Saving on Mortgage Insurance Fees

Insurance Fees

Mortgage Insurance Premiums

The recent rise in mortgage insurance premiums is a good reason to re explore all your options for financing in search of the least cost solution. In mosts cases CMHC and GE offer the best, or only, alternative. However there are ways to avoid paying too much in insurance premiums.

Fees Quoted & Calculated On Entire Mortgage Balance

The above chart shows that mortgage insurance fees are quoted 'and calculated' on the entire mortgage loan amount. This is so even though the fees are paid to receive only the extra amount of mortgage financing required. The extra financing is that amount of financing above the conventional mortgage maximum of 75% of property value.  If a high ratio mortgage is equal to, say 80% of the value of the property, the CMHC mortgage insurance premium payable is 1.25%. This 1.25% is calculated on the entire loan amount. Therefore if your mortgage is $80,000, the mortgage insurance fee will be $1,000.   (1.25% of $80,000)

   

Cost of Incremental Finaning Received
 

A one time mortgage insurance fee of 1.25% doesn't sound like much. However, consider that at an 80% loan to value ratio the borrower is paying a fee of 20% for an extra 5% of mortgage financing. This is because 75% financing is available from any lender without the requirement of having the mortgage insured. As such the fee is paid to receive the high ratio portion of the mortgage financing.

  Puchase Price $100,000

An easier way to understand these costs is too assume a purchase price of $100,000. A qualified borrower can receive financing of up to $75,000 (75%) without having to insure the mortgage. At $80,000 (80%) the mortgage is high ratio and must be insured. The mortgage insurance fee of $1,000 is calculated as 1.25% of the full $80,000 mortgage. In reality the borrow is paying a fee of $1,000 for the additional $5,000 of mortgage financing. As such the actual cost of this additional financing is 20% ($1,000 / $5,000).

The above chart shows the mortgage insurance fees for each loan to value category along with the actual cost of the additional financing. In the case of a $5,000 (5%) downpayment, $95,000 of mortgage financing would be required. The fee for this additional $20,000 is $3,562 under CMHCs new pricing schedule. This results in an actual cost of 17.8%.

RRSP Home Buyers Plan

Financial advisors warn against the opportunity costs of withdrawing invested sums from an RRSP under the Home Buyers Plan to use as a downpayment. However there are many occasions where a home buyer may have a 23% downpayment along with additional savings in their RRSP. Unless the homebuyer can ante up a larger down payment they would require 77% high ratio mortgage financing. This mortgage would have to be insured because it is above the 75% conventional maximum. In this case the borrower is receiving an additional 2% of financing at a cost of 1.25% of the entire $77,000 mortgage balance. The resulting cost of this additional mortgage money is 48%. The home buyer would be receiving an extra $2,000 at a cost of $962.50.

In these circumstances there is little chance that the RRSP would out perform the costs associated with this financing. As such it is far better to withdraw the funds from the RRSP if other savings, or cheaper credit, is not available.

While it is true that RRSP investments enjoy the benefit of deferred tax treatment. It is also true that saving for your down payment through  an RRSP is the best approach to accumalate a downpayment. Once this down payment is saved it makes little sense to abort the dream of home ownership simply to avoid foregoing the returns these investments would otherswise earn. It also makes no sense to save for your long term retirement needs in your RRSP, while saving for your short term housing needs outside an RRSP in a separate account. The best approach is to save as much through an RRSP as possible, long or short term, and access the funds through the Home Buyers Plan when eligable.

Family Financing
 

Some home buyers may be able to use the real assets of their parents, or other family members, to secure the additional high ratio mortgage financing they require. In this case it may be possible to reduce, or avoid entirely, the mortgage insurance fees payable.

Assume the above purchase price of $100,000. The home buyer qualifies for a conventional first mortgage of $75,000 (75%) but only has a down payment of $5,000. In order to purchase their home they require an additional $20,000 of mortgage financing. This additional financing could be borrowed by way of a second mortgage using the equity in their parents home as security. This approach would allow the home buyer to avoid the mortgage insurance fees entirely at a substantial savings.

Parents willing to co sign for their childrens high ratio mortgage may be risking their entire personal fortune. However at a loan to value ratio of 75% the conventional mortgage lender may be willing to advance the mortgage funds on the strength of the borrowers covenant alone without the requirement of a parent as guarantor. The parents are then only risking the $20,000 mortgage they have given.

Gifts

Many first time buyers are gifted their down payment from their parents. This often requires their parents to tap into savings or borrow the money themselves, often at higher consumer loan rates. The down payment is then combined with high ratio financing in order to purchase the home. The total cost of this financing, now 100%, is far higher than would be paid were the parent simply to allow the child to mortgage the family equity. In addition, by avoiding the gift the parents will not be out of pocket any cash and the children will be obligated to carry the entire cost of their purchase.
 

Mortgage Insurance Still A Good Option

While alternatives exist they are not always the least cost solutions and are certainly not available, or preferred, by all home buyers. Mortgage insurance has enabled many Canadians to purchase a home sooner than would have otherwise been possible. While the actual costs of mortgage insurance may seem high, they fairly compensate the risks associated with higher ratio mortgage financing. Mortgage insurance remains an important option for Canadian home buyers.

 

RFO

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