Understanding CMHC Mortgage Loan Insurance in Real Estate Transactions

Jul 26th 2023

This article provides an in-depth exploration of mortgage loan insurance, with a specific focus on the role and functionality of the Canada Mortgage and Housing Corporation (CMHC). We aim to demystify the complexities of this topic for those interested in understanding the intricacies of real estate transactions in Canada.

What is CMHC Mortgage Loan Insurance?

Mortgage loan insurance in Canada is a significant facilitator for potential homeowners who cannot afford a 20% down payment. By offering protection to lenders against default, it opens up real estate opportunities for buyers with as little as a 5% down payment.

The main provider is the Canada Mortgage and Housing Corporation (CMHC), although companies like Sagen and Canada Guarantee Mortgage Insurance Company also provide similar policies. This insurance plays a key role in balancing the risks for lenders while making homeownership more accessible, making it an essential aspect of Canadian real estate transactions.

Benefits of CMHC Mortgage Loan Insurance

The overarching goal of the Canada Mortgage and Housing Corporation (CMHC) Mortgage Loan Insurance is to provide a safety net for lenders, ensuring they’re protected in case a borrower defaults on their loan. If a borrower fails to keep up with their mortgage payments, the lender is shielded from substantial financial losses thanks to the insurance policy.

In Canada, a majority of financial institutions are cautious about offering mortgages that exceed 80% of the property’s purchase price. This means if a buyer’s down payment is less than 20% of the property value, the mortgage falls into the high-ratio category, representing a higher risk for the lender. It’s in these scenarios that the CMHC Mortgage Loan Insurance comes into play, protecting the lenders from potential losses tied to high-ratio loans.

Beyond providing a safety buffer for lenders, CMHC Mortgage Loan Insurance serves another important purpose: ensuring the stability and accessibility of the housing market. It fosters a real estate environment where buyers, even those without a full 20% down payment, can secure mortgages and thus continue to participate in the housing market. In essence, CMHC Mortgage Loan Insurance not only safeguards lenders but also encourages an inclusive and robust real estate market.

Qualifying for CMHC Mortgage Loan Insurance

To qualify for CMHC Mortgage Loan Insurance, applicants must adhere to several significant criteria:

• The property must be located in Canada.
  
• The purchase should not violate the Prohibition on the Purchase of Residential Property by the Non-Canadians Act. 
• The maximum purchase price or improved property value should be below $1,000,000 for CMHC-insured mortgages. 
• Minimum down payment starts at 5%: 
  1. For a purchase price of $500,000 or less, the minimum down payment is 5%. 
  2. For prices above $500,000, the down payment is 5% for the first $500,000 and 10% for the remaining portion. 
• The down payment must originate from your own resources. A gift from an immediate relative is acceptable for 1 to 4-unit dwellings (subject to lender approval). 
• Total monthly housing costs (Principal, Interest, property Taxes, Heating – P.I.T.H., annual site lease if leasehold, and 50% of condominium fees) shouldn’t exceed 32% of gross household income (Gross Debt Service – GDS ratio). 
• The Total Debt Service (TDS) ratio, which includes P.I.T.H., annual site lease (if leasehold), 50% of condo fees (if applicable), and all other debt payments, shouldn’t surpass 40% of your gross household income. 
• Budget for closing costs (legal and land transfer fees, etc.) which typically range from 1.5% to 4% of the purchase price. 

CMHC’s Home Purchase Cost Estimate worksheet can assist in calculating these costs (GDS/TDS).

These guidelines are designed to ensure a balanced risk profile for the lender and manageable repayment obligations for the borrower.

How to Calculate Mortgage Loan Insurance and Premiums

CMHC Mortgage Loan Insurance premium rates are a critical component of understanding your potential financial obligation. The cost of this insurance is determined by the loan-to-value ratio, essentially the mortgage loan amount in relation to the purchase price. It is worth noting that these premium rates can vary significantly based on the size of your down payment, ranging from 0.6% to 4.5% of the mortgage amount.

As a guideline, here are some standard premiums:

• Up to and including 65% loan-to-value: 0.60% premium
• Up to and including 75% loan-to-value: 1.70% premium
• Up to and including 80% loan-to-value: 2.40% premium
• Up to and including 85% loan-to-value: 2.80% premium
• Up to and including 90% loan-to-value: 3.10% premium
• Up to and including 95% loan-to-value (Traditional Down Payment): 4.00% premium

While the CMHC’s online Mortgage Calculator can provide a helpful estimate of these costs, the exact premium will only be determined once you apply for a mortgage.

The insurance premium may be paid as a lump sum or rolled into your monthly mortgage payments. However, adding the premium to your mortgage will incur additional interest over the loan period, increasing the overall cost of borrowing. Also, be aware that in Ontario, the premium, whether paid upfront or added to the mortgage, is subject to provincial sales tax.

Some homeowners may be eligible for premium savings if they are porting an existing CMHC-insured mortgage or purchasing an energy-efficient home. Your mortgage professional can provide additional details and help you navigate these possibilities.

Example of Calculating Mortgage Loan Insurance

Understanding how to compute mortgage default insurance can give you a clearer view of your home-buying expenses. It is directly linked to the amount of your down payment in proportion to the home’s purchase price.

Let’s break down an example for clarity:

Suppose you’re buying a home for $300,000 with a down payment of $40,000. First, calculate the down payment percentage:

$40,000 (down payment) ÷ $300,000 (home price) = 13.33%

Subtracting the down payment from the home price gives you the pre-insurance mortgage value:

$300,000 (home price) – $40,000 (down payment) = $260,000

Applying the CMHC tax rate to this value gives the mortgage insurance premium:

$260,000 (mortgage before CMHC) × 3.10% (CMHC tax rate) = $8,060

This premium is added to your mortgage, meaning you would need to borrow $268,060 ($260,000 + $8,060) from your lender.

Mortgage default insurance does not require an upfront cash payment like some closing costs. Rather, it is added to your mortgage amount and paid off over your loan’s lifespan, resulting in a slight increase in your monthly payments. Familiarizing yourself with this calculation process can empower you to better predict your total financial commitment when purchasing a home.

Disclaimer: The above example is for informational purposes only and might not apply to your specific situation. Mortgage Default Insurance may change from time to time. 

Minimizing Costs for Mortgage Loan Insurance

To lessen the financial impact of mortgage default insurance, you should aim to increase your down payment relative to your home’s price. Essentially, there are two ways to do this: increase your down payment or opt for a less expensive property.

Exploring the first strategy, consider different sources for boosting your down payment. You could receive a monetary gift from a family member or, if you are stepping onto the property ladder for the first time, make a tax-free withdrawal from your Registered Retirement Savings Plan (RRSP) under the RRSP Home Buyers’ Plan. Starting in 2023, the Tax-Free First Home Savings Account presents a new opportunity to accumulate funds for your down payment.

Adopting these strategies will help you reduce the cost of mortgage loan insurance and make your journey to homeownership more financially manageable.

Conclusion

In conclusion, mortgage loan insurance is an essential tool that allows many Canadian homebuyers to step onto the property ladder. It not only offers security to lenders but also paves the way for aspiring homeowners to make their dream a reality with a lower down payment. Understanding how to calculate the cost of this insurance and strategies to minimize it is a significant step towards homeownership.

At Nazarian Law, we have years of experience guiding Ontarians through the complexities of real estate transactions. We hope that this article has enlightened you about CMHC Mortgage Loan Insurance and how it plays a vital role in your home-buying process. Remember, we are always here to provide professional assistance and answer any further questions you may have. If you require a referral to a mortgage broker, we would be happy to introduce you with a few from our network. 

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Disclaimer

The content provided in this article or blog is for informational purposes only. It is not intended to constitute legal advice or to replace the advice of a qualified legal professional. While we strive to provide accurate and current information, the law is complex and constantly changing, and each person’s circumstances are unique. Therefore, you should not rely on this information as a substitute for professional legal advice. This information does not create an attorney-client relationship between you and our law firm. We strongly recommend that you consult with a qualified attorney in your jurisdiction to understand your legal rights and obligations. Always seek legal advice before making any decisions that may impact your legal rights or obligations.