What is Mortgage Default Insurance in Canada?

Mortgage default insurance, commonly referred to as CMHC insurance or mortgage insurance in Canada, is a financial product designed to protect lenders and borrowers in the residential property market. Its primary purpose is to provide a safety net for lenders in case borrowers default on their mortgage payments. This insurance is particularly relevant for home buyers who have a down payment of less than 20% of the property's purchase price. By offering this insurance, the Canadian government aims to facilitate home ownership for a broader segment of the population while safeguarding the stability of the housing market.

Mortgage default insurance is not to be confused with mortgage life insurance, which is a separate type of insurance that provides coverage to pay off the mortgage in the event of the borrower's death.

Purpose of Mortgage Default Insurance

The primary purpose of mortgage default insurance in Canada is to mitigate the risk for lenders when providing mortgages to home buyers who have a down payment of less than 20% of the property's purchase price. By having mortgage insurance, the lender is protected and has a financial backstop in case the borrower is unable to meet their mortgage obligations.

How Mortgage Default Insurance Works

When a high-ratio borrower applies for a mortgage, the lender evaluates their creditworthiness and financial stability. To protect against potential losses due to default, the lender requires the borrower to obtain mortgage default insurance. The insurance policy is taken out by the lender, but the borrower is responsible for paying the premium. The insurance premium can either be paid upfront or added to the mortgage principal, spreading the cost over the life of the loan.

If a borrower defaults on their mortgage, the insurance company pays a portion of the outstanding mortgage balance to the lender. The insurance coverage amount gradually decreases as the borrower makes mortgage payments and reduces the principal balance.

Mortgage default insurance covers the lender, not the borrower.

Mortgage Default Insurance Providers in Canada

In Canada, three main entities provide mortgage default insurance:

1. Canada Mortgage and Housing Corporation (CMHC)
2. Sagen Genworth
3. Canada Guaranty Mortgage Insurance Company

How much does mortgage default insurance cost?

As with any insurance, you’ll need to pay a premium when you take it out.

The amount you’ll pay in fees will depend on the size of your down-payment and is worked out as a percentage between 0.60% to 6.30%. The more you pay upfront, the lower the fees, so it’s a good idea to increase your down payment if possible.

A mortgage default premium can amount to thousands of dollars, and can be paid upfront or added to your total mortgage amount and paid off over time. If you choose to add your fees to your mortgage, you’ll pay interest on them at the same rate as your mortgage.

Example 1: Sarah is a first-time home buyer in Canada, and she has found her dream home priced at $300,000. However, she has managed to save 10% as a down payment, since her down payment is below the 20% threshold, her lender requires her to obtain mortgage default insurance.

Insurance Premium = 3.15% of $270,000 = $8,505

Sarah decides to add the insurance premium to her mortgage principal, making the total mortgage amount $278,505.

Example 2: Michael is looking to buy a house worth $500,000 in Canada with 5% as down payment which is $25,000. His lender requires him to obtain mortgage default insurance.

Insurance Premium = 4% of $475,000 = $19,000

Michael opts to pay it upfront to avoid paying interest on the insurance premium over the life of the mortgage.

You can get 25% of your insurance premium back with an energy efficient home.

Advantages & disadvantages to consider:

Mortgage default insurance benefits both lenders and borrowers in several ways:

1. Increased Access to Homeownership: It makes homeownership more attainable for buyers who might otherwise struggle to save for a large down payment.
2. Lower Interest Rates: Due to lower risk, the lenders may offer more competitive interest rates to borrowers with mortgage default insurance.
3. Enhanced Financial Stability: It lowers the risk, thereby contributing to the stability of the housing market and the financial system.
4. Support for First-Time Home buyers: It is particularly beneficial for first-time home buyers who often have limited savings for a down payment.

Disadvantages:

1. Increased Costs: The insurance premium adds to the overall cost of homeownership.
2. Lower equity: Buying with a lower down payment means you don’t have as much equity in your home.
3. Higher Monthly Payments: The insurance premium may lead to slightly higher monthly mortgage payments.

If you want to increase your down payment, you may consider waiting to save more, or buy a less expensive property.

It's important for prospective home buyers in Canada to understand the implications of mortgage default insurance and how it affects their overall mortgage costs.

There are pros and cons to paying less upfront, so make sure to do plenty of research & talk to your mortgage broker before making your decision.

Mortgage Default Insurance makes home ownership more accessible, but it's essential to carefully budget & do plenty of research before making your decision.

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