Default Insurance and How it Affects Your Mortgages Costs

Introduction:

In a previous blog, we explored the differences between Insured, Insurable, and Uninsurable mortgages. This time, we’ll dive into how default insurance impacts the overall cost of your mortgage. We’ll compare three scenarios: 5% down payment (Insured), 20% down payment (Insurable), and 20% down payment with the borrower paying the default insurance premium. To keep things consistent, we’ll use the following parameters:

• Purchase Price: $500,000

• Interest Rates (as of Aug 19, 2024): Based on First National Rates for their standard products

• Amortization: 25 years

• Term: 5 years with monthly payments

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Scenario 1: 5% Down Payment (Insured)

• Interest Rate: 4.69%

• Down Payment: $25,000

• Default Insurance Premium: 4% of the mortgage balance

• Premium Amount: $475,000 mortgage × 4% = $19,000

• Total Mortgage Cost (interest + premium): $360,974

In this scenario, the default insurance premium is added to the mortgage balance, which increases the total cost over the life of the mortgage. While the overall cost is higher, the lower down payment makes homeownership more accessible for those who might struggle to save a larger amount.

Scenario 2: 20% Down Payment (Insurable)

• Interest Rate: 4.89%

• Down Payment: $100,000

• Default Insurance Premium: None

• Total Mortgage Cost (interest only): $290,432

With a 20% down payment, the borrower avoids paying any default insurance, resulting in a lower overall cost despite a slightly higher interest rate. This scenario provides the greatest savings over the life of the mortgage.

Scenario 3: 20% Down Payment with Borrower Paying Default Insurance

• Interest Rate: 4.69%

• Down Payment: $100,000

• Default Insurance Premium: 2.8% of the mortgage balance

• Premium Amount: $400,000 mortgage × 2.8% = $11,200

• Total Mortgage Cost (interest + premium): $295,856

Here, the borrower chooses to pay the default insurance despite having a 20% down payment to secure a lower interest rate. While it came with a lower rate, the overall cost ends up being higher than in the insurable scenario. Additionally, the insurance premium is non-refundable. The benefits of a lower interest rate do not offset the added cost.

Conclusion:

When you have a 20% down payment, opting not to pay for default insurance is typically the best financial decision. While paying for insurance might offer a lower interest rate, it often results in a higher overall mortgage cost, especially when you consider the non-refundable nature of the premium. The insurable option provides greater flexibility and lower costs in the long run.

The 5% down payment option, though more expensive over time, is valuable for those who need or prefer to enter the housing market with a smaller upfront investment. It’s particularly useful in high-cost housing markets or for individuals who might achieve better returns by investing the difference.

Ultimately, the best option depends on your personal financial situation and long-term goals. Working closely with a mortgage broker and financial advisor will help you navigate these choices and find the mortgage solution that best meets your needs.