What is Mortgage Default Insurance?
Mortgage default insurance, popularly known as CMHC insurance in Canada is mandatory on high ratio mortgages, that is, mortgages with a down payment of 20 per cent or less. In other words, CMHC insurance is required when you are paying 20% or less of the price of a home as down payment to buy it. This insurance protects the lender in case borrower defaults and stops making payments on his mortgage loan. Such insurance is generally based on the amount of the mortgage. Also, such insurance can be paid in lump sum upon closing, but it is usually added to the mortgage amount and paid over the period of the mortgage. Mortgage default insurance is offered by only three insurance providers in Canada: the Canada Mortgage and Housing Corporation (CMHC) and Genworth Financial and Canada Guaranty.
Eligibility Conditions for Mortgage Default Insurance in Canada
In order to get CMHC insurance, following requirements need to be fulfilled:
- The home must be in Canada.
- The potential borrower needs to make a down payment of at least 5% of the purchase price depending on the type of property. In case of single family and two unit dwellings down payment should be at least 5% of purchase price, while it should be at least 10% of purchase price in case 3 or 4 units are being purchased.
- If the loan to value ratio is more than 80%, the maximum purchase price must be below $1,000,000
- The total housing cost (including principal, interest, property taxes, and heating cost and 50% of condo fees if applicable) should not be more than 32% of borrower’s gross household income (GDS).
- The total debt service (TDS) of the borrower shouldn't be more than 40% of borrower’s gross household income.
- The borrower should make a minimum down payment from his own funds. However, he/she is allowed a down payment as a gift from an immediate relative for dwellings of 1 to 4 units.
- The maximum amortization period for insured mortgages is twenty five years.
What is Mortgage Default Insurance Premium?
In order to obtain mortgage default insurance, lenders are required to pay an insurance premium, which they generally pass on to the borrower. The lenders provide an exact price for insurance premium when a borrower applies for a mortgage. Mortgage default insurance is based on the size of down payment. It is calculated as a percentage of the mortgage.
How Mortgage Default Insurance Is Beneficial For Lender As Well As Home Buyer?
Mortgage default insurance acts as protective shield for lender, so that the lender doesn’t have to worry so much about default on the loan. On the other side, a home buyer/borrower may avoid insurance premium without mortgage default insurance, but he/she typically needs to pay higher interest rate and other fees along with loan. Mortgage default insurance cost is generally completely offset by saving attained.
A borrower can minimize his mortgage default insurance by increasing the down payment. One can do it either by increasing the amount of down payment or buying less costly home. In order to increase down payment, you may consider additional sources like a gift from a family member or a tax-free withdrawal from your Registered Retirement Saving Plan, applicable to first time home buyers only. Following is the breakdown of the Mortgage Insurance Premium in Canada:
|Loan-to-Value||Premium on Total Loan||Premium on Increase to Loan Amount for Portability and Refinance|
|Up to and including 85%||
|Up to and including 90%||2.40%||4.90%*|
|Up to and including 95%||3.60%||5.65%*|
|90.01% to 95% - Non-Traditional Down Payment**||3.85%||*|
How To Calculate Mortgage Default Insurance Premium?
Let’s say you have purchased a home for $400,000 and also you paid $50,000 as a down payment. Then, your mortgage default insurance premium would be calculated in the following manner:
Down payment $ 50,000 ÷ $ 400,000 = 12.5%
Mortgage Amount = (Home Value – Down Payment)
400,000-50,000 = 3,50,000
Mortgage Insurance Premium
350,000 * 2.40% (*refer table) = 8400 (insurance premium)