It doesn't make much sense, but a skimpy down payment on a home might actually get you a better mortgage rate in today's market.

Blame the government subsidy known as mortgage default insurance, which ultimately makes it less risky to lend money to someone who has only 5% down compared to someone with 20%.

Consumers with less than 20% down must get mortgage default insurance in Canada if they are borrowing from a federally regulated bank. The cost is up to 2.75% of the mortgage amount upfront on a 25-year amortization but that fee comes with 100% backing from the federal government if the insurance is provided by Crown corporation Canada Mortgage and Housing Corp.

"It's already happening," says Rob McLister, editor of Canadian Mortgage Trends, who says secondary lenders are now offering rates that are 10 to 15 basis points higher for a closed five-year mortgage for uninsured consumers.

The crackdown on mortgage insurance announced by Jim Flaherty, the federal Finance Minister, could exacerbate the situation. Mr. Flaherty, who mused to the Financial Post editorial board last week about getting CMHC out of the mortgage insurance business, has placed the agency under the authority of the country's banking regulator, the Office of the Superintendent of Financial Institutions.

Mr. Flaherty also put in new rules on bulk or portfolio insurance. The banks had been paying the insurance premium on low-ratio mortgages - loans with more than 20% down - because it was easier to securitize them.

However, Mr. Flaherty says those loans will no longer be allowed in the government's covered bond program.

"Long story short, it is going to tick up rates to some degree," Mr. McLister says. "You are seeing an interesting phenomenon where if you go to get a mortgage today, you are oftentimes quoted a higher rate on a conventional mortgage. Presumably you have less risk because you have more equity."

It all depends on the lender. For now, the Big Six banks have kept consistent pricing between low-ratio and high-ratio mortgages.

"There is a question on whether they will continue doing that or raise rates overall to compensate for higher conventional mortgage costs," Mr. McLister says.

Farhaneh Haque, director of mortgage advice and real estate-secured lending at Toronto-Dominion Bank, says competition among the Big Six banks is keeping rates down and stopping any of them from raising rates for conventional mortgages.

"When we can't securitize a deal, there is a different cost of funds but the bank continues to offer the same rate," said Ms. Haque, adding her bank did charge a premium for stated income deals, which usually means self-employed people, but removed the difference last week. The premium was 20 basis points.

"Looking at the competitive landscape, it was a disadvantage," she says. "We were aiming to target pricing that was specific and for the risk appetite for that deal itself. We didn't want one [deal] compensating for the other."

But the banks have bigger fish to fry than just your mortgage. Those with the larger equity position in their homes may be a costlier mortgage to fund, but they also could be a future line-of-credit customers. There's also the potential for other business such as RRSPs and TFSA, so losing a few basis points might make more sense in the long run.

Peter Routledge, an analyst at National Bank Financial, says he wouldn't want to be an investor in a bank that approached its business any other way, though he did acknowledge there is a cost to keeping those conventional mortgages. "It's in effect a subsidy," Mr. Routledge says.

While banks may be eating some of the costs for people who are not eligible for a subsidy, if they continue down that road they might not be able to match the rates some of the secondary lenders are able to offer with insured mortgages.

It doesn't sound like much, but the difference between, say, 3.14% and 3.29% on a $500,000 mortgage amortized over 25 years would be about $3,500 extra in interest on a five-year term.

It's true that those people getting the better rate pay a hefty fee up front in insurance premiums, but they also represent a greater risk to the taxpayer. Do they deserve a better rate?

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The Canadian government has introduced a new Mortgage Code of Conduct for federally regulated financial institutions. It requires lenders to clearly explain the differences between mortgage products, show how to pay off a mortgage faster without incurring penalties and explain how prepayment charges are calculated.

"In the low interest rate environment of the past few years, many people wanted to break their mortgage to take advantage of lower interest rates, but may not have understood how mortgage prepayment charges were calculated," says Terry Campbell, president of the Canadian Bankers Association.

Some financial institutions charge hefty fees for the privilege of paying off the mortgage early. The Canadian Bankers Association explains why: "When interest rates are declining and borrowers decide to break their mortgage contract, the bank will then lend that money to someone else at the current lower rate, resulting in a shortfall for the bank. The bank will allow the borrower to break the mortgage contract, but the borrower would need to pay a mortgage prepayment charge to help the bank manage its risk and cover its costs from the customer paying off the mortgage early. Typically those charges are three-months’ interest or the interest rate differential, whichever is greater."

But the Financial Consumer Agency of Canada (FCAC) says over the past few years it "has observed a significant increase in the number of complaints related to mortgage prepayment penalties.

Specifically, consumer complaints have primarily focused on the interest rate differential (IRD) option that appears in many mortgage agreements."

FCAC says the three main consumer complaints are:

Descriptions of the way prepayment penalties are calculated are vague and/or difficult to understand