You’ve decided to take the plunge and buy a home. It’s something you’ve always wanted to do and you’re thrilled that your dream is about to become a reality.
The lender requires that you put a down payment of 20%. Your heart sinks because you can only afford 10% of the purchase price of the home. In spite of this hurdle, your lender assures you that with mortgage insurance you can still buy your house with 10% down payment.
And you’re sitting there thinking to yourself: “What is mortgage insurance? I’ve never heard of it before”. It sounds like something you’d be crazy not to get.
After all, if something were to happen to you, it would be nice to have that piece of mind that your mortgage payments would be covered. But, is that how it actually works? Well, not exactly.
In this article we take an in-depth look at mortgage insurance, what it is and if you really need it. Read on.
What Is Mortgage Insurance?
Mortgage insurance refers to the suite of insurance policies that are tied to the whole mortgage process. Some are targeted at the lenders while other policies are for the borrowers. Others still are for the home.
But all three components are part and parcel of mortgage loans. Let’s explore three of the most popular ones.
1. Mortgage Default Insurance
Mortgage default insurance is a policy taken out on specific mortgage loans to protect the lender against loss. This type of insurance is often confused with mortgage life insurance.
However, the two are entirely different types of insurance policies. Mortgage life insurance works by paying off the mortgage in the event the borrower dies. We’ll look at this later on in the article.
In Canada, mortgage default insurance is a mandatory requirement when making a down payment of less than 20% of the total value of the home. Just like any other insurance policy you take, there is a premium that has to be paid by the insured which in this case is the lender.
Remember, mortgage default insurance protects the lender against loss. So, essentially it’s the lender who should be paying the premium to keep them insured since they are the ones who get charged. If only it were that simple.
The lenders actually pass the cost of this premium down to the borrower. It can be paid upfront or integrated into the mortgage payment to form part of the monthly payment. Some lenders allow you to settle a portion of the premium upfront and spread the rest of it in monthly installments.
The amount of the premium is determined by the size of the down payment and the total amount of the mortgage loan. If the size of the down payment falls way below the 20% threshold, the borrower should expect to pay a lot more in premiums. Nonetheless, mortgage default insurance can help you qualify for a loan you otherwise wouldn’t be eligible for.
Should You Get Mortgage Default Insurance: How to Tell
Getting mortgage default insurance is compulsory if you can’t meet the minimum 20% down payment threshold required to get the loan. But, you might not need it if you explore all your options. Here are some factors you should consider:
First, have you shopped around? If you settle for the first mortgage lender who preapproves you for a loan, you may end up paying substantially more in mortgage default insurance premiums and in loan interest.
As a rule of thumb, always compare policies from at least three different lenders. Settle on the one that gives you the best deal.
Your lender will get mortgage default insurance form either of the following providers: The Canadian Mortgage and Housing Corporation, Genworth Canada and Canada Guaranty.
Second, can you beef up your down payment? If you’ve waited this long to own a home, you can as well spend a little more time saving up for your down payment so that it meets the minimum 20% that's required. Bumping up your down payment will save you a lot more in the long run by lowering the amount you have to pay in monthly installments.
Finally, have you considered other types of home loans? Conventional mortgage loans might be a popular type of home financing solution, but, it’s not the only one. Browse for other options to ensure you get the best fit for your situation.
Once you’ve explored the different options available and you still find that mortgage default insurance is the only key to homeownership, then, by all means, go ahead and get it. The extra bucks might just be worth it.
Benefits of Mortgage Default Insurance
At the risk of stating the obvious, the whole reason behind the existence of mortgage default insurance is to allow you to buy a home with a lower down payment. This has opened up the housing market to thousands of Canadians who would have otherwise never been able to afford a home and a lot sooner than they anticipated.
What’s more, because of the sense of security mortgage insurance gives lenders, they’re more flexible in giving out home loans. Some lenders accept down payments of as little as 3% of the purchase price of the home. That’s a long stretch from 20%.
The best part about mortgage default insurance is that it’s not a one-size-fits-all solution. The amount you’ll pay in premiums also rests on what your credit score is. Having a higher score means you’ll pay less in premiums.
Additionally, even if you started off with mortgage default insurance, you can continue paying for it until you have at least 20% equity in your home. Once you meet that threshold you can request your lender to cancel your premium payments. The other option you have would be to wait for the automatic cancellation of your mortgage insurance premiums once you attain 22% equity in your property.
Drawbacks of Mortgage Default Insurance
Mortgage default insurance does have some disadvantages. For one, it adds on to the overall cost of your mortgage. You'll find that you're paying more in monthly installments than you would have if your down payment met the minimum required 20%.
The other point against mortgage insurance, from the borrower’s perspective, is that it protects the lender from potential loss. You pay for a policy that has no bearing whatsoever on your wellbeing.
So, if you die unexpectedly while the mortgage is active, it covers only the exact amount of the outstanding mortgage – no more, no less. For instance, say you get mortgage default insurance for $500,000 and you pay approximately $100 in monthly premiums.
If something happened to you when the outstanding balance on your mortgage was $150,000, the policy payout would be on that remaining balance. Term insurance, on the other hand, would pay out the full $500,000.
2. Mortgage Life / Disability / Critical Illness Insurance
While mortgage default insurance protects the lender, mortgage life insurance, mortgage disability insurance, and mortgage critical illness insurance are all designed to protect the consumer. Life is full of ebbs and flows. Sometimes the unexpected happens and you find yourself unable to make your monthly mortgage installments.
This could be due to the death of the family breadwinner, an injury that leads to the borrower’s permanent disability or critical illness that interferes with your income stream. This type of mortgage insurance ensures that nothing interferes with your mortgage payments.
It fills in the gap to make certain that your actual payments continue to be made every time they’re due. In the event of your demise, the insurer pays off the outstanding balance on your home in full.
3. Mortgage Fire Insurance
Mortgage fire insurance is required by law. There are no two ways about it.
Most people don’t understand how easy it is for a fire to break out in their homes and destroy everything they own. You can take the necessary precautions to minimize the risk, but having insurance protects you in case the worst happens.
Some of the most common causes of fires that break out can be attributed to cooking, heating systems, electrical appliances, candles, and cigarettes. How much do you think it would cost to replace or renovate the structure of your home if it was reduced to ashes?
Forget about the contents – just the structure alone? Let’s just say, it would be an uphill task to recover financially. That’s why the law makes it mandatory to take out fire insurance for your home and why it’s part of the mortgage process.
The Bottom Line
The responsibility of having a mortgage goes beyond simply repaying the principle and loan interest. There are many other costs involved in the process. Insurance is just one of them.
If your question going into this article was “What is Mortgage insurance?” we trust that you found all the answers you were searching for.
Are you determined to keep the roof over your head? Here are seven reasons why you need mortgage protection insurance.