Understanding Mortgage Default Insurance: Do You Need It?

Mortgage Default Insurance, often called CMHC insurance in Canada, is mandatory for homebuyers who make a down payment of less than 20% of the property's value. It protects lenders in case the borrower defaults on their mortgage. This insurance allows buyers to qualify for a mortgage with a lower down payment, but it adds an extra cost, typically ranging from 2.8% to 4% of the mortgage amount. The premium can be paid upfront or added to the mortgage balance. While it facilitates homeownership for many, it increases the overall borrowing cost, so understanding its impact on long-term affordability is essential.

Mortgage default insurance is provided by three insurers in Canada:

1. CMHC (Canada Mortgage and Housing Corporation)

2. Genworth Canada

3. Canada Guaranty

It allows homebuyers to qualify for mortgages with as little as a 5% down payment, making homeownership more accessible.

If possible, aim to save for at least a 20% down payment to avoid the added cost of mortgage insurance and reduce your overall borrowing expenses.

Pros of Mortgage Default Insurance For Homebuyers

1. Lower Down Payment Requirement

- Without default insurance, you'd need at least a 20% down payment. With it, you can purchase a home with just 5%, making homeownership possible for many first-time buyers.

- Example: If you want to purchase a $400,000 home but only have $20,000 saved, mortgage insurance lets you proceed with your purchase without needing to wait and save $80,000 (20% down payment).

2. Lower Interest Rates

- Insured mortgages are often considered less risky by lenders because of the insurance, meaning they can offer you lower interest rates. This can lead to significant savings over the life of the mortgage.

- Example: The interest rate might be 4.29% with mortgage default insurance, versus 4.65% for an uninsured mortgage, saving thousands over time.

3. Opportunity to Enter the Housing Market Sooner

- Saving for a 20% down payment can take years, especially with rising real estate prices. Mortgage default insurance allows you to buy a home sooner with a smaller down payment, enabling you to start building home equity faster.

- Example: Imagine home prices in your area are increasing by 2% annually. If you wait three more years to save a 20% down payment, the cost of your desired home could rise significantly, making it harder to afford.

4. Spreading Out Costs Over Time

- Instead of paying the insurance premium upfront, you can add it to your mortgage and pay it off over the life of your loan.

- Example: If the insurance premium is $12,000, adding it to a 25-year mortgage spreads the cost, making it more manageable. This way, you’re paying a small amount each month instead of a large upfront fee.

5. Building Equity Faster

- Purchasing a home sooner allows you to take advantage of potential property value increases.

- Example: If you buy a $400,000 home now and the market appreciates 2% over the next year, your home’s value increases to $408,000. This $8,000 equity gain can be beneficial, especially if you wouldn’t have been able to buy without mortgage default insurance.

These examples illustrate how mortgage default insurance can be a strategic tool to help homebuyers access the market sooner, manage costs, and potentially benefit from favorable financial conditions.

Budget for this cost carefully. Remember, the premium can be paid upfront or added to your mortgage, which will increase your monthly payments and the interest paid over time.

Cons of Mortgage Default Insurance For Homebuyers

1. Increased Cost of Homeownership

- Additional Expense: Mortgage default insurance adds a significant cost to your overall mortgage, ranging from 2.8% to 4% of the total loan amount.

- Example: For a $400,000 mortgage with a 4% insurance premium, you would pay an extra $16,000. If this premium is added to the mortgage and amortized over 25 years, you’ll also pay interest on the premium, increasing your overall cost.

2. No Benefit for the Buyer

- Lender Protection: The insurance protects the lender, not the buyer. It does not cover you if you run into financial difficulties or cannot make your mortgage payments.

- Example: If you default on your loan, the insurance ensures the lender is compensated, but you still face foreclosure and the loss of your home. The insurance does not provide any financial safety net for you.

3. Long-Term Financial Impact

- Interest on the Premium: If the insurance premium is rolled into your mortgage, you pay interest on that amount for the duration of your mortgage term.

- Example: Using the previous $16,000 insurance premium example, if added to a 25-year mortgage at a 5% interest rate, the actual cost of the premium could end up being around $28,000 over time due to interest.

4. Requirement Despite Financial Stability

- Inflexibility: Even if you have a stable income and excellent credit, you still have to pay for mortgage insurance if your down payment is less than 20%.

- Example: A young professional couple with a high income and stellar credit score but only 10% saved for a down payment must still pay for mortgage insurance, even though they pose minimal risk of default.

5. Impact on Monthly Payments

- Higher Monthly Costs: The added insurance premium increases your monthly mortgage payments, reducing your monthly cash flow for other expenses.

- Example: If the insurance premium increases your mortgage balance from $400,000 to $416,000, your monthly payments will be higher than if you had a mortgage without insurance. This could strain your budget, especially if other unexpected expenses arise.

These examples show that while mortgage default insurance can make homeownership more accessible, it also adds a financial burden and increases the cost of borrowing over time. It's essential to weigh these drawbacks against the benefits to determine if it's the right choice for your situation.

If you are a first-time buyer with a limited down payment, view this insurance as a pathway to get into the market sooner, especially if property values are rising.

??Pro Tips for Homebuyers

1. While mortgage default insurance allows you to buy with a 5% down payment, aiming for at least 10% can significantly reduce your insurance premium.

- Example: On a $500,000 home with a 5% down payment, the premium is 4% ($19,000). If you increase your down payment to 10%, the premium drops to 3.1%, saving you around $4,500.

2. Even though the insurance is mandatory, you can still shop around for the best mortgage rates. Some lenders might offer better rates on insured mortgages, helping you save over the long term.

3. If you have an insured mortgage, making accelerated payments (bi-weekly instead of monthly) or lump sum payments can help you pay off your mortgage faster and reduce interest costs.

4. When deciding whether to buy a home with less than 20% down, factor in all the costs, including the mortgage insurance premium, monthly payments, property taxes, maintenance, and utilities. This will help you avoid financial strain.

Mortgage Default Insurance (CMHC Insurance) can be a valuable tool for first-time buyers to enter the market sooner, but it’s important to consider the long-term cost. Weigh your ability to save a larger down payment against the benefits of homeownership and market conditions.

Talk to a mortgage broker to understand the total cost of the insurance over time and how it affects your monthly payments. This can help you decide if waiting to save more is a better financial move.

Happy house hunting!

[email protected] I (780) 233-8500