The general rule is that you need to pay a deposit of 20% of the purchase price of a house to qualify for a mortgage. Unfortunately, many people can’t afford to put down that amount, especially if they're buying a highly priced home.
To make mortgages more accessible, borrowers who can’t afford 20% may be allowed to put down a lower percentage. However, if you can’t raise the 20% deposit, you’ll have to take out mortgage insurance. This type of insurance is also known as mortgage default insurance.
You may have heard you need mortgage insurance, but the details are hazy. Turn to this guide as we answer the question, "Who does mortgage insurance protect?"
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Who Does Mortgage Insurance Protect?
With insurance, the lender can allow you to put down a much smaller deposit, sometimes as low as 5%, which the minimum in Canada. Lenders become cagey when you give a lesser deposit. Such a deposit increases the risk to lenders who then need protection. The industry designed mortgage insures for this. Please note that mortgage insurance is different from mortgage life insurance.
Having taken an insurance cover, you qualify to get a mortgage at the same interest rate as those who put down a higher deposit would get.
From a practical standpoint, mortgage default insurance intends to protect the lender more than anyone else.
Mortgage insurance in Canada emerged in 1946. At the end of the Second World War, the government concern was to reintegrate the returning soldiers. One of the barriers was that there wouldn’t be enough homes for them.
The Crown formed Central Mortgage and Housing Corporation (CMHC), to deal with the problem of housing. In 1979 the name was changed to Canada Mortgage and Housing Corporation.
Even then, many borrowers still couldn’t afford the required 20% down payment. They could pay for their homes in the long run, but they posed a risk, and they needed to be insured.
The above history is how mortgage insurance began in Canada. CMHC enabled war veterans to acquire homes but also assisted in the construction of rental houses for the accommodation of tenants.
Eventually, CMHC started financing the general public for home ownership. In addition to CMHC, there are two other insurers for mortgages. AIG and Genworth Financial Canada. To date, CMHC remains a top company known in mortgage insurance.
How Does It Work?
With only three insurers offering this service in the whole of Canada, CMHC tightly controls the market. Insurers who provide these services are relatively stable, and the danger of their collapse is minimal.
With the stability of insurers out of the way, the next issue you’re bound to consider necessary is the cost of this insurance.
The amount of deposit you have put down determines the cost of your insurance. The range is typically between 2.8% and 4%. Therefore, if your deposit is 5% of the price of your house, you may end up being insured at a rate of 4%.
On the other hand, if you’ve given a down payment of 15% -19.9%, insurance will be charged at a rate of 4%.
Qualifying for Mortgage Insurance
To qualify for this insurance, you must meet the following terms:
- Your home must cost $1 million and below
- The property of your interest must be within Canada
- The total value of costs associated with the house shouldn’t exceed 32% of your household income.
- Your down payment should be at least 5% on the first $500,000 of the cost of the house
Who Doesn’t Qualify?
As we have seen, mortgage insurance qualifies you for a mortgage even when you can't raise the minimum deposit amount. Unfortunately, this facility isn’t available to everyone in Canada. The following aren’t eligible:
- Anyone buying a home worth more than $ million
- Typical mortgage amortization periods in Canada range between 25-35 years. If the amortization period of your loan is more than twenty-five years, you don’t qualify for mortgage insurance.
Please note that there’s a difference between the amortization period and the mortgage term.
Ineligibility for this insurance means that you must raise the 20% discount for any mortgage of this definition. If you’re lucky enough to find a lender, you’ll pay back your mortgage at higher interest.
Your credit history may prompt such a requirement, location of the house you want, or other factors that may cause the lender to consider your mortgage risky.
How Premiums Are Paid
Premiums can be paid in two ways. Either as monthly payments or lump sum payments.
Unlike in other markets, such as the United States, there’s only one way of paying premiums in Canada. The lender charges you a slightly higher premium and then pays it onwards to the insurer. You don’t need to pay your premium directly to the insurer.
We have earlier observed that the reason you need this cover is that you were not able to raise a 20% discount. You might, therefore, expect to stop paying for this insurance when you have paid 20% of your house.
If this option isn’t available, you’ll continue paying your monthly premium for the duration of your mortgage.
Some people might argue that the certainty of the amount you need to pay throughout the mortgage helps you plan. However, the opportunity to save some money is always welcome. Therefore, it would be good if it were possible to stop paying the premiums at some point.
Lump Sum Payments
As a borrower, you have the option to pay for your mortgage insurance upfront. Upfront payment is when you pay the whole premium amount as part of your closing settlement.
However, it’s noteworthy that a lump sum payment may be a fairly considerable amount. Such an amount may be out of reach for a borrower who couldn’t raise the 20% discount.
As a borrower, you would need to seek advice on where the amount would serve you better. Would it be better off paid as the premium upfront or as a deposit?
Paying it as deposit would reduce the mortgage principal. A reduced principal amount means you would be paying less interest and a lower premium rate on your insurance.
Can You Get Out of It?
As a mortgage holder, you might be pleased to avoid mortgage insurance. It makes sense to avoid it altogether or eliminate it at some point since it would lessen your financial burden. Here are some ways you can stop paying:
- Investment properties are not eligible to get this cover. In their case you need to raise the requisite 20% deposit.
- Through vendor-supplied mortgage finance, the seller gives you a loan to buy the house. To secure their interest, they retain some equity in the property. In this way, the investment remains under protection from default. Also there's no need of further insurance.
- Refinancing:- After paying the mortgage for a certain period with a particular lender, you can move on to another one. After this movement, you may retain 20% of house ownership and avoid paying the premiums.
Mortgage Insurance Could be Desirable
In Canada, the mortgage insurance business isn’t as open as in other developed countries. As we have observed, there’re only three insurers in the market, one of them, being a crown company.
Lenders and insurers have minimum control on rates. As a privately ran crown company, CMHC operates in the interest of the public.
Considering some of the benefits below, you might find it advisable to take out the insurance even when you qualify to avoid it.
- Mortgage insurance reduces the interest rate on your mortgage by at least 0.3%. The lower the interest will be means you’ll save your money.
- Another advantage is that having this insurance opens more financing options for you. More lenders feel safe when they know that you have protection.
- In the Canadian market, your mortgage is attached to you. This attachment to the borrower is unlike other markets where it's done to the property. This arrangement means you can move your loan to other lenders after under certain conditions.
- The other lenders are likely to feel more comfortable with you if you have insured your loan.
Importance of Mortgage Insurance in Decision Making
So, who does mortgage insurance protect? From the above information, the answer to this question is technically ambiguous. Mortgage insurance protects the lender from the risk of losing money.
On the other hand, it enables prospective homeowners to start the process of buying a home without the required deposit. The cover also reduces the interest borrowers have to pay on their mortgage.
As a borrower, it’s prudent for you to consider the pros and cons of mortgage insurance carefully. As a borrower, you must decide whether to wait and raise your 20% deposit or start paying for your home now and take the insurance cover.
You need to consider all factors, including that you’ll be paying rent in the meantime. On the other hand, when you own the house, you’ll need to pay land rates and maintenance costs.
As a tenant, your home insurance may also be lower depending on the location of your house. Contact us to help you put all factors into consideration and make the decision that will be most favorable to you.