What is mortgage insurance?

With home prices still at record highs across the country, not every homeowner can afford to make a 20% down payment.

The good news is you can make a down payment between 5% and 19.99% and still buy a home, but there’s a catch: you’ll need to pay for mortgage insurance, also known as mortgage default insurance.

When you put less money down, you’re viewed as a higher risk to mortgage lenders. In Canada, mortgage default insurance, which is provided by the Canada Mortgage Housing Corporation (CMHC), compensates your lender if you default on your mortgage. Although foreclosure is always an option, if the housing market takes a turn for the worse, your lender may not be able to recover all the money owed to it. That’s where mortgage insurance comes in.

Advantages of mortgage insurance

The biggest advantage of mortgage insurance is that it enables you to get into the housing market with a smaller down payment. Without it, many buyers would be forced to sit on the sidelines until they could save up a 20% down payment. Homebuyers could find themselves priced out of the market if their savings aren’t able to keep up with how quickly home prices have risen.

Also, if mortgage insurance weren’t required, chances are you’d pay a higher mortgage rate to offset the risk you pose to the lender. Since mortgage insurance ensures your lender is compensated if you fail to repay your mortgage, it’s a less risky loan for lenders.

Disadvantages of mortgage insurance

The biggest disadvantage of mortgage insurance is, of course, the cost and the fact that it’s inescapable if you’re putting down less than 20% of the purchase price. Although you can pay your mortgage insurance premium upfront in a lump sum, few buyers do. Mortgage insurance can range from 0.6% to 4% of a buyer’s mortgage amount. And most buyers choose to amortize this over the life of their mortgage.is over the life of their mortgage.

When you make your regular mortgage payment, you’re paying your principal, interest, and your insurance premium. This can prove costly. Your mortgage insurance premium can end up costing you thousands over the life of your mortgage. You might come out ahead if home prices continue to go up, but if we see a housing correction, that may not be the case.

If you’re on the cusp of a 20% down payment, you might want to consider waiting to buy a home until you’ve saved enough to avoid mortgage insurance.

How to qualify for mortgage default insurance

Before qualifying for mortgage insurance, a buyer is subject to certain conditions based on the price of their home and how long they have to pay off their loan. Some conditions include:

• Your amortization period can’t exceed 25 years
• If you bought your home for $500,000 or less, your down payment must be a minimum of 5%
• If you bought your home for more than $500,000, you must put at least 5% down on the first $500,000 and 10% on the remaining amount
• If you paid $1,000,000 or more for your home, mortgage loan insurance is not required

The CMHC has further qualifying factors regarding your personal finances. Some include:

• Having a gross debt service ratio of 32% or less
• Having a total debt service ratio of 40% or less
• Paying the minimum down payment with your own funds or a gifted payment from an immediate relative (for dwellings with one to four units)

How is mortgage default insurance calculated?

Mortgage insurance is calculated using a ratio of the percentage of your down payment and your total mortgage loan. This is referred to as the loan-to-value ratio.

According to the CMHC, if you purchased a house for $500,000 and put the minimum 5% down ($25,000), your mortgage insurance calculation could look like this:

$500,000 (home price) - $25,000 (down payment)

= $475,000 (mortgage loan)

$475,000 x 4% (tax rate)

= $19,000 (mortgage insurance premium)

How can I lower my mortgage loan insurance?

If you’re trying to minimize your mortgage insurance premium, you need to minimize your mortgage loan amount. In order to do that, you’ll have to make a larger down payment with respect to your home’s purchase price.

Considering a less expensive home is an alternative method. Either way, you’ll always have to put the minimum 5% down, so keep that in mind when budgeting for your mortgage.