Adding mortgage default insurance same as financing with 0% downpayment?… may sound good but does this protect your investment?

The attached link c/o The National Post explores the risks and advantages of low downpayments…

‘At one point during this housing boom, people could buy a house with no money down. In fact, once mortgage default insurance was tacked on, they have loans for almost 103% of the value of their purchase.’… ‘The housing industry wants no part of any increase in the down payment. A study this month from the Canadian Association of Accredited Mortgage Professionals estimated half a million sales since 2007 would have been lost.’… ‘CAAMP asked respondents in a survey released last week what would happen if they were asked for a 10% down payment. Of those who purchased since 2007, 45% say it would take them out of market and another 14% were not sure – about 100,000 lost deals a year.

Hmmm… so is it; what’s good for the real estate industry is good for the individual investor or the other way around?

Breaking it down…

– mortgage default insurance protects the banks not the individual

– the cost of mortgage default insurance is anywhere from 1-3% of the value of the mortgage

– the longer your amortization period, the higher your premium

– the lower your down payment, the higher your premium

– anything less than a 20% downpayment must be insured by law in Canada

– sometimes, especially with rental properties, mortgage default insurance may be required with over 20% down payment

– the premium is added to your mortgage so you pay interest on it

– on average purchase price of $30000. with 5% downpayment ($15000.) the premium would cost $7000. to $10000.

– $7000. to $10000. premium adds $40. to $60. month to your mortgage of which approximately 1/3 pays the compounded interest on the loan

– GST/HST is charged on the insurance which you pay upfront

Essentially you are now carrying a $295000. mortgage on a $300000. purchase which translates into the same as a 1% +/- downpayment…. hmmm again…

Real Estate activity is definitely profitable for the entire real industry – which includes a substantial part of our GDP. Beyond the actual purchase and financing of real estate, construction, DYI and employment, materials, insurance, maintenance, utilitity providers and more all benefit our collective economy.  

The ultimate question is whether you are safe? Are your personal investment and associated commitments are safe with low down payments? The answer is probably yes – assuming you are safely employed and in a part of the country (like Halifax) where annual property value increases tend to average out at 5%+ a year over 7 years. The answer is more likely no if you are investing a more volatile market where prices swing more than 10%. 

The best protection is to invest in stable regions where the market tends to be predictable and where 5% downpayment investments can safely grow to 10-20% over a few years. (the’ ladder approach’ to buying real estate) In higher risk regions, however, ideally self impose ‘insurance’ by either increasing your downpayment to 25 – 30% or invest in owner occupied investment properties. This will buy you peace of mind and time! If the market is slow and your property value is down, you will be in the best position to wait out the typical 7 year cycle…. more on this at another time:)