Distributing the Risk: Mortgage Default Insurance

Mortgage Default Insurance (MDI) is mandatory in Canada for residential purchases where the purchaser’s down payment is between 5% and 19.99%. Most MDI premiums fall in the range between 2.4% to 6.6% of the mortgage amount. The idea behind MDI is to increase the protection of lenders in the event that a borrower defaults on their mortgage, that is, fails to make the outstanding payments. Countries that have adopted MDI in the housing market increase home buyers’ access to the real estate market, simply by distributing the risk of the lender between the lender and the insurer. This redistribution of risk enables lenders to offer lower mortgage rates and provides them with more protection against mortgage defaults. However, as the risk is distributed between the lender and the insurer, the cost is usually borne by the purchaser.

The general requirements to qualify for MDI in Canada are quite simple: (1) the property must be located in Canada; (2) the property being purchased must be below $1M; (3) the minimum downpayment is not lower than 5% for purchase prices up to $500,000 and 10% for the remaining purchase price over $500,000; (4) the purchasers total monthly housing costs must not exceed 32% of their gross income (Gross Debt Service – GDS); (5) the purchasers total debt load must not exceed 40% of their gross household income (Total Debt Service – TDS); (6) the purchaser also needs to factor in estimated closing costs of 1.5% to 4% of the purchase price (e.g. lawyer fees, GST, land transfer, etc.).

MDI costs are passed onto the borrower and are included in the overall mortgage price. MDI premiums are generally calculated based on the size of the down payment, the lower the down payment, the higher the MDI premiums. It is generally argued that without MDI purchasers would typically pay higher interest rates and additional administrative fees, and most often the cost of MDI premiums to the purchasers is offset by what the purchaser would have otherwise paid in higher interest rates and additional administrative fees.