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Should I Pay CMHC Insurance Just to Get a Lower Rate?

As you may know, it’s the law in Canada that all mortgages that have a down payment of under 20% must be insured. The insurer is usually the Canadian Mortgage and Housing Corporation (CMHC), which is why this insurance is generally referred to as CMHC insurance: but really, it’s mortgage default insurance. There are a couple other insurers that deal in mortgage default insurance, namely Genworth Financial and Canada Guaranty, but the product is more or less the same.

But CMHC insurance isn’t free; nor is it cheap. CMHC premiums range from 2.8% of the purchase price (not mortgage amount) of the home all the way up to 4%. With the average detached home price in the GTA sitting at around $900,000, CMHC premiums alone could cost as much as $36,000. As homes worth more than $1 million aren’t eligible for CMHC insurance, the theoretical maximum cost of CMHC is therefore 4% of $999,999, or 4¢ less than $40,000.

Seeing these numbers, you might think that it’s always in your best interest to avoid paying CMHC premiums. But something your mortgage broker might tell you is that insured mortgages (mortgages with less than 20% down) are up to 0.3% cheaper than uninsured mortgages (with 20% or more down). So you might end up having more mortgage, but you would save money every month.

And while it’s true that insured mortgages are cheaper than uninsured mortgages, it’s not a no-brainer to always pick an insured rate. Let’s take a look at why.

 

How does CMHC insurance work?

Before we go any further, let’s talk about exactly how CMHC insurance works.

CMHC insurance protects the lender (your bank) in case the borrower (you) defaults on their mortgage (is unable to pay). CMHC insurance does not protect you, it protects your lender. And while your bank is the beneficiary of the insurance policy, they still force you to pay the premiums.

You could choose to pay the premiums all at once before your mortgage starts, but you probably won’t be able to. If you had tens of thousands of dollars lying around, you’d probably be better served using it to increase your down payment.

The more likely option is to roll the cost of CMHC premiums into your mortgage. This increases your mortgage amount, but not the purchase price of the home. You then pay your mortgage as normal, and there’s basically no other differences – unless you default.

When you default, your lender has the right to force you to sell your home using power of sale. Under power of sale, the lender puts your home on the market to recoup their outstanding mortgage balance. They have a duty to sell it for fair market value. After the sale, they are only entitled to the outstanding balance owed to them. Any remaining money is then given to the borrower. At no point during power of sale does the bank take possession of your home. You are always the property owner, they just have the legal right to sell your home on your behalf.

If the home value is as much or more than the outstanding mortgage balance, everything is hunky-dory. You get whatever money is leftover and that’s the end of it. Notice that at no point in this process is CMHC involved.

CMHC only gets involved when the value of the property is less than the outstanding mortgage balance. At that point, CMHC will reimburse the lender for any loss: i.e. the difference between what they got when they sold and what you owed them.

So that’s the end of that, right? Wrong. While the bank is covered by CMHC, you aren’t. No one is in the business of losing money, and if CMHC had to cover a loss for your bank there’s a good chance that CMHC is going to come after you for that amount.

That’s right, you could still be on the hook for that amount, even though you paid for insurance! Because you simply paid for the insurance. You were never covered by the insurance. The bank is covered.

 

Why is CMHC insurance necessary?

Banks go to great lengths to make sure they don’t lose money. Banks won’t consider mortgages with less than 20% if they were uninsured because they’re riskier. If you don’t have a lot of money at the start of the mortgage, data shows that you’re statistically more likely to default. One of the ways that banks manage risk is by not lending to risky borrowers, so without insurance, you’d be out of luck.

Even if you could convince a lender to give you a mortgage with less than 20% down, you wouldn’t be able to convince the Canadian government. All mortgages with less than 20% down are legally required to carry CMHC insurance.

 

Why do CMHC insured mortgages have lower rates?

I said earlier that one way banks compensate for risk is by not lending to risky borrowers. Another way they compensate is by charging higher interest rates.

In every case, an uninsured mortgage is riskier than an insured one, regardless of the profile of the borrower. Insured mortgages are literally guaranteed to at least get your money back. Uninsured mortgages can be extremely likely to get all your money back, but they’re never 100% guaranteed.

Because insured mortgages are less risky, they’re cheaper.

 

Should I pay CMHC premiums to get a lower rate?

You may know be wondering, since CMHC-insured rates are cheaper, if it’s worth it to lower your down payment from 20% to 19.9% and pay the extra 2.8% of the purchase price.

Opting out of CMHC insurance comes at a 0.35 percentage point increase (on average) to your interest rate. On RateShop.ca, the best 5-year fixed rate is 2.59 per cent, but the best uninsured 5-year is 2.79 percent. Let’s see if that 0.2 per cent can pay for itself on the purchase of a $500,000 home.

 

 

Scenario 1

Scenario 2

Scenario 3

Scenario 4

Scenario 5

Interest Rate

2.59%

2.59%

2.59%

2.79%

2.79%

Down Payment

5%

15%

19.9%

20%

20%

CMHC Insurance Premium

$19,000

$11,900

$11,214

$0

$0

Mortgage Amount

$494,000

$436,900

$411,714

$400,000

$400,000

Monthly Payment

$2,387

$2,111

$1,989

$1,974

$1,724

Amortization

25 years

25 years

25 years

25 years

30 years

Total Cost (Interest + CMHC)

$242,514

$209,579

$197,497

$193,692

$237,815

*Numbers are estimates based on a steady interest rate for 25 years.

 

As you can see, the higher your down payment, the lower your total cost of buying a home, when you include interest and the cost of CMHC premiums. Even though the interest rate is 0.2 percentage points higher, you’d have to finance more money – and that costs more than getting a higher rate.

In all cases with the same amortization, it is not cheaper to get CMHC insurance to bring the rate down. If you can, you should strive to get as high a down payment as possible. Bumping up to the next CMHC tier will save you thousands of dollars, even if you can’t make it to 20% down.

The only time you end up paying more is when you choose to go with a 30 year amortization because you’re financing for longer. While this does cost you more in the long run, it significantly reduces your monthly payments which frees up your cash flow. You can also choose to increase your monthly payments with your pre-payment privileges if you wish, which would save you in interest.


Chris Chris 01/26/2019
Canadian personal finance buff and all-around writing enthusiast, Chris loves breaking down complicated money ideas to show that they're really not so complex. 
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