"Default insurance" is one of the most misunderstood mortgage concepts. One big misconception is that by paying a hefty insurance premium, the borrower is off the hook if they default.
That would be false, says the Canada Mortgage and Housing Corporation (CMHC), the largest provider of mortgage insurance in Canada.
If you default on an insured mortgage and the lender can't make itself whole by selling your property, you could owe the difference. And not just for the mortgage principal, but for the lender's lost interest and legal fees too.
It doesn't happen very often but if home values ever plunged, forced liquidations of homes would happen more often. In such cases, declaring bankruptcy may or may not prevent CMHC from taking your money.
Fact: Mortgage default insurance is mandatory when you: (A) buy a home with less than 20 percent down, and (B) get your mortgage from a prime lender. The "premium" you pay for that "high-ratio" insurance ranges from 2.80–4.50 percent of your mortgage amount, depending on the size and source of your down payment. Here's more on the differences between insured and uninsured mortgages.
Default Insurance Shields the Lender, Not You
Mortgage loan insurance is designed to protect the lender if the borrower doesn't pay the mortgage. Here's how it works...
"For CMHC-insured homeowner loans, a lender must take all reasonable and appropriate measures to manage borrower default situations," explains CMHC spokesperson Audrey-Anne Coulombe.
In the event of a mortgage that's been in default for at least three months, the lender would then try to recoup its outstanding loan through a foreclosure, power of sale or other legal remedy.
"Once the sale occurs, the borrower has an obligation to repay any shortfall if the proceeds of the sale are insufficient to cover the amount owed under the mortgage and other eligible holding costs," Coulombe says. "In these situations, the lender will obtain a deficiency judgment from the courts where it is financially feasible to do so and then submit an insurance claim to CMHC along with an assignment of the judgment. CMHC will then attempt to recover on the judgment."
Fact: A few provinces (Alberta and Saskatchewan) prevent lenders from coming after you for the difference if your home sale doesn't make them whole. That only applies to uninsured mortgages, however. If you're mortgage is default insured, you can still be sued for the deficiency.
Coming After the Borrower
During the U.S. housing crash of 2006 to 2012, there were countless stories of borrowers simply walking away from their homes (and mortgage obligations) when the going got tough.
That doesn't happen here. "CMHC has the right to garner wages where there is an active judgment," says Coulombe. It can even have your bank accounts frozen.
There are two common ways out of this mess. For one, borrowers can settle those judgments based on their ability to pay. This requires "full financial disclosure and supporting documents" Coulombe adds.
Failing that, some borrowers simply declare bankruptcy. In that case, CMHC would have to file a claim with an appointed Trustee for any shortfall of the mortgage, similar to the process for other unsecured creditors. Coulombe says CMHC would then receive a prorated portion of the funds from the estate through any actions taken by the Trustee. Only then, would the borrower finally be off the hook.
Fact: CMHC cannot garner a borrower's wages after a consumer has filed bankruptcy, says Coulombe. That is, "Unless the bankruptcy has been declared null and void, which reinstates the judgment," she said.
Canada's Low Delinquency Rate
In Canada, insured mortgages are "full-recourse," meaning responsibility for the mortgage loan ultimately rests with the borrower even in the event of default.
That, naturally, encourages borrowers to do everything possible to make their payments and avoid foreclosure.
In the U.S., "strategic defaults" (where borrowers stopped making payments despite being able to) were widespread during the mortgage crisis. By comparison, a housing sell-off in Canada would likely see a much lower percentage of borrowers simply handing in their keys to their lender. A study by National Bank found that home prices would likely have to fall by at least 30% to 40% to trigger "strategic" defaults here. It's hard to get away from lenders and CMHC.
The above partly explains why delinquencies in Canada remain near historic lows. The latest data from the Canadian Bankers Association shows that just one in 416 mortgage borrowers were behind in their payments by three months or more. Unless unemployment skyrockets, that probably won't change much.
Visit Rates.ca to compare mortgage rates, or better understand how CMHC premiums impact your mortgage with the CMHC Mortgage Calculator.
