Are you planning to buy your first house? If you dread paying the 20% down payment, or just can't afford it, there are ways to reduce your initial costs.
In fact, you can bypass the 20% down payment requirement that most mortgages require in Canada by opting for mortgage insurance. Read on to find out how you can get CMHC mortgage insurance and buy the house of your dreams with as little as 5% down payment.
What is Mortgage Insurance?
When buying a house, you are usually expected to make a 20% down payment on your mortgage. This defines your budget and determines your mortgage options. By paying one-fifth of the total cost up front, you are protecting your lender against loss, but not everyone can afford that kind of down payment.
For most people, paying that down payment is the biggest obstacle that prevents them from buying the house of their dreams. They can either save up some money, or look for cheaper alternatives, but there is a third option.
Here is where mortgage insurance can help you find more options. Mortgage insurance basically insures your lender against loss in case you default on your mortgage payments. If they don't have a sizable down payment to balance their risk, they will have to get their risk protection from mortgage insurance.
How Does Mortgage Insurance Work?
If you can't make the down payment but you are willing to pay a premium on your mortgage, then you can get a better deal through mortgage insurance. But how does this work?
There are three official mortgage insurance providers in Canada, with the Canada Mortgage and Housing Corporation (CMHC) being the largest and most commonly used.
CMHC provides mortgage loan insurance for home buyers with a down payment between less than 20% and 5%. This insurance protects the lender and not the buyer. It triggers if the buyer defaults on their mortgage and pays the lender a lump sum to cover their damages from the default.
This happens because lenders would not normally give a mortgage loan unless they had some solid guarantee that their investment is safe. This guarantee is usually the down payment. When that is not available, mortgage insurance covers the gaps.
For example, if you are buying a $250,000 house with a 10% down payment, you are only actually paying $25,000 up front, and the lender pays the remaining $225,000, which you have to pay back through your mortgage payments. The insurance is there to offset the risk of you not following through.
Understanding CMHC Mortgage Insurance
As we have seen above, lenders will buy CMHC mortgage insurance to protect their assets in case of default. This means that lenders are technically paying for the CMHC mortgage insurance.
However, in practice, the cost of this insurance is passed on to the borrower through higher monthly mortgage rates. Since the insurance premium will be added into your mortgage payments, you will not have to pay it back right away.
The cost of CMHC mortgage insurance will vary depending on your down payment. More specifically:
- A loan-to-value of up to 65% will require a 0.60% premium on the total loan
- A loan-to-value of up to 95% will require a 4.00% premium on the total loan
The values from 65% and up to 95% climb accordingly.
So, the smaller your down payment, the more you pay in mortgage insurance premiums. Moreover, longer mortgage terms with smaller monthly payments will incur higher premiums. That is because the longer you owe a mortgage, the longer your lender will have to pay for their mortgage insurance, and the costs will be passed to you.
The aim of CMHC insurance is to allow buyers to get into their homes faster, without having to pay the full amount of down payment up front.
There are certain qualification criteria you will have to meet for mortgage loan insurance. The property you are insuring should cost less than a million dollars, and you can't avoid a 5% down payment.
Moreover, your total monthly housing costs should not be higher than 32% of your gross household income. This ensures that you will have money to pay back your mortgage with the insurance premiums down the road. You need to prove to CMHC that you will be able to keep meeting your mortgage obligations.
CMHC Premium Refund for Energy Efficiency
If you are considering a CMHC mortgage loan and want to reduce your costs, you should look into the CMHC premium refunds for energy-efficient homes.
CMHC offers a premium refund of up to 25% on their mortgage loan insurance premiums if you buy or build a house that is energy efficient. The refund also applies if you buy an existing home and renovate it to be more energy efficient as well.
The energy-efficient housing program is a great way to save money while protecting the natural environment. According to CMHC, more than 16% of the energy consumption in Canada goes to power our homes.
Is CMHC Mortgage Insurance Better Than Saving Up?
As we have seen above, mortgage insurance gives you more flexibility when buying or building your new home. With just a 5% down payment and a 25% reduction to your insurance premiums due to eco-friendliness, CMHC insurance may look appealing.
With CMHC insurance, you can get in your dream house faster and enjoy the benefits of your new home right away. However, mortgage insurance raises the total sum you will have to pay during the full course of your mortgage.
The more your down payment decreases, the higher the premiums you will have to pay. Also, the longer it takes you to pay your mortgage, the more insurance you will pay.
Being insured against loss, lenders are more open to giving you favorable mortgage agreements. That way, you can take out a mortgage and start building equity on your new home instead of paying rent for a house you don't own.
However, you should always consider if you can afford a larger down payment. If you can save for a few years to buy a bigger house, why not save for an even bigger one with mortgage insurance?
Saving up to pay the full 20% is not always feasible, especially in areas where real estate prices are rising fast. If the prices are going up faster than your savings are piling up, you won't be able to catch up!
On the other hand, prices might go down, and if you wait you might get your dream house with a more favorable mortgage.
The Hard Facts
To recap. IF you want to buy a house with less than 20% down payment, you need mortgage insurance. This is taken out by your lender and passed to you through higher mortgage payments.
Your lender will give you the exact price of the mortgage premiums you will have to pay when you apply. There are online calculators you can use to measure how much you are going to be paying yourself.
CMHC Mortgage Loan Insurance premiums are calculated as percentages of the total loan in relation to your down payment. The more you pay up front, the smaller the premiums are going to be.
Without mortgage insurance, you won't have to pay any insurance premiums, but you will have to pay a higher down payment and possibly higher administrative fees.
Deciding If CMHC Mortgage Insurance Is Right for You
The final decision is completely up to you and your financial plans. Choosing to pay the full down payment or opting for mortgage insurance is something only you can make.
The things you have to consider in addition to your current status is your job security and how your financials will be in the foreseeable future. Making the right choice can save you a lot of money and get you inside your house building equity faster.
Mortgage insurance is a surefire way to get a favorable loan to buy your house with a small down payment, but it makes your mortgage somewhat harder to repay if your financial future is not clear.
In the end, you will have to decide if waiting a few years to save up for the 20% down payment is more preferable than paying a larger mortgage bill each month so you can get into your house faster.
Find Out More about CMHC Mortgage Insurance and Secure the Best Insurance Rates
Securing the right insurance deals isn't always easy. Here at Insurdinary, we are the leading insurance comparison website in Canada and North America. Our mission is to help people find the best and lowest insurance rates and financial promotions online.
Through our search engine, you can browse all available CMHC mortgage insurance deals, and you can educate yourself on insurance advice and tips at our blog. We strive to help you make informed decisions when it comes to obtaining the best insurance products for you and your family!