CMHC announced changes to their high ratio mortgage insurance programs on March 31, 1998. These changes are to take effect on May 11 1998.
The bad news is that CMHC has done away with the First Home Loan Insurance (FHLI) Program that allowed first time buyers to purchase a home with as little as 5% down payment. The good news is that they have re engineered this program so that it is economically sustainable in the long run. Now anyone can purchase a home, whether it is their first, second, or third, with a 5% down payment.
Essentially CMHC has simply dropped the requirement that applicants must be "first time home buyers" to qualify for this program.
The FHLI program was originally only scheduled to run for 2 years, 1992 to 1994. The goal of the program was to provide Canadians with greater access to home ownership by reducing the high hurdle of a 10% minimum down payment. Since, 1992 the program has been adjusted and refined, it was ultimately extended to the year 1999. These changes are intended as a further refinement in an effort to extend the program indefinitely.
The rules for the new CMHC 5% down payment program have remained substantially unchanged. The maximum home prices are still the same at $250,000, $175,000 and $125,000. CMHC is currently reviewing these maximums. Gross and Total debt service ratios remain the same as does the requirement that borrowers take a minimum mortgage term of 3 years, with qualification based on the 5 year rate.
The increased fee will have a slight affect on maximum financing amounts as the payment to finance the fee is also considered in the maximum debt service ratio calculations.
The only bad news is that in order to continue offering the program permanently CMHC has had to up the cost. The new fee is intended to fully compensate the increased risk of default and recovery this program has suffered. These added risks are attributed to the low amount of equity in the home. Prior refinements tackled a policy that allowed first time homebuyers to become more indebted, relative to income, than other borrowers.
The fee for any person wishing to buy a home with a 5% down payment will be 3.75% of the mortgage amount after March 11, 1998. Currently the first time homebuyer fee is 2.5% of the mortgage amount. The mortgage insurance fee is a one time fee paid by the borrower to the mortgage insurer, it is usually added to the mortgage and financed.
This means that if you purchase a $100,000 home with a $5,000 (5%) down payment your mortgage insurance fee will be 3.75% of the $95,000 mortgage required. The result is a fee of $3,562.50, which is typically rolled into the mortgage and financed over the full amortization. The current fee would be $2,375.
The cost of this financing is substantial
but so are the risks. Consider that with a $25,000 (25%) down payment, mortgage insurance would be avoided entirely. As such this $3,562.50 (3.75%) fee is the price paid for the additional $20,000 (20%) of financing required. The new fee is equal to 17.8% of this additional $20,000 of financing while the current fee is only 11.9% of the added financing required.
Please see Saving on Mortgage Insurance Fees.
Opportunity cost of RRSP Home Buyers Plan
Borrowers may want to take a closer look at all their options. Alternative sources of financing may be cheaper in some cases. Most financial planners warn of the high opportunity cost of using RRSP funds as down payment money. However, withdrawing a larger amount from an RRSP under the Home Buyers Plan could result in a lower mortgage insurance fee and lower overall costs. This may be the case if the amount withdrawn results in a down payment of 25% and the mortgage insurance fee is avoided. In addition, a down payment of 10% or 15% would reduce the CMHC fee from 3.75% of the mortgage amount to 2.5% and 2% respectively. In some cases the return expected on the RRSP may be less than the sum costs of this added financing.
Alternatives To Mortgage Insurance
Borrowing the additional funds required from other sources in order to avoid, or reduce, the CMHC fees payable may also be a good move. Some mortgage lenders refer to this as the Family Financing Plan because the borrower uses the equity in their parents home to secure second mortgage financing that will constitute the down payment on their new home. Assuming the above home purchase example the borrower will be paying a mortgage insurance fee of 3.75% for an additional 20% of mortgage financing. If the borrower can secure a conventional mortgage of 75%, and the parents are willing to allow their son or daughter to mortgage their home for the balance of the funds required (20%), the mortgage insurance fee will be avoided entirely- and the cash down payment is still only 5%.
The added financing received by insuring the mortgage is $20,000, at a cost of $3,562.50. The result is usually $23,562.50 added to the $75,000 conventional mortgage as most borrowers typically finance the mortgage insurance fee. This fee is a cost of this extra financing, and necessarily a form of interest. The effective interest rate can be calculated in order to compare the insured mortgage approach with alternative financing such as the "Family " approach.
Assume an average interest rate of 8% for the entire 25 year amortization of the $23,562.50 debt.
In reality we have $20,000 at an interest cost of 8% per annum plus an up front cost of $3,5621.50. The effective annual interest rate of the two costs combined is 10.07% The mortgage insurance fee has the effect of increasing the assumed average annual interest rate of 8% by two full percentage points on the additional financing.
If the parents were to lend their son or daughter the $20,000 at this 10.07% rate of interest the monthly mortgage payments would be $179,83. Taking the CMHC approach, where $23,562.50 is financed at 8%, would also result in a monthly payment of $179,83. In either case the costs are the same and the borrower is equally indifferent to each alternative, from a financial perspective. However, the added cost of arranging this family financing must also be considered. These costs could include added legal fees and mortgage application fees.
In many cases no other financing options are available, or are not available at a cost competitive with the insured mortgage approach. The 5% down payment program has helped hundreds of thousands of Canadians reach their goal of home ownership sooner than would have otherwise been possible. It remains an important option for homebuyers, first, second, and last, who require or prefer high ratio financing.