loans lenders make, and when the increased risk of lending on a less liquid high-value property is layered on top, lenders use a sliding scale to mitigate it.

Simply put, a sliding scale is designed so that as a property’s price increases, the maximum loan amount offered decreases on a proportionate basis.

Let’s illustrate how sliding scales work with an example.

Assume that you buy a house for $3,500,000 and you want to make a down payment of 20% of the purchase price, which in this case would be $700,000.

Instead of requiring you to put down 20% of the purchase price (the typical minimum for a conventional loan), the lender agrees to lend you 80% of the first $2,500,000 of the purchase price, but only 50% of the remaining $1,000,000 of the purchase price.

In this example, the sliding scale increases the minimum required down payment from $700,000 to $1,000,000.

Lenders use individualized sliding-scale policies which can vary widely.

For example, one Canadian lender will offer 80% financing on the first $3,250,000 of purchase (and 50% financing on anything over that threshold), while another lender’s sliding scale might kick in at purchase prices of as little as $2 million.

If you want to maximize the size of your mortgage, an experienced independent mortgage broker who works with a multitude of lenders can guide you to ones which offer the most sliding-scale flexibility.

Here are a few other points to keep in mind if you are seeking a large mortgage amount:

• Pay special attention to the terms and conditions that come with your mortgage, especially your prepayment penalties. Larger loan amounts magnify the differences in the penalties charged by different lenders.
• Large loans have to be escalated up the ranks for management approval so expect lenders to take an extra day (or two) to get your approval back. If you anticipate tight timelines, get pre-approved first, which is a good move for lots of other reasons anyway.
• While lenders are more cautious with large loans, you should still be offered the best rates in the market (they may take a bit more work, but in the long run, large loans can still be more profitable for lenders). If you want to know what the best rates are, shop around.

One other important point to keep in mind. When real estate prices flatten or drop, lenders can become much more conservative when underwriting higher-end real estate. At such times, there can be a wider than normal disparity in the sliding scales used by different lenders.

Partnering with an independent mortgage broker will help ensure that you and your property are matched with the lender who is offering the best fit for your particular situation, regardless of current market conditions.