It is possible to get into the housing market with a downpayment of less than 25 per cent, if you buy mortgage loan insurance
Maroney on Money for May 17, 1998
Scraping up a 25 per cent down payment to buy a house may not be overly difficult in some parts of the country but here on the West Coast the story is quite different. Even in today’s less than buoyant real estate market, saving 25 per cent of the average house price will require some pretty serious sacrifices for most people.
Fortunately, it is possible to get into the housing market with a downpayment of less than 25 per cent, however, lenders will require that you buy mortgage loan insurance. Mortgage insurance ensures that the lender is paid back (by the insurer) in the event the borrower defaults on his or her mortgage.
When you read the word “insurance” you can’t help but think cost. And you’re absolutely right. Since the risk of default on a mortgage increases as the size of the downpayment decreases, you can expect to pay more to insure your mortgage when your downpayment is small.
If your downpayment represents 20 to 25 per cent of the value of the property, mortgage insurance will set you back 1.25 per cent of the mortgage amount. The cost of insurance of insurance increases to 2 per cent when the downpayment is 15 to 20 per cent of the value of the property; then 2.5 per cent for a down payment of between 10 and 15 per cent and, finally, 3.75 per cent for a down payment in the 5 to 10 per cent range.
The 5 per cent option is the lowest down payment available and has proven to be very popular. In fact, the Canada Mortgage and Housing Corporation (CMHC) estimates that, of the 610,000 first-time home buyers during the past six years, fully 70% of purchasers wouldn’t have been able to buy without it.
Originally introduced in 1992 to kick-start Central Canada’s moribund housing market, this 5% option used to be the domain of the first-time buyer. But that all changed this past week when CMHC announced that the program would be extended to all home buyers. Unfortunately, along with the good news came the bad news that the insurance rate increased from 2.5 per cent to the 3.75 per cent noted above (no doubt a reflection of the high default rate of the 5 per cent down group).
Big deal! Who cares about a measly 1.25 per cent? Consider the case of Bea Tenant who is looking to buy a $200,000 property. Living like a hermit for the past few years, she has managed to squirrel away the required 5 per cent downpayment of $10,000. Like most buyers making the minimum downpayment, Bea couldn’t afford to pay for her mortgage insurance outright so she chose to simply add it to her mortgage. Knowing that cash will be tight, she also chose to amortize her 6.75 per cent mortgage over 25 years.
Under the old rules, mortgage insurance would have cost $4,750 or 2.5 per cent of Bea’s $190,000 mortgage. Bea’s monthly payment would have been $1,346 and she would have paid $208,915 of interest assuming a 6.75 per cent rate throughout the life of the mortgage.
Under the new rules, Bea will have to pay an additional $2,375 for mortgage insurance leaving her with a total mortgage of $197,125. Using the same interest rate and amortization period as above, Bea will find her monthly payment has increased by $16 to $1,362. While Bea will most likely be able to handle such a modest increase, she will be disheartened to know that she’ll pay an extra $2,548 in interest before her loan is paid off. In this case, the total cost of a 1.25 per cent increase in mortgage insurance rates is $4,923.
The lesson here is that little things can mean a lot. The increase in CMHC insurance rates can represent a fair amount of money, so if you’re in the same position as Bea, do what you can to increase the size of your down payment. Consider a private loan or maybe just accept being a tenant for a little longer. If you can increase your down payment to 10 per cent from 5 per cent your mortgage insurance rate will drop back to the old rate of 2.5%.
Jim Maroney is a chartered accountant with Andrews, Brown, Maroney in Maple Ridge.
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