What is mortgage default insurance?

Key takeaways

Mortgage default insurance is required if you’re buying a home with a down payment under 20%.
This is to protect the lender in case you’re unable to make your mortgage payments.
There are 3 providers of mortgage default insurance in Canada.

An intro to mortgage default insurance

For many Canadian homeowners, it’s not possible to purchase a property outright. Instead, the cost is split between what is paid upfront, known as the down payment, and the remainder of the cost that’s borrowed, known as the mortgage.

Depending on the size of your down payment, you may also need mortgage insurance, also called “mortgage default insurance” or “mortgage loan insurance”. This is different from mortgage life insurance, which you may also want to look into when preparing to buy a house.

There are 3 main providers of mortgage default insurance in Canada – the Canadian Mortgage and Housing Corporation (CMHC), Sagen, and Canada Guaranty.

How does mortgage default insurance work?

To buy a home in Canada, you’ll need a down payment of at least 5% of the purchase price. In cases where you’re buying with a down-payment between 5% and 20%, you’ll need to purchase mortgage default insurance.

However, this means that you’ll be borrowing most of the property’s purchase price, which is known as having a high-ratio mortgage. The more you borrow, the higher your monthly payments will be. If you find yourself unable to make these payments, this is known as defaulting on your mortgage.

In this case, your lender may take action to reclaim the money you’ve borrowed, such as selling your home. They’d use the money from the sale to cover what they can on the amount owed. If after the sale of your home you still owe money, the insurance provider will pay-out the remaining balance.

Let’s look at an example. Brittany and Mike bought their home and now have a mortgage balance of $850,000. As they’ve defaulted on it, their home is now being sold – but the real estate market is going through a rough patch. Their home sells for $750,000, meaning there’s still $100,000 owing to the lender. In this case, the mortgage default insurance provider will pay the lender that outstanding $100,000.

How much does mortgage default insurance cost?

As with any insurance, you’ll need to pay a premium (also called fees) when you take it out.

The amount you’ll pay in fees will depend on the size of your down-payment and is worked out as a percentage between 0.60% to 6.30%. The more you pay upfront, the lower the fees, so it’s a good idea to increase your down payment if possible.

A mortgage default premium can amount to thousands of dollars, and can be paid upfront or added to your total mortgage amount and paid off over time. If you choose to add your fees to your mortgage, you’ll pay interest on them at the same rate as your mortgage.

Let’s look at an example. In Ontario, Tracey and Sam are buying their first home for $500,000 and have saved a 5% down payment of $25,000. Because their down payment is less than 20%, they’ll need insurance, which they get through CMHC. In this case they’ll pay CMHC fees of 4% of the purchase price, which comes to $19,000.

Pros and cons to consider

There are benefits and things to think about when considering mortgage default insurance.

Pros

In many markets, saving a down payment of 20% can take several years. Being able to buy with less upfront can help get you into the housing market sooner and start building equity.
Insured mortgages often get better interest rates than uninsured mortgages.
This “security blanket” for lenders helps keep them protected even during tough economic times, meaning buyers can get mortgages they may not have been able to otherwise.

Cons

Insurance premiums can add to the cost of your monthly payments, which may already be quite high if your down payment is low.
Buying with a lower down payment means you don’t have as much equity in your home.
If you’re buying in Ontario, Quebec, Manitoba or Saskatchewan, you’ll need to pay provincial sales tax (PST) on your insurance premiums. This cost can’t be added to your mortgage however, and must be paid upfront when you close on your home.

Other closing costs and rebates

Aside from mortgage insurance, there are other closing costs to consider, such as title insurance, home inspections and surveys, legal fees, as well as land transfer and property taxes. All of this can add up to thousands of dollars in closing costs, so make sure to account for this in your budget when you’re looking at properties and price ranges.

But while there are some costs to pay, you might be able to receive some money back in the form of government programs and tax rebates. For example, if you’re buying your first home, you could qualify for the first-time homebuyer tax credit, and if you live in a qualifying province or municipality, you might be able to receive some or all of your land transfer tax (LTT) through a rebate.

If you’ve bought a new or substantially renovated property, you might qualify to receive some of the provincial or federal tax back through the GST/HST new housing rebate.

What's next?

There are pros and cons to paying less upfront, so make sure to do plenty of research before making your decision.
If you want to increase your down payment, you may consider waiting longer to buy in order to save more, or looking in a cooler market or perhaps for a less expensive property.

The above example is for illustrative purposes only. Situations will vary according to specific circumstances. The information provided is based on current laws, regulations and other rules applicable to Canadian residents. It is accurate to the best of our knowledge as of the date of publication. Rules and their interpretation may change, affecting the accuracy of the information. The information provided is general in nature, and should not be relied upon as a substitute for advice in any specific situation. For specific situations, advice should be obtained from the appropriate legal, accounting, tax or other professional advisors.