The general wisdom in real estate says that you should save 20% of your down-payment before taking up a mortgage. You can still get a mortgage with 5%, but you must pay for mortgage protection services to protect the lenders.
Because of the rising prices of real estate, this 20% is tall order for many, particularly younger Canadians who haven’t saved much. For instance, in 2016, 20% on an average-priced house was equal to about two years’ earnings at the average wage. The disparity is even greater today.
Therefore, this article addresses the question of waiting to save 20% or jumping in with mortgage protection services. Additionally, it covers the two major insurance options and the benefits and drawbacks of each. Read to learn more.
Should I Wait to Save or Jump in the Market Now?
If you have 20 percent down-payment, you don’t have to pay mortgage insurance. The insurance protects the lenders from not recovering their principal if they had to foreclose because you defaulted. The default insurance (the difference between your down-payment and 20%) is added to your principal, so your monthly installments increase.
With an 80% loan-to-value ratio, a lender is guaranteed at least principal if you default so insurance isn’t necessary anymore.
However, waiting the extra year or two to come up with 20 percent may offset any savings you’ll have made, thus avoiding mortgage insurance. In many markets, housing prices are rising by 4-5% annually. If interest rates also rise in that time, you’ll be stuck with the higher fixed interest for at least five years.
This is good news for many Canadians looking to get into the property market. Over 50 percent of young Canadians don’t own their home, and for 43% of them, it’s because they’re saving up for the down-payment.
The only exception is if your city has a slow-growing real estate market. Suppose you have 10 percent saved up now, and it takes you three years to double it. If, in the three years the annual rate is 2%, your principal increases by just 6%. With insurance at 2.8-4 percent in 2017, this would have been a 9-12% increase on the principal.
Why Is Your Down-Payment Important?
Your down-payment determines the price of a home you can afford, the mortgage amount and monthly installments and the insurance you pay. Minimum down-payments are as follows:
- 5% for houses up to $500,000
- 5% for the first $500,000 and 10% up to $999,999
- 20% for houses above $1,000,000
With a low down-payment, there’s a limit to the maximum home price you can buy. At $25,000 for instance, the maximum purchase price should be $500,000 so that your down-payment is 5%.
This, however, isn’t a big setback; research shows that first-time buyers spend about $318,000 against the overall average of $433,367.
If you’re thinking about buying a home, doing your research can help you determine the best time to do it. If you decide to buy with less than 20% down-payment, you’ll need some kind of insurance. Use this mortgage calculator to help you weigh your options.
These are the two insurance options you have:
Mortgage Insurance Premium (MIP)
The mortgage insurance premium is insurance offered by the government through the Canada Mortgage and Housing Corporation (CMHC). Therefore, it is also called the CMHC premium.
The MIP helps you get homes with mortgages that finance up to 95 percent of the home purchase price. This is good news if you don’t have a lot of savings or avenues to raise your savings in a short time.
Because of the insurance, you’ll get a favorable interest rate, even if your down-payment is small. Having insurance also stabilizes the housing market, helping citizens to own homes even during economic slumps when saving power reduces.
Cost of MIP
MIP is arranged for and paid by your lender, but most often the lender passes the cost down to you. The premium payable is calculated as a percentage of the mortgage and it is determined by the size of the down-payment.
Most often, the lender factors the premium into your monthly installments so that you pay it over time. However, you can pay the insurance as a lump sum at the beginning of your mortgage. This will keep the interest low because interest is also charged on the premium, just like with other insurance policies.
The current CMHC premiums are as follows (Loan-to-value ratio, LTV – the percentage of the home purchase price that is mortgage-financed):
- LTV up to 65.00 percent – 0.60%
- LTV of 65.01-75.00 percent – 1.70%
- LTV of 75.01-80.00 percent – 2.40%
- LTV of 80.01-85.00 percent – 2.80%
- LTV of 85.01-90.00 percent – 3.10%
- LTV of 90.01-95.00 percent – 4.00% TDP* and 4.50 NTDP*
*Traditional vs. Non-Traditional Down-Payments – traditional payments come from savings, property sales or non-repayable financial gifts from family. Non-traditional payments come from arm’s length sources e.g. unsecured personal loans or unsecured credit lines.
Note that MIP in Quebec, Manitoba, and Ontario are subjected to a provincial sales tax. The tax amount cannot be added to your installments; it must be paid upfront as part of your closing costs.
Benefits and Drawbacks of MIP
CMHC does not only provide mortgage protection services for conventional single-family homes, which is its biggest advantage. You can also buy a condominium, duplex or prefabricated or mobile home and still be covered. Rental properties and retirement homes are also covered.
Another advantage is that you may be able to transfer your mortgage when moving houses. Unlike many countries where the mortgage is tied to a specific house, mortgages in Canada are tied to the buyers. This means that if you refinance, you may not have to pay new premiums on the new property.
Note that the maximum purchase price under CMHC-insured mortgages is $1,000,000. This isn’t really a problem though, because above $1,000,000, your down-payment must be 20% and higher. In which case you don’t need the loan anyway.
The only drawback is that MIP (and PMI) does not benefit the borrower or homeowner. It protects the lender in case the buyer dies or defaults. The buyer will have lost whatever equity they had in this case, unless the mortgage is restructured.
Private Mortgage Insurance (PMI)
PMI is insurance that is provided by lenders other than the government. If you don’t want a CMHC-insured loan, you’ll have to go for the PMI option. PMI is also necessary when you’re refinancing a loan and your home equity falls below 20 percent.
In Canada, there are two PMI providers: Genworth Financial Mortgage Insurance (GFMI) and Canada Guarantee Mortgage Insurance (CGMI). The latter is fairly new in the market (2010) and fully Canadian-owned, whereas GFMI is a conglomerate. GFMI has been the sole provider of PMI for years and is the biggest provider in the sector globally.
Genworth provides a number of products such as:
- Purchase plus improvements – mortgages for homes that need a little fixing up
- Business for self – for people who are self-employed hence cannot offer conventional income verification; you must prove two years of responsible credit/finance handling
- New to Canada – mortgages for new Canadian citizens or people relocating to Canada
- Vacation or secondary homes
- Family immediate residence
- Building custom homes
- Energy-efficient housing – you can get some discounts on insurance if you’re buying an energy efficient home or adding energy-efficiency improvements.
Like MIP, Genworth also offers insurance portability, so you can refinance your mortgage for a different home.
Cost of PMI
Below are the premiums on various LTV ratios for standard mortgages:
- LTV up to 65.00 percent – 0.60%
- LTV of 65.01-75.00 percent – 1.70%
- LTV of 75.01-80.00 percent – 2.40%
- LTV of 80.01-85.00 percent – 2.80%
- LTV of 85.01-90.00 percent – 3.10%
- LTV of 90.01-95.00 percent – 4.00% TDP* and 4.50 NTDP*
Be sure to find premium rates for their non-standard programs, i.e. business for self, Vacation/secondary home, and second mortgage programs.
During your application process, your lender will tell you whether or not you need PMI. If needed, your lender makes arrangements with the provider; there’s nothing you need to do.
Benefits and Drawbacks of PMI
The greatest benefit of PMI is that it is available to a larger number of buyers than CMHC insurance. People that wish to be homeowners but are excluded from getting conventional mortgages can use PMI to become homeowners. These include people with bad credit, self-employed people and non-citizen Canadian residents among others.
Also, you can get mortgage insurance for secondary homes/ investment properties and insurance for second mortgages or mortgage refinancing.
Mortgage Protection Services - Final Thoughts
Whether or not you need mortgage insurance depends on your unique financial situation. In the ideal circumstance, you should save up for your first home from the moment you start working. The higher your savings, the less you’ll need to invest in mortgage protection services.
It is also good to get your down-payment from gifts of family members. However, it isn’t wise for relatives to go into debt to finance down-payments for their beneficiaries. This ensures that a person gets a mortgage on a home that they can truly afford.
Where the rubber meets the road, home ownership is the biggest investment most people will ever make. It pays to do thorough research before taking the plunge.
If you're looking for insurance, be sure to get quotes before picking the ideal plan.
