Mortgage Insurance ... Advisable or not?

Question

Dear all

I am close to secure my first property (Canada) and currently  discussing the mortgage details my banker. He  strongly reccomends (for logical reasons) a mortgage insurance.

1) What's your take about about it ?

2) Is the mortgage insurance tax deductible?

Thanks in advance

Edison

Roy N. · Answer

@Edison Reis

@Thomas Franklin provided you an overview of the concept, but mortgages and mortgage insurance are executed a little differently in Canada and several of his points are not applicable north of the 49th.

In Canada, you can insure pretty much any residential mortgage (and a few commercial mortgages), however, similar to in the U.S.A. example provided by Thomas, mortgages must be insured when they are greater than 80% LTV (high-ratio).    The reason one may opt for insuring a <=80% LTV mortgage is the lender is offering a sufficiently lower mortgage rate that it more than offsets the cost of the insurance premium {not usually a factor in today's ultra-low interest rate environment}.

High-ratio mortgages are only available on owner-occupied, residential properties (1-4 units) and your maximum LTV is 90% (3 - 4 unit) or 95% (1-2 unit).  The greater the LTV ratio of the mortgage, the greater the rate of the insurance premium {you can visit the CMHC premium calculator here to get an idea}.   The insurance premium is added to the initial principal of the mortgage, so you pay for it over the entire amortization period.

In Canada, the interest paid on the mortgage of your primary residence is not deductible from your income for tax purposes.  If you are owner-occupying a 2-4 unit property than the apportion of mortgage interest that corresponds to the portion of the building you occupy is not deductible as a business expense {similar situation for property taxes}.

In Canada, I would also recommend you entertain a variable rate mortgage over the "traditional" fixed-rate 5-yr term {a mathematical analysis conducted a few years ago, looking at mortgage rates from the end of WWII to the (then) present, showed that over any 25-year period (conventional amortization in Canada), going with a variable rate mortgage came out ahead of using a fixed rate}.

If you read this older BP post, I lay out the approach we use to effectively hedge interest rates ourselves, rather than paying the lender to take the risk.  It essentially comes down to analysing your deal using the BoC posted 5-yr fixed mortgage rate (which is always higher than even the bank/lender's 5-year fixed rate) to know the property could carry such a mortgage.  You then take out a variable rate mortgage (at a much lower interest rate), but make your {bi-weekly} payments as though you were paying the fixed rate mortgage.  The result is you pay down your principal much more quickly, but still have the "escape hatch" of a capped rate and/or the ability to convert your variable mortgage into a fixed if rates start to rise quickly enough to spook you.

Edison Reis · Answer

I am putting 20% down @Alice K. hence the Mortgage insurance isn't a must.

Adding it represents increasing the monthly payment by approx 10% which is a big expense that I can't back. (From 912 to 1000 per month)

As mentioned by Roy ... My answer will be "no thank you" (well I will keep it for the first two months because is free for 60 days and is helping to get a better mortgage rate from the start)

Thanks for your feedback

Edison

Alice K. · Answer

I'm a US-based person, but I've just had this discussion with my mortgage broker. I told him, although I'd prefer to do 10% down, I really didn't want to larger mortgage payments.

Question: Do you have enough to pay the down payment? If not, then reconsider if you should be getting it. If you do have enough cash to comfortably pay it, I myself would (not a CPA but my two cents). In 2 - 5 year run, that PMI will eat away at your cash flow (I'm assuming you want cash flow?)

In America, you can get it removed once you hit 20% or after 2 years (I hear a required 2 years of PMI payments regardless of getting to 20% of not).

Sure, you can use that money on other things, but why pay the bank more than you need to? Unless, the tenant situation can easily cover the PMI costs! Then, I wouldn't be so annoyed by it.

Also, as far as tax deductions-- I thought it was deductable, but some in here say it isn't. Regardless, let's say it is-- say you're in the 30% tax bracket. You're still paying 70% of that PMI cost.

Hope this helps!

Joel Sherlock · Answer

@Edison Reis

@Roy N. is spot on, mortgage insurance from the bank is always a bad idea as you are insuring a declining balance. Typically the bank rates would be about the same as an equivalent term life policy.

For example With the banks policy if something were to happen to you in 10 years and you had borrowed 200,000 and 100,000 was left owning the bank would pay out the remaining 100,000. With a term life policy of 200,000 (name the bank as the first payee) the costs monthly would be same if not less and in the same scenario the 100,000 would get payed out and your estate would get the other 100,000

I completely agree on the comments above and  I don't recommend insurance on the business purchases for the reasons mentioned above.

Roy N. · Answer

@Edison Reis

It would appear that @Stephen E.'s spidy senses were spot on.  The bank is trying to entice you into mortgage life insurance {this is what we get as a result of banks buying insurance companies}.  The best answer is, "No thank-you."   If you have the assets to cover the mortgage in the event of your premature departure, then you can effectively self-insure.  If you do feel you need {term} life insurance to cover your debts and provide for your family, then you will do better shopping around on your own for a policy rather than paying for one with each mortgage (specific to that mortgage).

Additionally, a rental is different from your family home.  On your family home, it is often a good idea to have the mortgage paid out in the even of your death.   On a rental property, this is not necessary, nor even desirable.  As long as the "business" side of your rental business is comfortably servicing its debt, then it should continue to do this even if you are not involved.  Your efforts would be better spent on succession planning to ensure the business continues to perform if you are gone.

Roy N. · Answer

Samuel:

Not mortgage interest on your primary residence.

Even if you execute what has become known as the Smith manoeuvre, you are deducting the interest in the income withdrawn for investment in income producing vehicle (stocks, bonds, company, real estate) as an expense from your income.   Additionally, a person planning this approach needs to fully understand the additional risk and procedural requirements.  Finally, they need to be pedantic in its execution lest you provide the CRA with the opportunity to deny the entire arrangement and hand out a sizeable tax bill.

@Stephen E - I had completely forgotten about the variety of credit, life, & disability insurances lenders propose along with residential mortgages.  We've never taken them and have "trained" our finance contacts to not bother offering them.

Stephen E. · Answer

@Edison Reis

Your post is unclear in that banks generally shill two types of insurance, the first being the kind of CMHC mortgage insurance discussed above to insure the banks in case you default. As @Thomas Franklin sagely observes above, this generally benefits the bank. The other kind of insurance Canadian banks routinely offer, even if you have 20% or greater downpayment, is credit insurance in case you are unable to make payments due to illness, disability, accident, etc. They typically get homeowners with this product but they offer it to investors also. The bottom line is that the primary beneficiary of this is also the bank. If you think about it, if you were to be in any of those scenarios then the bank would have to chase you for payments. Their having sold you credit insurance gives two benefits: a rich stream of premium payments (you can bet that this is priced so as to be highly profitable) and their insurance products giving financial reserves to cover potential losses which would otherwise have to be recouped through collections activity.

So my response to this when the banks routinely offer this insurance is to say that we will self insure. If your rental business is sufficiently capitalised and you have a good emergency fund then you should be OK. If not then inability to make payments is your problem but it is also most assuredly the bank's also. The banker's reasons may well seem logical but they are in fact commercial. These are not charitable organizations.

Samuel Sedore · Answer

In Canada you can deduct interest from your mortgage payments, it just requires some shuffling http://kwcinvestor.com/ I have an article about it.

Roy N. · Answer

Samuel:

I was being a bit pedantic to illustrate the same point - don't try something like the Smith Manoeuvre unless you, or your accountant, have a thorough understanding of the process and possible ramifications of straying from the path.

As for putting 5-10% down on multi-family properties ... we appear to have different definitions of "multi-family" ;-)   That said, we are presently working prospect that would see us put 15% down and pay north of $50K in insurance premiums.

Mortgage Insurance ... Advisable or not?

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