Full Disclosure Finance

By Justin

What do you know about mortgage loan insurance? In Canada it is provided by the CMHC, Canadian Mortgage and Housing Corporation. To quote the website, insurance is required when homebuyers make a down payment of less than 20% of the purchase price. These homebuyers are deemed to be more of a lending risk but because the CMHC steps in to insure them, lenders respond with a loan and lower interest rates.

So, this is a good thing right? Yes and No.

Good thing:

If you don’t have 20% and want to buy a home, mortgage insurance allows you to make the purchase. Without it you’d be back to the stock market as your only investment vehicle. Keep in mind that you can borrow money on top of cash you have to get to 20%. It is the primary lender that charges CMHC fees for lending more than 80% of the purchase price.

Bad Thing:

It comes at a substantial price. The insurance premium breakdown is as follows:

Note: See your lender for premium surcharges and other terms and conditions that apply.
Taken from http://www.cmhc-schl.gc.ca/en/co/moloin/moloin_005.cfm.

At 20% down payment, most purchases will not require any insurance. However, in some cases where the lender still feels the deal is a risky one, they could require it for up to 65 % of the purchase price. I have changed to top of the chart (down payments > 20%) to reflect that one would opt out in most deals.

As you can see, there could be a trade off between the increasing rate of return but increasing mortgage insurance amounts with low down payments.

From the above chart, you can see that putting 20% down will eliminate mortgage insurance and save $4800 relative to a deal where one puts down 10%. This savings is partially hampered by the fact that one would have to tie up the 10% ($24000) in order to save $4800 (20% return on additional 10%).

Assuming it is an investment property being purchased, positive cash flow is the first priority. If positive cash flow can be achieved by putting any amount down, which means you have a great deal, then we can begin to discuss altering the down payment amount to maximize returns.

Currently, my investment property has $500 per month positive cash flow with 5% down payment. This results in approximately $6600 in mortgage insurance or 13.2 months of operating profit. Therefore, you would use up more than an entire year of operating income to cover the mortgage insurance. Selling after 1 year is not a profitable option in this scenario especially when you include real estate fees of 5%.

Putting 20% down would reduce my mortgage payment by $200 thus increasing my cash flow to $700 per month. This is a cash on cash return of 18%, not bad ($8400 profit per year / $47400 down payment). However, the above example with 5% down has a cash on cash return of 51% ($6000 profit per year / $11850 down payment).

In a case where you plan to buy and hold, putting 20% down is the best strategy to avoid such a significant penalty. However, if you use some borrowed money to get you to 20%, you can avoid mortgage insurance and maximize your return on investment while ensuring positive cash flow. A line of credit, family, or friends can serve as a means to borrow money to get you to 20%, therefore you’re not asking the primary lender for more than 80% of the purchase price.

Overall, it is key to get to 20% whether you need to beg, borrow, or ……okay, just make it happen!
1)Figure out a full cash down payment amount to ensure you will have positive cash flow.
2)Borrow or put cash down to get to 20% from a source other than the primary lender
3)No mortgage insurance needed! You’ve just saved from 1.75 – 3.10% of your purchase price.

Keep this in mind and the exit strategy from your real estate deals will be more profitable.