Mortgage Insurance…Do I Really Need It?
For first-time homebuyers, one of the most confusing parts of the process of purchasing real estate is often mortgage insurance. After all, if you are already buying homeowner’s insurance for your property, why do you need another insurance policy for your mortgage? For that matter, why does your mortgage need to be insured at all? Even if you don’t voice these questions to your bank, they’re probably rattling around in your brain. In this article, we have attempted to get to the bottom of some of the more frequently asked questions, misconceptions and myths of mortgage insurance.
Different Types of Mortgage Insurance
To start, let’s address the question that is probably the elephant in the room: What is Mortgage Insurance?
The most confusing part of mortgage insurance is there isn’t just one answer to this question. On the contrary, Canadian homebuyers can purchase multiple types of insurance for their mortgages.
Mortgage Default Insurance
The most common type of mortgage-related insurance is mortgage default insurance (though most people just call it mortgage insurance). Unlike homeowner’s insurance, mortgage default insurance doesn’t protect you as the homeowner. Instead, this type of coverage is in place to protect the lender should you default on your mortgage. One of the most recognized providers of this type of insurance is CMHC (Canada Mortgage and Housing Corporation).
Not all homebuyers are required to buy mortgage default insurance. On the contrary, lenders will typically only require this type of coverage for high-ratio mortgages. We think of a mortgage as high-ratio if the buyer’s down payment is less than 20% of the home’s value. These mortgages are riskier for the lender, hence the insistence from the bank that the buyer purchase mortgage insurance.
Mortgage Protection Insurance
The second type of mortgage-related insurance is what is called mortgage protection insurance or mortgage life insurance. A mortgage is the biggest debt that the average person will take on in their lifetime. If you die or become disabled before you have paid off your mortgage, mortgage protection insurance should cover your remaining debt. It should protect you and your family from financial hardship. You can secure this coverage through life insurance companies and can be purchased through a broker.
Is Mortgage Insurance Mandatory?
In the case of mortgage default insurance, whether it is mandatory will depend on you, your mortgage and your bank. In general, lenders do require homebuyers to purchase mortgage insurance if they are putting less than 20% down. Said another way, if you can manage a 20% down payment on your home, you likely will not be expected to pay for mortgage insurance.
Mortgage protection insurance is not mandatory, and your lender cannot insist upon it. As with other types of life insurance, it is entirely up to you to decide whether to buy this coverage. Your lender may try to sell you mortgage protection insurance, but most industry experts advise homebuyers to decline buying coverage through a lender (for reasons to be discussed later).
The Costs of Mortgage Insurance
Both mortgage default insurance and mortgage life insurance are calculated based on the size of your mortgage loan. In the case of mortgage default insurance, you will pay less the closer your down payment is to 20%. Your mortgage insurance payments should go away when you reach 20% equity in your home. The type and length of your mortgage could also affect what you are paying.
In the case of mortgage life insurance, view your policy to judge if your getting a good deal. What seems like a good premium might be less attractive if your mortgage protection insurance payout has a limit. This means it will only pay a portion of your mortgage in the event of your death. If you decide to buy this type of insurance, know that you are not required to obtain it from your lender. You have complete freedom to shop around and find a policy with the best premiums and terms for you.
How Mortgage Insurance Pays Out
A common misconception about both types of mortgage insurance is that they could deliver payouts to mortgage holders or their families. As was previously mentioned, mortgage default insurance is not even there to protect the buyer. If you default on your mortgage, the policy will pay out to your bank, protecting them from any potential losses. While reaching a 20% down payment can be a challenge given high real estate prices and living expenses, you are always better off avoiding mortgage default insurance. Otherwise, you essentially end up throwing money away. The money you spend on insurance doesn’t protect you, doesn’t build equity in your home and will never yield any dividends.
Mortgage life insurance provided through lenders also does not yield monetary payouts for your family. This tends to be a surprise to home buyers given their general understanding of life insurance.
In this instance, let’s say your original mortgage is $300,000 and the premium is $20 a month. Let’s also assume you pay this premium for ten years. The amount left on the mortgage is now $200,000, and you have paid $2,400 into the life insurance policy. Suddenly, something horrible happens to you or someone named on the mortgage. In the case of a traditional mortgage life insurance policy, you or your family members would receive $300,000. In the case of a lender purchased policy, the bank gets the payout and then covers the remaining $200,000 of your mortgage. This policy is what is called a “decreasing benefit,” which means it is essentially worth less the more money you pay into it.
Who’s Legally Allowed to Sell Mortgage Life Insurance?
A warning to those buying mortgage life insurance through their lending institution, lenders are not legally allowed to sell insurance. Selling insurance requires specific training and licencing, which lenders lack. What your lender can do legally is ask pre-qualifying questions and collect premiums. If something happens to you or the mortgage holder, the insurance company reviews the claim and reserves the right to decline the claim. If your claim is declined, the lender will simply give you back the premium you paid them up to that point in time. This situation is known as Post-Underwriting. Which basically means that the actual insurer is collecting information about your insurability after the fact.
For these reasons, we recommend working with a broker or agent that can guarantee your death benefit.
To Sum It Up
Mortgage insurance is a confusing thing, especially since your unique circumstances will dictate whether you need to worry about it at all. The best thing you can do is educate yourself and know all your options. Try to put yourself in a situation where your insurance is protecting you, not your bank. We are here to help, let us take care of your mortgage insurance needs while you Enjoy the View!