Which scenario would require mortgage default insurance?
Correct Answer
C) A borrower purchasing a $400,000 home with a $60,000 down payment
Mortgage default insurance is required when the loan-to-value ratio exceeds 80%. Option C has an LTV of 85% ($340,000/$400,000), requiring insurance. The other options have LTVs of 75%, 75%, and 75% respectively.
Why This Is the Correct Answer
Option C is correct because it results in an LTV ratio of 85% ($340,000 mortgage ÷ $400,000 purchase price). Since the LTV exceeds 80%, mortgage default insurance is mandatory under Canadian federal regulations. The borrower's $60,000 down payment represents only 15% of the purchase price, falling short of the required 20% minimum to avoid insurance. This scenario clearly triggers the insurance requirement that protects lenders against potential default losses.
Why the Other Options Are Wrong
Option A: A borrower purchasing a $500,000 home with a $125,000 down payment
Option A has an LTV of 75% ($375,000 mortgage ÷ $500,000 purchase price). The $125,000 down payment represents 25% of the purchase price, exceeding the 20% minimum threshold. Since the LTV is below 80%, mortgage default insurance is not required.
Option B: A borrower purchasing a $600,000 home with a $150,000 down payment
Option B results in an LTV of 75% ($450,000 mortgage ÷ $600,000 purchase price). The $150,000 down payment equals 25% of the purchase price, which exceeds the 20% minimum requirement. With an LTV below the 80% threshold, mortgage default insurance is not mandatory.
Option D: A borrower refinancing with 25% equity remaining
Option D involves refinancing with 25% equity, meaning the LTV would be 75%. Since the borrower has more than 20% equity (above the minimum threshold), the LTV is below 80% and mortgage default insurance would not be required for this refinancing scenario.
Deep Analysis of This Mortgage & Real Estate Finance Question
This question tests understanding of mortgage default insurance requirements in Canada, specifically the loan-to-value (LTV) ratio threshold. Mortgage default insurance protects lenders against borrower default and is mandatory when the down payment is less than 20% of the purchase price, resulting in an LTV ratio exceeding 80%. This requirement is established by federal regulations and enforced by mortgage insurers like CMHC, Genworth, and Canada Guaranty. The 80% LTV threshold serves as a risk management tool, as higher LTV ratios correlate with increased default risk. Understanding this concept is crucial for real estate professionals as it affects buyer qualification, financing options, and transaction feasibility. The insurance premium, typically added to the mortgage amount, impacts affordability calculations and must be factored into pre-approval discussions with clients.
Background Knowledge for Mortgage & Real Estate Finance
Mortgage default insurance in Canada is required when the loan-to-value ratio exceeds 80%, meaning the down payment is less than 20% of the purchase price. This insurance protects lenders against borrower default and is provided by CMHC, Genworth Canada, and Canada Guaranty. The insurance premium ranges from 0.6% to 4.5% of the mortgage amount, depending on the LTV ratio and amortization period. Federal regulations under the Bank Act and guidelines from OSFI mandate this requirement. The 80% LTV threshold applies to purchases, while refinancing typically allows up to 80% LTV without insurance, though some exceptions exist for certain mortgage products.
Memory Technique
The 80-20 RuleRemember '80-20 Insurance Due' - when the mortgage is more than 80% of the home's value (or down payment less than 20%), insurance is due. Think of it like a seesaw: when the mortgage side tips over 80%, the insurance requirement kicks in to balance the risk.
When you see LTV calculations on the exam, immediately check if the result exceeds 80%. If it does, insurance is required. Alternatively, check if the down payment is less than 20% - same result, insurance needed.
Exam Tip for Mortgage & Real Estate Finance
Calculate LTV quickly by dividing mortgage amount by purchase price. If over 80% (or down payment under 20%), insurance is required. Don't get confused by dollar amounts - focus on percentages.
Real World Application in Mortgage & Real Estate Finance
A first-time homebuyer wants to purchase a $450,000 condo but only has $50,000 saved for a down payment. As their agent, you explain that their 11% down payment means they'll need mortgage default insurance, adding approximately $15,000-$18,000 to their mortgage amount. This affects their affordability calculations and monthly payments. You help them understand that while the insurance increases their costs, it enables homeownership with a smaller down payment, and the premium can be paid upfront or added to the mortgage.
Common Mistakes to Avoid on Mortgage & Real Estate Finance Questions
- •Confusing LTV calculation (mortgage ÷ purchase price, not down payment ÷ purchase price)
- •Thinking insurance is optional when LTV exceeds 80%
- •Forgetting that refinancing rules differ from purchase rules
Key Terms
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