The question I often hear, "Is mortgage insurance mandatory?" and before I answer I always have to clarify what the client is asking. Mortgage Insurance could refer to Mortgage Default Insurance or it could refer to Mortgage Life Insurance, to find out if mortgage life insurance is mandatory, click here.
In this article I will talk about mortgage default insurance (also known as mortgage loan insurance) and "Is Mortgage Default Insurance Mandatory?"
Mortgage loan insurance is mandatory if you have less than 20% down payment to purchase a home and this insurance protects the lender if you default on payments. Default Insurance is offered by 3 companies in Canada: CMHC, Genworth and Canadian Guarantee and is sometimes referred to as "CMHC" or "high ratio" insurance.
Let's talk a little bit about this mandatory insurance and why you have to pay for it.
What is Mortgage Default (Loan) Insurance?
Mortgage default insurance is there to protect the lender and to allow a lender to finance more than 80% of the value of a home.
Mortgage default insurance was originally created by the Government of Canada. In 1954, Canada's National Housing Act was expanded and introduced Mortgage Loan Insurance (mortgage default insurance) that would protect lender's risk when financing property with less than 25% down payment.
Proir to 1954, lenders could only finance homes up to 75% of the value. This was conventional financing at that time. Home buyers struggled to come up with the down payment, therefore the Canadian Government stepped in to allow borrowers up to 90% of a home's value.
Lenders today are allowed to lend up to 80% of the value of a home, called conventional financing, without mortgage loan insurance. However, a lender is required to arrange mortgage loan insurance (also known as mortgage default insurance) if they finance more than 80% of the value of the home.
For many years, CMHC (Canada Mortgage and Housing Corporation) was the only provider of mortgage loan insurance. Later Genworth Mortgage Insurance Canada and Canada Guaranty entered the Canadian market. They are privately held corporations that offer mortgage loan insurance to banks and other lenders in Canada.
All mortgage loan insurance companies charge the same premiums to the banks, who pass on those premiums to the clients. Typically, the premium is included in the mortgage financing.
How much are mortgage default insurance premiums?
The premium will depend on the down payment. The higher the down payment, the lower the premium. Here is the table of current premiums:
5.0% - 9.99%
10.0% - 14.99%
15.0% - 19.99%
20.0% - 24.99%
25.0% - 34.99%
35.0% or more
Mortgage Insurance Premium
Notice that even though mortgage loan insurance is not required with 20% down or more, there is a premium listed.
Why is there a premium for 20% down or more?
For most purchasers, you will not be required to pay a mortgage loan insurance premium with 20% down or more. However, sometimes a lender will require a mortgage default premium depending on the location of the property or they type of property.
For example, some lenders will have requirements for minimum square footage for a home or condo. If the property that you want to purchase doesn't meet the lenders requirements and you have 20% down, then the lender could request mortgage loan insurance to offset their risk.
How is the Mortgage Loan Premium Calculated?
The mortgage loan insurance is calculated based on the down payment or the mortgage loan amount compared to the value of the property, known as loan to value (LTV).
Let's look at an example to see how this works. Let's use a purchase price of $400,000 with 5% down, the mortgage loan insurance premium would be 4%:
Down Payment (5%)
Insurance Premium (4.0%)
Total Mortgage Amount
As you can see from the example above, the premium is 4% of the net amount (purchase price minus the down payment). A lender would then set up a mortgage for the total amount including the premium.
The borrower effectively pays the premium to the insurer up front but then pays the premium over the life of the mortgage.
Is it better to pay the premium in cash up front rather than include the premium in the financing?
I get this question all the time. I think the best way to determine which is better is to look at an example.
Let's assume that you have enough saved for the down payment and you also have enough cash to pay for the premium up front. Therefore,
Premium paid separately to Insurer, total paid out $35,200
down pmt $35,200, premium included in mortgage
As you can see in this example. The column on the right the purchaser has $20,000 down (5%) and then pays $15,200 from their own resources to pay the mortgage loan insurance premium. They effectively pay $35,200 toward the purchase of their home.
In the example on the right side, then purchaser takes the $35,200 and uses that toward the down payment. The insurance premium is then calculated on a lower net amount. This results in a lower premium being charged.
As you can see this saved the purchaser close to $600 by not paying the insurance premium directly to the insurer.
If the purchaser could have come up with 10% down, then the premium would have been even lower. Instead of paying 4% premium the purchaser could pay 3.10%. See the example below:
5% Down Payment
10% Down Payment
How does the mortgage loan insurance get paid?
The mortgage lender will pay the mortgage default insurance on behalf of clients to the insurer. The lender directs this portion of the mortgage amount to the insurer and the balance of the mortgage funds are directed to the solicitor handling the purchase.
Note, in some provinces you may have to pay a provincial tax on the premium. This tax can not be financed by the lender and you would pay the tax as part of the purchase closing costs with your solicitor.
Is it possible to reduce the amount of mortgage default insurance?
There are two ways to reduce the amount of default insurance is to increase your down payment. As shown by the last example, a client who has 10% down pays approximately $4,000 less default premium than a client with 5% down.
The other way to reduce the premium amount is to choose a home with a lower purchase price.
We created a mortgage pre-approval calculator for clients to see calculate mortgage payments and see how the insurance premium is added to the mortgage. Check out the calculator here.
Is there a way to avoid the mortgage insurance premium?
If you have close to 20% down but not quite enough for the full 20% down, sometimes it could be worth it to take out a personal loan or line of credit to bring your down payment up to 20%.
Let's look at an example. You are purchasing a home for $400,000. You have $70,000 saved but can't come up with the extra $10,000 from savings to make 20% down.
In the above example, if you were short $10,000 for your down payment and you set up a personal loan for $10,000, then you would save a premium of $9,240. That's a substantial savings.
The disadvantage is that now you will have a payment for a personal loan in addition to your mortgage payments and other housing costs. This could make sense as long as you don't have too much other debt. This will also make sense if you can afford the payments for the loan and the mortgage.
A $10,000 loan would have a monthly payment ranging from $250 to $300.
Another discussion that I've had with clients is whether or not to take a second mortgage to avoid the insurance premium.
I won't do the calculations here, but there will be additional fees and a higher interest rate to arrange a second mortgage. In every example I have done for a client, the high ratio insurance is the better option compared to a second mortgage.