The Importance of Mortgage Loan Insurance

Mortgage Loan Insurance is intended to protect the lender from default on the part of the borrower, plain and simple. However, the Canada Mortgage and Housing Corporation (CMHC) designed mortgage loan insurance for more than just protecting the banks. The CMHC wanted homeowners to have a greater ability to enter the housing market, at an earlier time and with better success. After all, more privately owned housing means more jobs, more consumer activity, more money being spent and so on. If there are more jobs and more spending, then the economy benefits. In short, the risk to lenders has been removed, leaving them in a better position to offer lower interest rates and smaller payments.

When the CMHC laid out their plan for mortgage loan insurance (MLI), it included the stipulation that if the buyer had less than 20% of the purchase price as a down payment, the insurance was required. Before the advent of MLI, The Canadian Bank Act prohibited federally regulated lending institutions from lending to those with less than that 20%. Now the banks can finance up to 95% of the purchase price, provided MLI is purchased. The change meant so many more people who had previously given up on owning a home, now had hope.

For those who already own a home, MLI provides options for those wanting to renovate, refinance or move to another home. CMHC MLI's are portable from an existing home to a newly purchased one, and sometimes without having to pay the initial premium on the new home. Additionally, the self-employed who are seeking to finance the purchase of a new home are now able to do so without providing traditional forms of proof of income. Even those who are new to Canada are eligible. Existing homeowners who wish to incorporate energy efficient elements into their home (NRCan energy assessment rating must rise by at least five points) are entitled to an extended amortization period – without a surcharge and with a ten percent insurance premium rebate. There are even further benefits for borrowers purchasing a second home or income property.

Now that we know the importance of MLI, how does it translate into numbers? Well, for starters it depends on a few calculations. Your lender will do them for you, but if you want an idea ahead of time then begin with calculating the Gross Debt Service (GDS). The GDS estimates the most expenses you can afford each month, more specifically the expenses related to running the home. To qualify for an MLI, the total GDS should not be more than 32% of your gross household income. Next is calculating your Total Debt Service (TDS), which estimates the most debt load your income will support. The TDS should not be more than 40% of your gross monthly household income. Then use an online mortgage calculator to enter the information along with your total monthly income along with other factors, and you will be provided with the maximum allowable mortgage you will qualify for.

The MLI premium rate will then be calculated as a percentage of the total loan with the size of the down payment taken into account. For example, if you require the lender to finance 80% of the cost of the home then your premium will be 1% of the total loan. If your purchase requires 95% financing on the part of the lender, the premium will be 2.75% of the total loan amount. Thus, the lower the amount financed, the lower the insurance premium.

In June of 2011 the CMHC reported their findings of recent survey which asked 3512 mortgage buyers about their goals in paying off their debt. A whopping 39% said they had purposefully set their payments higher than the suggested amount so they could pay off the debt faster. A further 20% reported making a lump sum payment since the date their mortgage took effect. The summary statement offered by the CMHC was that Canadian homebuyers have "a high level of financial literacy". The statistics offered by the corporation is certainly a good sign, and any proud Canadian homeowner should give them self a pat on the back.

Furthermore, the harder homeowners work to pay their mortgage down, the more equity they build in their home. Clearly the opportunity to purchase sooner than what was previously possible (through the installation of the MLI), homeowners have taken the chance to go further than even the lender anticipated. As of 2009, the CMHC reported that Canadian homeowners' equity position sits at an average of 74% while their American counterparts were at 43%. The importance of the MLI is certainly clear now, isn't it?