What Is Mortgage Insurance? And Why Do I Need It?
Fee-for-service financial planner and founder of PlanEasy.ca
Mortgage insurance is one of those things that most first-time home buyers run into when buying a home. Unless you’re lucky enough to save up a 20% down payment you probably need to get mortgage insurance on your home.
So, what is mortgage insurance exactly? And why do you need it?
Mortgage insurance is a requirement for all homes with under 20% down payment (Some banks even require it for down payments of 20%+. But in those cases it’s the bank making that decision, it’s not actually mandatory).
Mortgage insurance helps protect the lender in case you default on your mortgage. It’s a way to provide stability to the housing market. The largest provider of mortgage insurance is the CMHC, a federally backed agency. This means that the federal government is essentially backing the Canadian housing market, and this adds a lot of stability for buyers, sellers and lenders.
How Does Mortgage Insurance Work?
Mortgage insurance is something that is required for anyone with a down payment under 20%. This is a one-time fee and it gets added to your mortgage. This actually makes the cost of mortgage insurance seem very small because it gets spread of the length of the mortgage. But make no mistake, the cost of mortgage insurance is usually in the thousands or tens of thousands.
Let’s say your mortgage insurance premium was $5,000 and this was added to your mortgage. Over 25 years this only adds $25 to your monthly mortgage payment. Not a big deal, right?
It might not seem like a very high fee to pay, especially when the alternative is saving up a 20% down payment, but it’s important to keep in mind that this will add up to about $7,500 when you include interest charges.
The Canadian Mortgage and Housing Corp (CMHC) is usually the one that provides mortgage insurance.
How Much Does It Cost?
Mortgage insurance fees decrease in steps as your down payment increases. There is a cliff at the following down payment thresholds, 5%, 10%, 15% and 20%. Sometimes it can make sense to scrimp and save to get to the next threshold.
For a 5% to 10% down payment the fee is 4.0% of the mortgage. For a 10% to 15% down payment the fee is 3.1% of the mortgage. For a 15% to 20% down payment the fee is 2.8% of the mortgage. This gets added to your mortgage, so the amount you pay monthly is quite small. Depending on your mortgage it might be $50-$100 extra per month.
If you have over 20% down payment, mortgage insurance is optional, but might be required by your bank. Sometimes a bank will offer you a lower interest rate if you buy the optional mortgage insurance. Your mortgage broker or financial planner can help you figure out if it’s better to take the higher mortgage rate or buy the optional insurance and get a lower mortgage rate.
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“It can make sense to scrimp and save if you can squeak past the next down payment level.”
How Can You Avoid Mortgage Insurance?
Because mortgage insurance fees decrease in steps as your down payment increases the best way to avoid mortgage insurance is to save enough to get to the next step.
The drop between 5% and 10% down payment is pretty big so it can make sense to scrimp and save if you can squeak past the 10% down payment level.
There is also a really big drop between 15% and 20% down payment, so if you’re close to a 20% down payment then it can make sense to take drastic steps to get to that 20%.
If you want to avoid mortgage insurance entirely you need to get above 20% down payment.
Plan ahead. Saving up for a down payment won’t seem quite as daunting if you stretch it over a few years or more.
Gifts from family are one way to make it to 20% down payment. Many first-time home buyers get help from family when buying their first home. These funds need to be a gift and not a loan though.
The traditional way to get to a 20% down payment is to save aggressively. Track your spending. Start budgeting. Clarify your personal values and goals and then check how your spending aligns with your values and goals. Usually you’ll find a few expenses that don’t align with your values and those are easy budgeting wins.
Financial planner, personal finance geek and founder of PlanEasy.