Mortgage insurance (which is sometimes called mortgage default insurance) is a credit risk management tool that protects lenders from losses on mortgage loans. If a borrower defaults on a mortgage, and the proceeds from the foreclosure of the property are insufficient to cover the resulting loss, the lender submits a claim to the mortgage insurer to recover its losses.
The law requires federally regulated lenders to obtain mortgage insurance on loans in which the homebuyer has made a down payment of less than 20 per cent of the purchase price (also called high loan-to-value mortgages). The homebuyer pays the premiums for this insurance, which protects the lender if the homebuyer defaults.
The Government backs insured residential mortgages in Canada. It is responsible for the obligations of Canada Mortgage and Housing Corporation (CMHC) as it is an agent Crown corporation. In order for private mortgage insurers to compete with CMHC, the Government backs private mortgage insurers’ obligations to lenders, subject to a deductible equal to 10 per cent of the original principal amount of the loan.
Since 2008, the Government has taken measured steps to strengthen the minimum standards for government-backed insured mortgages, including:
These standards apply for mortgages on residential property with four units or less. They do not affect multi-unit buildings with five units or more.
Measures Announced Today
Today, the Government announced further changes to the standards for government-backed insured mortgages. These measures would apply to new high loan-to-value mortgages backed by the Government.
The amortization period is the length of time it will take to pay off the entire mortgage loan. It is usually much longer than the term of the mortgage. A typical mortgage in Canada may have a term of five years or less during which a specific fixed or variable interest rate will apply, and the mortgage can be renewed at the end of the term.
The measure announced today will reduce the maximum amortization period from 30 years to 25 years for high loan-to-value mortgages, which are backed by government insurance. (Banks will still be able to offer 30-year amortization periods on low ratio—20 per cent or more down payment—mortgages, if they so choose.). For any given mortgage loan, a lower amortization period would result in a moderate increase in the monthly payment along with a significant reduction in the total interest paid over the amortization period. The following table illustrates the benefit of reducing the amortization period from 30 years to 25 years for a mortgage loan of $350,000.1
|Interest Rate||30-Year Amortization—Monthly Payment||25-Year Amortization—Monthly Payment||Difference in Monthly Payment—
25-Year vs. 30-Year Amortization
|Interest Savings—25-Year vs. 30-Year Amortization|
|3 per cent||$1,472||$1,656||$184||$33,052|
|4 per cent||$1,664||$1,841||$177||$46,832|
|5 per cent||$1,868||$2,036||$168||$61,765|
Borrowers can refinance their mortgage and increase the amount of the loan secured against their home. The measure announced today will reduce the limit on refinancing from 85 per cent to 80 per cent of the value of the home. Reducing the maximum refinancing amount to 80 per cent follows the change from 90 per cent to 85 per cent in March 2011. Reducing the maximum loan-to-value ratio on refinancing will encourage Canadians to keep equity in their home and save through home ownership.
As an illustration, for a home valued at $350,000, refinancing at 85 per cent would allow the homeowner to access up to $297,500, whereas refinancing at 80 per cent would allow the homeowner to access up to $280,000. The lower refinancing limit means homeowners will keep an additional $17,500 in the equity of their home and at the same time save up to $5,200 in insurance premiums.
There are two ratios commonly used to measure the risk associated with household debt: the gross debt service (GDS) ratio and the total debt service (TDS) ratio. The GDS ratio is the share of the borrower’s gross household income that is needed to pay for home-related expenses, such as mortgage payments, property taxes and heating expenses. The TDS ratio is the share of the borrower’s gross income that is needed to pay for home-related expenses and all other debt obligations.
Lenders must review a borrower’s debt service ratios before granting a mortgage loan. In 2008, the Government announced a 45 per cent TDS limit as part of the adjustments to the rules for government-backed insured mortgages. The measure announced today will limit the GDS ratio to 39 per cent and lower the maximum TDS ratio to 44 per cent. Setting a GDS limit and lowering the TDS limit will help prevent Canadian households from overextending themselves and reduce the number of financially vulnerable households.
The measure announced today will establish that government-backed mortgage insurance is only available for a new high loan-to-value mortgage if the home purchase price is under $1 million.
Establishing a maximum allowable price will ensure that government-backed mortgage insurance operates the way it was originally intended: to help working families and first-time homebuyers. According to the Canadian Real Estate Association, the national average price (based on Multiple Listing Service sales activity) for a home sold in May 2012 was $375,605. This measure is expected to have a negligible impact on working families and first-time homebuyers as the vast majority of these borrowers purchase properties priced below the threshold. Borrowers purchasing homes priced at or above the maximum allowable price would require a down payment of at least 20 per cent.
These adjustments will come into force on July 9, 2012. Exceptions would be allowed to satisfy a binding purchase and sale, financing or refinancing agreement where a mortgage insurance application has been made before July 9, 2012. While the changes announced today come into force on July 9, 2012, any mortgage insurance applications received after June 21, 2012 and before July 9, 2012 that do not conform to the measures announced today must be funded by December 31, 2012.
1 The mortgage loan amount used in the illustrative example represents approximately the size of the mortgage loan needed for an average house in Canada. According to the Canadian Real Estate Association, the national average price (based on Multiple Listing Service sales activity) for a home sold in May 2012 was $375,605.