What Is Mortgage Default Insurance? What You Need to Know
Mortgage default insurance, often called CMHC insurance, is a central aspect of the home-buying process in Canada. The insurance coverage is mandatory for homeowners who make a down payment of less than 20% when buying a home.
However, the mortgage default coverage doesn’t protect the borrower. It protects mortgage lenders if a borrower stops making mortgage payments and defaults on their loan. This added protection allows more Canadians to enter the housing market with smaller down payments while still ensuring reasonable interest rates.
What Is Mortgage Default Insurance?
Mortgage default insurance protects mortgage lenders if you, as a borrower, stop making mortgage payments and default on your loan. It’s designed to help minimize the risk for lenders, allowing them to provide mortgages with smaller down payments.
With mortgage default insurance, you can secure a mortgage with a down payment as low as 5%. For example, if you’re purchasing a home for $300,000, a 20% down payment would be $60,000. However, with mortgage default insurance, you could potentially put down as little as $15,000 (5%).
To cover the cost of this insurance, you’ll pay an insurance premium on top of your mortgage payments, typically added to your monthly mortgage payments. These premiums vary depending on the size of your down payment and other factors.
How Does Mortgage Default Insurance Work?
The cost of the mortgage default insurance is determined by the size of your down payment. A smaller down payment results in a higher insurance premium. It can be paid upfront as a lump sum, but most borrowers add the premium to the mortgage amount.
If the borrower defaults on their mortgage, the lender can file a claim with the mortgage default insurance provider. The insurance provider then compensates the lender for their losses up to a certain limit, as outlined in the policy.
Who Offers Mortgage Default Insurance?
There are three companies providing mortgage default insurance in Canada. The primary provider is the Canada Mortgage and Housing Corporation (CMHC). The CMHC is a crown corporation that offers a variety of insurance options for buyers and lenders.
The leading private insurers in the market are Sagen (formerly Genworth Financial) and Canada Guaranty. These companies offer similar insurance products and premiums to CMHC. If you’re applying for a mortgage with default insurance, your lender will usually forward your application to one of the three providers for approval.
How Mortgage Default Insurance is Calculated
As mentioned, mortgage default premiums are determined by the mortgage amount and the percentage of the down payment. For illustration purposes, here is a breakdown of CMHC’s fee structure:
|Up to and including 65%||0.60%|
|Up to and including 75%||1.70%|
|Up to and including 80%||2.40%|
|Up to and including 85%||2.80%|
|Up to and including 90%||3.10%|
|Up to and including 95%||4.00%|
Example: $400,000 home purchase with 10% down payment ($40,000). The mortgage default insurance premium (CMHC Premium) would be 3.10% of the mortgage amount of $360,000, or $11,160.
However, if the same borrower only put down 5% ($20,000), their insurance premium would increase to 4.00%, or $15,200, a difference of $4,060.
Keep in mind that a 5% down payment is only available on the portion of the purchase price up to $500,000. The portion above $500,000 must have a down payment of at least 10%. For example, if you purchased a home for $700,000, the minimum down payment would be 5% of $500,000 ($25,000) plus 10% of $200,000 ($20,000) for a total down payment of $25,000 + $20,000 = $45,000.
It’s also important to note that mortgage default insurance is subject to provincial sales tax in some provinces, which varies depending on your location. This sales tax cannot be added to your mortgage and must be included in the mortgage closing costs.
Be sure to review the mortgage contract and consult with your lender to understand all the costs associated with CMHC insurance, including any applicable sales tax.
Can You Reduce Your CMHC Fees?
The simplest way to lower your CMHC fees is to increase your down payment. Because CMHC premiums are calculated as a percentage of the loan, a higher down payment directly lowers the amount you need to pay. For instance, if you can put 10% down instead of 5%, your insurance premium will be lower.
If you can’t come up with a larger down payment, another option is to keep the same down payment but purchase a cheaper home. This would result in a lower loan-to-value ratio (LTV). LTV represents the ratio between the mortgage loan and the appraised value of the property.
A lower LTV ratio may qualify you for a lower CMHC insurance premium. For example, if you move from a 5% down payment to a 10% down payment on a more modestly priced home, you would save on CMHC fees.
Should You Pay Mortgage Default Insurance?
If you can save 20% or more for a down payment, that is the best scenario because you can avoid paying mortgage insurance premiums and take out a smaller mortgage. However, it’s unrealistic for many homebuyers in our current housing market.
Saving a 10% down payment (versus 5%) will reduce the amount you pay in CMHC fees and your mortgage payments. Remember that there are several places to obtain down payment funds. If you’re a first-time homebuyer with money in an RRSP, you can borrow funds under the Homebuyers Plan. Or, if you have a family member willing to sign a gift letter and contribute to your down payment, that can also help.
Is mortgage default insurance mandatory in Canada?
Mortgage default insurance is mandatory when your down payment is less than 20% of the home’s purchase price. The premiums vary depending on the down payment percentage.
Who are the main mortgage default insurance providers?
The primary mortgage default insurance provider in Canada is the Canada Mortgage and Housing Corporation (CMHC). However, there are other private insurers, such as Sagen (formerly Genworth Canada) and Canada Guaranty, that also offer mortgage default insurance.
How much does mortgage default insurance cost per month?
The cost of mortgage default insurance varies depending on your down payment amount and the size of your mortgage. Premiums are calculated as a percentage of your total loan and are usually added to your mortgage payments. CMHC premiums range from 0.60% up to 4.00% of your total loan amount.