Wednesday, September 13, 2017
Mortgage Loan Insurance – What you need to know about CMHC
Welcome back to Wednesday WTF, my weekly rant about things that waste your money. As we are in the midst of Mortgage Week here at Budget Boss, I think it is only prudent that I delve a little bit into the Canadian Mortgage and Housing Corporation (CMHC). Many homeowners across Canada have used CMHC to purchase their home. Borrowers are required to have a 20% down payment for the purchase of a home. CMHC provides the lenders with mortgage loan insurance to insure the mortgages of those who are only able to put less than 20% of the purchase price down. This service does come at a cost, however. This cost is paid as a premium and is passed on to the borrower. The premium is based on the homes purchase price and is paid as a mortgage, along with regular monthly mortgage payments. Using CMHC makes your mortgage more expensive so then the question remains: is it worth it? That question is answered differently for different people. In this post, I will describe CMHC and discuss what you should be thinking about when using mortgage loan insurance services.
Overview of CMHC
CMHC is a crown corporation set up by the government of Canada that began after World War 2 to help veterans find housing. Since then it has expanded in efforts to help all Canadians with housing. It is the largest Crown Corporation in Canada with assets totaling over $252 Billion in 2015. CMHC has several mandates including providing support to Canadians in housing need, contributing to the stability of the Canadian housing market, and providing objective research to the government, citizens and the housing industry. Primarily CMHC has taken the lead when it comes to the mortgage loan insurance industry and currently provides loan insurance for over 50% of new mortgages in Canada, according to a 2015 Financial Post report. This is a double edge sword in some senses as it provides stability during tough housing markets, such as in 2008. It also has an effect on the Canadian taxpayer as they, in turn, are exposed to the housing market and the risk is shared by all. Despite this, the Government of Canada has no plans on privatizing CMHC and why would it as it is a very large cash cow. With such a strong hold on the Canadian Housing Market, what does mean to you, the home buyer?
With CMHC holding such a large portion of the share of mortgage loan insurance in Canada, this shows that many people cannot come up with the 20% needed to put as a down payment for their home. I think it is important to understand what exactly using mortgage loan protection from CMHC or other carrier’s means to you. Here is a case study to show exactly what mortgage loan insurance costs.
$300,000 Home, 25 Year Amortization
5% Down Payment = $15,000 ($11,400 for Mortgage Insurance) Mortgage Amount = $296,400
10% Down Payment = $30,000 ($8,370 for Mortgage Insurance) Mortgage Amount = $278,370
15% Down Payment = $45,000 ($7,140 for Mortgage Insurance) Mortgage Amount = $262,140
As you can see, not having a down payment of 20% for your home can cost you a good amount of money. This only becomes exasperated as the asking price for your home is increased. For a $500,000, mortgage loan insurance costs on down payments of 5%, 10% and 15% are $19,000, $13,950 and $11,900 respectively. This adds extra costs to your monthly budget. It is important to understand and be diligent with your expenses as adding extra costs can hurt you.
Where Do I stand on Mortgage Loan Insurance?
Corporations like CMHC, Genworth Financial, and Canada Guaranty provide mortgage loan insurance for lenders, not for you. While it is easy to think that you should be happy that this is available to you, don’t for one second think it is because someone is looking out for you. These are extremely profitable businesses and remaining that way is what their aim is. That being said they do provide a valuable service, as I have mentioned most people do not have the required 20% down payment for an unsecured mortgage. I have 2 key points for you to take away from this post:
1) If you are going to use mortgage loan insurance because you don’t have the necessary 20% down payment, you must have your cash flow in order. What this means is that you cannot be running negatives every month and accumulating debt. Adding extra interest charges in the form of mortgage loan insurance can be alright as long as you aren’t adding extra charges in the form of interest on personal debt. You also need to have an emergency fund that allows you to absorb any costs that may arise should the home need repairs or other costly things happen. This leads me to my next point.
2) The more troubling part of mortgage loan insurance is the fact that it does not allow you to escape from your mortgage without taking a huge hit. For instance, if you buy that $300,000 home mentioned earlier, your mortgage cost will be $296,400. Add to that the cost of taxes, realtors and other expenses and you will owe more than the home is worth if you put only 5% down. That is fine if you intend to pay down the home for many years to come, but it becomes a problem if you cannot meet monthly mortgage payments and have to sell or default. That means you should be fully secure in your budget and employment when making the leap to home ownership. Unlike renting you cannot pick and move without consequence when you can’t afford your mortgage. Doing so could have a drastic, everlasting effect on your finances.
The stress test for those who wish to purchase a home encompasses many parts of your financial picture. They look at debts, earnings, savings and more. It is important to understand that having a deep handle on your monthly finances is more important than what a bank can tell you. Just because they say you can afford a home, doesn’t mean you should. Also, just because you have 5% down for a home, doesn’t mean you should buy it. Many factors are far more important to you such as employment stability, monthly cash flow, quality of life and health concerns. The bank doesn’t know everything else you have going on in your life, so it is up to you to evaluate your own situation and act accordingly. In no way am I trying to dissuade people from buying a home as I believe it is an excellent part of any solid financial plan. All I am saying is proceed with caution and look out for yourself, as no one else will.
“The one thing that offends me the most is when I walk into a bank and see ads trying to convince people to take out second mortgages on their home so they can go on vacation. That’s approaching evil.” – Jeff Bezos
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