Everything You Wanted to Know About Mortgage Default Insurance
If you’re buying a home with less than a 20 percent down payment, mortgage default insurance is required by law. A lot of homebuyers like to grumble about the mortgage default insurance premiums, but mortgage default insurance is actually a good thing in most cases.
In this article we’ll look at what is mortgage default insurance, what are the benefits of it, what is the downside of it and an example of how the premiums are calculated.
What is Mortgage Default Insurance?
When taking out mortgage default insurance, it’s important to understand what it is. When you’re paying for insurance, you’ll probably assume that it protects you. While mortgage default insurance does offer a lot of benefits, it’s important to understand what it truly is.
If you were ever to default on your mortgage, mortgage default insurance protects your lender. Defaulting on your mortgage means that you didn’t meet the terms and conditions of your mortgage contract. The simplest way of defaulting on your mortgage is when you stop making your mortgage payments.
This is a surprise for a lot of homebuyers. It’s common to think of mortgage default insurance like home insurance. You’d think if you’re paying for mortgage default insurance, it would protect you, but that isn’t the case. It does offer many benefits, but it’s your lender who is protected, not you.
Let’s say that you stop making your mortgage payments and your lender is forced to sell your home to recover the money that is owed to them. Usually homes less for more, but let’s say it’s a slow real estate market and your home sells for less. If the sale proceeds aren’t enough to pay your lender the debt that’s owing to it, that’s when the lender could file a claim with the mortgage default insurer and recover the money owing to them. The mortgage default insurer then could choose to go after you, the borrower, for the money owing.
Mortgage default insurance is often referred to as “CMHC insurance.” That’s because CMHC is the best known provider of mortgage default insurance. There are also two other private mortgage insurers in Canada, Sagen (formerly Genworth) and Canada Guaranty.
What are the Benefits of Mortgage Default Insurance?
It’s true that mortgage default insurance has a cost, but there are also lots of benefits.
- You can afford to buy a home sooner. You can buy a home with a purchase price of $500,000 or less with only five percent down. Without mortgage default insurance you’d have to put 20 percent down. Imagine how long much longer it would take you to save a 20 percent down payment. During that time if home prices went up a modest three percent, you could see your purchasing power fall. You’d actually be worse off waiting to buy than buying right now with less than 20 percent down.
- You get the best available mortgage rates. With mortgage default insurance, you qualify for a lender’s best available mortgage rates. That’s because there’s zero risk to the lender with mortgage default insurance. If you default on your mortgage and the home sell for less, the lender can make a claim with the mortgage default insurer and recover the money owing to them.
- Keeping best available rates. When you transfer your mortgage to another lender, you can transfer the mortgage default insurance with you and continue to get best available rates at the new lender at no additional cost beyond the one-time mortgage default insurance premiums you paid.
- You can pay for home renovations. The mortgage default insurers offer a program called Purchase Plus Improvements. Using the program you can borrow additional funds to pay for home renovations before you qualify for a HELOC.
What is the Downside to Mortgage Default Insurance?
There are some disadvantages to mortgage default insurance, but those can be offset.
- Taking on more debt. Mortgage default insurance gets added to your mortgage balance. That means you’ll be taking on a larger initial mortgage balance. However, if mortgage default insurance helps you buy sooner, you might actually be saving money. You can buy at today’s home prices and you’ll save from no longer renting.
- Paying more in interest. Having a higher mortgage balance means you’ll pay more in interest. However, by making extra prepayments on your mortgage you can help offset that.
Mortgage Default Insurance Example
You can find CMHC’s table of mortgage default insurance premiums here. Let’s go through an example together to help you gain a better understanding.
Let’s say you’re buying a home for $500,000 with the minimum five percent down, $25,000. In that case your mortgage default insurance would be $19,000. That amount was calculated by taking the mortgage amount, $475,000, multiplied by the mortgage default insurance premium rate, four percent. Therefore, $475,000 X 4% = $19,000. Your starting mortgage amount would be then be $494,000 ($475,000 + $19,000). Make sense?
The Bottom Line
Are you trying to decide how much to put down on your new property purchase? Let one of our experts help you. We can do the math and show you ways to save on mortgage default insurance premiums.