Avoid CMHC or not... Help! First time buyer!

[Hurk]

My girlfriend and I are buying a house for $190,000. We have 20% down, but it will leave us with little cash afterwards.

My girlfriend is self-employed and wants a "cushion" of about $10,000 in our account for anything in the home that may pop-up and need repairs.

We have plenty of available credit ($20,000 line of credit, $5,000 on credit cards, etc)

If we don't put the $38,000 down, we're going to put $15,000 down as a minimum.

The CMHC will be around $5,000-$6,000 which we are okay with. What I can't figure out is the difference in interest between the two.

I'm sure others have been in a similar situation, can anyone help out?

Thanks!

[TheCheez]

You said that you have the available credit if there's an emergency. Pay the 20% down and rebuild your emergency pad.

Paying $6k extra so that 10k can sit in the bank 'just in case' is overly cautious. Someone else might post how much that 6k and the $26k difference in downpayment will cost you over the life of your mortgage in interest and that number is what you should focus on, not just the $6k of insurance.

I don't understand from your post how you're getting from 15k to 38k. If you have to dip into your LOC and emergency savings then it's a different discussion.

[Hurk]

You said that you have the available credit if there's an emergency. Pay the 20% down and rebuild your emergency pad.

Paying $6k extra so that 10k can sit in the bank 'just in case' is overly cautious. Someone else might post how much that 6k and the $26k difference in downpayment will cost you over the life of your mortgage in interest and that number is what you should focus on, not just the $6k of insurance.

I don't understand from your post how you're getting from 15k to 38k. If you have to dip into your LOC and emergency savings then it's a different discussion.

You are right, the figures don't add up. If we only put 10% down ($19,000), we'll still have $19,000 in our accounts.

I'm still trying to do the math on the interest, but I'm failing. :s

[Germack]

Interest payments are $157000 on a $171000 mortgage and $139000 on a 152000 mortgage over 25 years with an interest rate of 6%

[Wonderdollar]

You are right, the figures don't add up. If we only put 10% down ($19,000), we'll still have $19,000 in our accounts.

I'm still trying to do the math on the interest, but I'm failing. :s

If you can pay 20% down payment from your own savings with out dipping in to your line of credit and credit cards, then that is the way to go and will save you tremendously over the life time of mortgage. However, if you can not come up for 20% down payment entirely from your own savings, then go for at least 10% down payment and you would have to pay CMHC premium of 2% of the mortgage amount if you go for a 25 year amortization. If you go for a higher amortization, then the premium would be 2.2% for a 30 year amortization and 2.4% for a 35 year amortization.

For your convenience, I am giving you a rough calculation for both scenarios for a 25 year amortization. For the purpose of calculation, I am taking a 25 year amortization with a 5.25% interest rate, but keeping the payments same throughout the 25 year period in both cases so that you can compare apples to apples.

In the first scenario, if you put 10% down payment, then your mortgage amount would be $174,420 which includes CMHC premium of $3,420. If you make monthly payments of $1050 per month then you will end up paying $174,420 of principal and $134,154 in interest over the life of mortgage.

In the second scenario, if you put 20% down payment from your own savings (and not borrowed funds) and pay the same monthly payments of $1050 per month, then your mortgage amount would be $152,000 and you would pay a total of $ 87,460 in interest over the life of mortgage.

Now you can decide your selves as to what you would like to do.

[dealguy2]

Not really a good time to buy a house don't you think?

[squid]

Further to the excellent analysis above, also include in the options either the interest earned or the interest paid on the emergency fund depending on if it is used or not.

For example, if you do think it is likely that you will use the emergency fund, paying 20% down will now lead to expensive CC debt when forced to use the emergency fund; if unlikely, you will be earning 3% or so on the unused funds if you only pay 10%.

For self-employed, consider that cash flow might be more important. Having 20% down and having a longer amortization will reduce your monthly commitments, allowing you to get past the lean months easier.

If you secure a "one account" readvanceable mortgage, months where you earnings are high could accelerate the principle pay down, generating a cushion for subsequent bad months. For sure, this would give you the ultimate savings as your 'emergency fund' would be reducing your after-tax mortgage interest payments rather than generating a taxable 3% return.

[upupnorth]

We didn't have 20% and took 20K from a LOC to get up to 20%. We then focused like a laser beam on paying off the LOC, which we did in 6 months time, therefore not paying much interest at all and definitely coming out ahead than if we had gotten CMHC insurance .

Since we are disciplined in our finances, agree on aggressively paying down the LOC, have no other debts, have at least 1 very secure job, that was the right thing to do. Now we focus on aggressively paying down the mortgage.

But of course, everyone's situation is different.

[pitz]

My girlfriend and I are buying a house for $190,000. We have 20% down, but it will leave us with little cash afterwards.
If we don't put the $38,000 down, we're going to put $15,000 down as a minimum.

The CMHC will be around $5,000-$6,000 which we are okay with. What I can't figure out is the difference in interest between the two.


So let's assume that you're gonna put down $15k, and CMHC insurance will cost you $5500, so your downpayment is a total of $20,550. And let's assume that you use a standard 25-year amortization.

Let's assume that you'll get a loan at a stated interest rate of 5.5%.

Your monthly payment will be $1074.

It will take you a total of 6 years (assuming that house prices do not decline) to bring your loan to the 80% required loan-to-value for a non-CMHC insured loan.

So you're paying $5500 as a premium to borrow $23,000, in addition to the normal interest, over 6 years.

So the effective interest rate of CMHC insurance is equal to roughly 3.8% + 5.5% = 9.3%/annum.

The question becomes, simply, could you borrow for less than 9.3%/annum, reliably, for the next 6 years?

If yes, then don't use CMHC insurance. If no, then CMHC insurance is a good deal.

The key to doing this calculation is to properly amortize the CMHC insurance over the length of time that it would actually be required on your loan, assuming normal principal repayment. If your house goes up in price quite a bit in the next few years, than the effective interest rate of CMHC insurance will be very much higher (due to shorter amortization). If you intend to prepay your mortgage, the effective interest rate will be much higher. If house prices go down, then the CMHC insurance becomes increasingly less expensive compared to unsecured borrowing.

Remember, as always, that CMHC insurance does not absolve or protect you from lawsuits or foreclosure in the event of default. CMHC insurance just means that the bank will get paid if you don't pay your mortgage -- and CMHC will liquidate the property and sue you for any deficiency.

[pitz]

edit: actually I made a slight mistake on the above calculation, because the $5500 premium would cover $23,000, and would be paid off over 6 years.

So if you throw those cashflows into Excel:

Year 0:
$23,000 (borrowed) - $5500 (paid in premium) = $17,500

Year 1:
-$3354 (principal repaid)

Year 2:
-$3543

Year 3:
-$3743

Year 4:
-$3954

Year 5:
-$4178

Year 6:
-$4413

So if you find the IRR() of those cashflows in Excel, you get 8.26%, just on the theoretical "CMHC sub-loan".

And that's incremental interest, ie: in addition to the 5.5% you're paying on the entire loan.

So CMHC insurance, assuming flat house prices, is actually costing you 8.26%/annum + 5.5%/annum = 13.76%/annum.

Another way of thinking about CMHC insurance is to imagine that you're buying a call option that is barely in-the-money, on a stock. The implied interest rate on that option will be extremely high.

[i6s1]

I think it's pretty obvious that you should avoid the insurance.

[i6s1]

Why not?

Market cycles are usually fairly regular and surprisingly predictable. Almost a decade of rapid growth, now we're starting to see price drops every month for most areas. The market peak was probably this spring for most of Canada and last year for Alberta. I'm willing to bet that a house purchased today will lose thousands in value every month for the next few years.

[grant]

The only reason to buy CMHC insurance in this situation is to keep marital peace.

Why don't you go back to your g/f and ask her to explain what exactly she expects to spend the $10,000 on. Make her convince you that it's necessary to sit on that cash.

Odds are she'll eventually come around to the correct way of thinking, if you invite her logic to unfold on its own.

[upupnorth]

Great post.... when we took money from our LOC to get to a 20% downpayment, we didn't do any of these calculations but we knew we would be paying a giant premium for a relatively small amount! Great to see it articulated so well.

So let's assume that you're gonna put down $15k, and CMHC insurance will cost you $5500, so your downpayment is a total of $20,550. And let's assume that you use a standard 25-year amortization.

Let's assume that you'll get a loan at a stated interest rate of 5.5%.

Your monthly payment will be $1074.

It will take you a total of 6 years (assuming that house prices do not decline) to bring your loan to the 80% required loan-to-value for a non-CMHC insured loan.

So you're paying $5500 as a premium to borrow $23,000, in addition to the normal interest, over 6 years.

So the effective interest rate of CMHC insurance is equal to roughly 3.8% + 5.5% = 9.3%/annum.

The question becomes, simply, could you borrow for less than 9.3%/annum, reliably, for the next 6 years?

If yes, then don't use CMHC insurance. If no, then CMHC insurance is a good deal.

The key to doing this calculation is to properly amortize the CMHC insurance over the length of time that it would actually be required on your loan, assuming normal principal repayment. If your house goes up in price quite a bit in the next few years, than the effective interest rate of CMHC insurance will be very much higher (due to shorter amortization). If you intend to prepay your mortgage, the effective interest rate will be much higher. If house prices go down, then the CMHC insurance becomes increasingly less expensive compared to unsecured borrowing.

Remember, as always, that CMHC insurance does not absolve or protect you from lawsuits or foreclosure in the event of default. CMHC insurance just means that the bank will get paid if you don't pay your mortgage -- and CMHC will liquidate the property and sue you for any deficiency.

[pitz]

Great post.... when we took money from our LOC to get to a 20% downpayment, we didn't do any of these calculations but we knew we would be paying a giant premium for a relatively small amount! Great to see it articulated so well.

Yeah, a CMHC-insurance salesman will do the calculation over the entire life of the mortgage, and over the entire amount of the mortgage, to make the premium look extremely nominal, and hence inexpensive.

But when you actually calculate the cost of CMHC insurance on the amount of money that really needs insurance, and over the term that really needs to be insured, its very expensive.

PMI (private mortgage insurance) is required on <20% downpayment loans in the US, but banks found that they could loan money instead for cheaper, so they instituted what are known as 'piggyback' loans. Same idea.

[AllWheelDrift]

Hmmm... I always thought CMHC fees didn't seem that expensive considering it's insurance, but when you think about it, they really are just insuring the portion of the loan that's over 80% of the total equity and only until you pay the loan down to 80% of the total equity, yet they are taking a percentage of the entire loan.

I really wish I'd better educated myself when I was a first time home buyer. I'd love to go back in time to both take advantage of the HBP and make a larger downpayment to avoid CMHC fees.

[pitz]

Hmmm... I always thought CMHC fees didn't seem that expensive considering it's insurance..

Well if a person has other assets, its insane to get into a situation where you're buying CMHC insurance.. Because in the event of a default, those 'other' assets will be lost, either voluntarily, or through bankruptcy when CMHC sues you.

[rf134a]

Market cycles are usually fairly regular and surprisingly predictable. Almost a decade of rapid growth, now we're starting to see price drops every month for most areas. The market peak was probably this spring for most of Canada and last year for Alberta. I'm willing to bet that a house purchased today will lose thousands in value every month for the next few years.

If the OP is in it for the long term, it doesn't matter. They can't exactly live in mom's basement until the conditions improve. Anyone looking to buy now and sell within 1-3 years will probably come out with a loss.

[Thalo]

Not really a good time to buy a house don't you think?

Was last year a better time?

[Thalo]

Hmmm... I always thought CMHC fees didn't seem that expensive considering it's insurance,

You're not paying for your own insurance, you're paying for the bank's insurance, thus it is very expensive.

[i6s1]

If the OP is in it for the long term, it doesn't matter. They can't exactly live in mom's basement until the conditions improve. Anyone looking to buy now and sell within 1-3 years will probably come out with a loss.

Of course it matters, short term or long. Would you buy a house now if you believed it would cost 20% less in 2 years? I'd live in mom's basement for 2 years (or continue renting) to save $100 000 on a house.

The average house in Calgary has lost around $50 000 in value over the last year. A person buying now is paying $50 000 less money for the same house as someone who bought last summer.

Now explain to me how saving that much money doesn't matter.

[Hurk]

Wow,

This helps a lot! It gives us a lot to think about. A couple comments:

1) We're buying the house regardless. We love it and we're very happy with the price and location.

2) The $38,000 would be from our savings, and not from a line of credit.

3) We're going to be paying accelerated bi-weekly, regardless of what we choose.

4) We will be doing a standard 25 year.

5) If we don't put the $38,000 down, we'll be paying more when we can.

I appreciated all the help, and any more help would be great.,

[pitz]

5) If we don't put the $38,000 down, we'll be paying more when we can.


I think we've all layed it out pretty good for you then..

Just my own personal advice here, and that is, to try and set up a re-advanceable HELOC in addition to the mortgage. This will facilitate giving you some emergency credit (to satisfy your wife's need for $10k available), and it will be useful if you decide to do the Smith Manouevre in the future (which I think everyone should do, at least to a small extent, once they've paid down a significant chunk of their mortgage).

[sjweyman]

My advice would be to keep your payment schedules in line with how often you actually get paid. If you want to pay down your mortgage faster then simply increase your payments when you know you can (most mortgages allow this) or put down lump sums with the extra that you have.

People try to convince you that accelerated payment schedules will save you a bunch of money. It really isn't true. If you increase your payments to add up to how much extra the accelerated biweekly is costing your for the extra payment every so often and run the calculations you will see that you end up saving very little.

The reason I say this is because it sucks having a large payment come out of your account at odd times of the month when you don't have money coming in. It is much easier on your head to have the payments line up with your pay cheque. Just increase your payments a little to make up the difference.

Someone feel free to run the numbers ... just remember that if accelerated biweekly means you pay an extra $1000 per year then you need to add $1000/(# of payments per year) to each payment. Net interest costs will be very close over the life of the mortgage.

[grant]

People try to convince you that accelerated payment schedules will save you a bunch of money. It really isn't true.
[...]
The reason I say this is because it sucks having a large payment come out of your account at odd times of the month when you don't have money coming in.
That's a great point. If your mortgage paymens aren't in-tune with your income, then you will have a huge chunk of money sitting in your bank account for a few days earning 3%, rather than applied against your mortgage saving you 8% after tax.

"Accelerated" payment schedules are simply bi-weekly payments that have a shorter amortization. If you want & can afford a shorter amortization, then you should just set it up that way up front. Tell the bank "we can pay $x every two weeks, create an amortization schedule that has those payments"... and then you'll get 19.76 years or whatever.