Here’s part 4 of my 10 step series on mortgages here at Financial Uproar every Wednesday.  Every step of the process will be covered from the application to qualifying to tips and tricks to save money on your mortgage and everything in between. To read all of these just click on the category Mortgage Basics.

Now that we’ve covered the application process, the down payment and the income ratios needed to qualify for a mortgage in Canada, let’s move on to CMHC default insurance.

CMHC default insurance is required for every mortgage with less than a 20% down payment. It is an insurance product paid for by the buyer that protects the lender in case the buyer defaults on their mortgage. Thanks to CMHC mortgage insurance the majority of mortgages issued in Canada are 100% risk free for the lender. Being a CMHC approved lender in Canada is a good thing.

How it works

CMHC has all sorts of different homeowner products (more info on them can be found at CMHC’s website) that have different insurance policies depending on the size of the down payment and the length of the amortization. If you have a bigger down payment then the premium amount goes down. If you amortize the mortgage longer than 25 years then the insurance premium goes up. Basically anything a borrower does to make the loan more risky increases the premium amount.

CMHC has products for rental properties, new to Canada immigrants, as well as for self employed individuals and special insurance products for environmentally friendly homes. For a standard purchase, insurance rates start around 1% and peak at a little over 3% of the value of the mortgage.

Applying For CMHC Insurance

As stated above, CMHC insurance is mandatory for any mortgage with less than 20% down. Sometimes it required by the lender on properties with more than 20% down, especially rental properties. Once a borrower applies for a mortgage and the lender approves it, the lender then sends that mortgage into CMHC for their approval. CMHC receives the electronic submission and looks at two things- the borrower and the property.

Since so many homes have CMHC insurance, the system has a large database of similar homes in the very same neighborhood that it can use as comparables. Using the database, the system comes up with a value for the home, a number they will insure up to. Once the borrower’s credit is also verified CMHC will approve the property.

Sometimes CMHC will not support the value paid for the property. If a property sells at $300k but CMHC only thinks is worth $280k then CMHC may not approve the property. At this point the lender can request an actual person to look at the property and will also state the case as to why the property is worth more than the others in the neighborhood. If CMHC still thinks the property is worth less than what the buyer paid for it they can either decline to insure that particular deal or they will only insure up to the approved amount.

The borrower used to be charged an application fee of $165 which was only charged if the mortgage goes through and the borrower takes the insurance. This application fee has been eliminated.

Paying For Coverage

Once CMHC insurance has been approved, the amount needed for the premium is simply tacked on top of whatever the mortgage would have been. If somebody puts only the minimum 5% for a down payment then CMHC fees can eat up more than half of what they put down. Since the premium is added to the principle owing the borrower doesn’t have to come up with the case for an insurance policy totalling thousands of dollars.

Worst. Insurance. Ever.

Don’t confuse mortgage default insurance with mortgage life insurance. The only person mortgage default insurance protects is the lender. The borrower won’t see two dimes if the bank is forced to take back the house. Other types of mortgage insurance (namely mortgage life insurance and mortgage disability insurance) do protect the borrower if they get killed or disabled. Naturally both mortgage life and default insurance have their own premiums, charging the borrower monthly instead of just a one shot deal.

Conclusion

CMHC is a crown corporation that tries to make homeownership possible for as many Canadians as possible. By offering the lender an insurance policy CMHC both makes lenders more willing to lend as well as keeping mortgage rates low. As home values have increased, (and savings have decreased) more and more Canadians can’t save 20% down to avoid paying the premiums. Because of this, the dollar value of loans CMHC has guaranteed has now swelled to the hundreds of billions. There are some people who think a large decline in the Canadian housing market combined with a large amount of foreclosures could result in disaster for CMHC. Countless others though, are grateful at the opportunity CMHC has given themselves and fellow home owners to own a home when that might be impossible without CMHC.

Tell everyone, yo!