In recent years, the federal government in Canada has changed the rules about which homeowners need to get mortgage insurance. Mortgage insurance is, as you might expect, insurance that will pay any outstanding mortgage debts to the bank in the event that someone can't make their payments.
In this article, we'll discuss what mortgage insurance is, when you might need to get it, and whether or not you need it if you have the choice.
Currently, the law in Canada states that home buyers must put down at least 5% of the purchase value of the home (if it costs $500,000 or less) as a down payment. This means that on a $400,000 home, you must advance at least $20,000 to the bank when getting a mortgage, for example.
For homes valued between $500,000 and $1 million, you must put down an extra 10% as a down payment on the value of the house that exceeds $500,000.
So for example, for a house priced at $650,000 you'd have to advance 5% of the initial $500,000 (so $25,000) plus 10% of the extra $150,000 ($15,000). This would give you a total of $40,000 for a down payment.
Any home buyer putting less than a 20 percent down payment is classified as a "slightly higher risk" category buyer.
What Is Mortgage Default Insurance?
Often shortened to just "mortgage insurance," mortgage default insurance is an extra form of protection for the institution that issues a mortgage.
If you fail to make your mortgage repayments, the loan is considered to be "in default," and you will lose ownership of the home. The mortgage default insurance will then compensate the bank for the sum of your remaining outstanding debt.
Currently, Canadian law requires that any home buyer classified as a "slightly higher risk" buyer (i.e. has put down less than 20 percent as a down payment) needs to take out mortgage default insurance.
However, any homeowner with a mortgage can still get mortgage default insurance.
The way that mortgage loan insurance usually works is that the policy is taken out by the bank or lending institution. The costs are then passed onto the home buyer, which can be paid upfront at once or added to your monthly mortgage payments.
Mortgage insurance is available from the Canadian Mortgage and Housing Corporation (CMHC), and a few private insurance companies like Canada Guaranty Mortgage Insurance and Genworth Financial.
To learn more about how mortgage insurance works as well as ways to get a discount, visit the CMHC website.
Please keep in mind that homes valued at more than $1 million are not eligible for mortgage insurance. This means that a buyer will be required to advance 20 percent or more for the down payment.
Mortgage Insurance Costs
The monthly payment or "premium" on mortgage insurance depends on the amount of the mortgage loan and its ratio to the market value of your home. This is called the Loan-to-Value (LTV). In general, the cost of mortgage insurance is between 0.5% to 2.75% of the LTV.
Rates may vary between the CMHC and private insurers although they are usually quite similar.
Should I Obtain Mortgage Insurance?
Anyone with a mortgage can get mortgage insurance, although only those who are "slightly higher risk" are required to have it.
The advantage of having mortgage insurance is that it gives the bank or lending institution an extra guarantee that they will have their mortgage loan repaid.
Banks and lending institutions usually reward this reduction of risk by offering mortgages at better terms and/or with lower interest rates. As such, mortgage insurance allows you to buy more house for a lower amortized total cost.
The Canadian government believes that mortgage insurance also encourages buyers to save up for larger down payments. This demonstrates extra fiscal responsibility before taking on a big loan in the form of a mortgage.
The disadvantages of having mortgage insurance include having to make higher monthly repayments as they will have to pay both the premium on the mortgage insurance as well as the standard mortgage payments.
Because banks are at a slightly higher risk when home buyers don't have mortgage insurance, they may end up losing a lot of money if the loan goes into default.
In addition, when the home buyer has to take out a larger mortgage loan because they were only able to advance a smaller down payment, the total amortized cost for the home ends up being much larger.
Furthermore, it takes longer for the home buyer to build up equity in the home and thus make cheaper forms of credit available.
Mortgage default insurance is mandatory when a buyer does not advance at least 20 percent of the purchase price when purchasing a home using a mortgage loan. Mortgage insurance is available on homes valued less than $1 million but not in excess of that price. Anyone can obtain mortgage default insurance for a home valued less than $1 million. There are a number of advantages and disadvantages of choosing to obtain mortgage insurance, so always carefully evaluate your options before proceeding.