When you buy a home, your best results will come when you make it a point to make a 20% down payment. However, for some Canadians, that much of a down payment is prohibitive. So, what can you do if you can't make such a big down payment? If you are willing to pay extra for your mortgage, you can get special insurance to help lenders feel better about approving you for a loan with less than 20% down.
The Canada Mortgage Housing Corporation provides mortgage loan insurance to lenders for home buyers with a down payment of less than 20%, to as low as 5%. It offers a way for borrowers to get away with putting down a lower down payment than a lender might like. It's one way to boost home purchases in Canada.
However, it is important to note that this insurance is not meant to protect the buyer; it is used to protect the lender. CMHC insurance guarantees the bank or credit union that it will not lose money on this high ratio mortgage. If a borrower has more “skin in the game,” he or she is considered less of a risk. A 20% down payment usually represents a large commitment to the home, and a lender can feel reasonably sure that such a borrower won’t default on the mortgage loan. When you pay less than 20% down, the lender worries that the large amount of money provided won't be paid back. You pay for the insurance so that the lender doesn't have to worry so much about your default.
How Does CMHC Insurance Work?
CMHC mortgage insurance is purchased to compensate the lender in the event that you default on your loan. Since it is the lender that is putting up the capital for your home purchase, the lender takes on the bulk of the risk of you don’t follow through. Insurance can help offset some of the risk involved. While you feel as though you are buying the home, the reality is that the lender has fronted the capital for this purchase. If you are buying a $200,000 home, and have a 5% down payment, you are paying $10,000, while the lender is paying $190,000. That's a lot of money for the lender to lose if you default and don't finish the repayment on the loan.
It is the lender that technically pays the CMHC mortgage insurance premium, though the cost will pass to you. Many lenders add the insurance premium amount into the mortgage, so that you will not need to pay it immediately. This can be helpful, since many people don't have enough to pay the cost of CMHC insurance up front. If you can't manage a 20% down payment on your home, chances are that you won't be able to add an additional amount in upfront costs to cover your mortgage insurance.
How much will CMHC insurance cost you? There are three cost tiers for employed people with verifiable income:
- 15% to less than 20% down payment requires a standard insurance premium of 1.8%
- 10% to less than 15% down payment requires a standard insurance premium of 2.4%
- 5% to less than 10% down payment requires a standard insurance premium of 3.6%
As you can see, the smaller your down payment, the more you pay in charges. On top of that, if you want a longer mortgage term (resulting in a smaller monthly payment), you have to be willing to pay the surcharge. The longer your mortgage term, especially when combined with a smaller down payment, the larger the chance that you default on your commitment. The entire program is structured to encourage homebuyers to bring as much as they can to the table. Due to the inflation in home prices, this can be difficult, though. That is one of the reasons that CMHC insurance can be so helpful.
If you want to reduce your costs, the CMHC has a program that provides a 10% refund on your premiums and no surcharge on extended amortizations if you purchase an energy eficient home, or if you renovate your home to make it more energy efficient. If you are environmentally conscious, this can be a great way to save a little money, as well as the earth. Searching out programs like this can provide you with a way to save more money on your home, and even save money in the future. It just makes sense, if you have the ability to take advantage of these programs.
While you would benefit from having a 20% down payment, in both interest and premiums saved, CMHC mortgage loan insurance serves a purpose by allowing people to buy a house with a smaller down payment. Being insured against loss, the bank is less concerned about the higher risk they take on, which allows the buyer to stop renting and start building equity in a home of their own. If you are interested in purchasing a home, this can be a big deal. Rising home prices mean that it takes longer to save up for a big down payment. CMHC mortgage cuts the time in half, and provides solutions to the problem.
Before you decide to buy a house, though, think about whether or not you can afford a bigger down payment. Weigh the costs and benefits of saving up for a down payment and paying less over time, or getting into a home sooner, but paying a larger amount over the life of your loan. Each scenario has its benefits and drawbacks, and you will need to consider your current situation, and the way your financial resources are being used. Only you can decide which scenario is likely to provide you with the best use of your financial resources.