Congratulations! The offer is accepted on your new home. This is an important and exciting milestone but leads to hundreds more decisions you didn’t even know you had to make and questions about what is mortgage insurance.
Before you get a chance to run to the hardware store and cut keys or sign up for sleepover parties at a certain Swedish retailer, a call comes on your phone.
It’s your mortgage provider! And they want to talk to you about protecting the biggest financial decision you’ve ever made: “Do you have a few minutes to talk about insuring your mortgage?”
Don’t worry. Right now, you’re here. Before you accept the call, take a few minutes and get the low down on the two most adult words you’ve ever seen next to each other.
Read more about …
Jump to the following sections of this article:
- What is mortgage insurance?
- How does CMHC insurance work?
- What is the cost of CMHC mortgage insurance?
- Am I required to purchase mortgage insurance?
- Can I get life insurance to replace mortgage insurance?
- How does mortgage life insurance work?
- Determining the amount of mortgage protection I need
- Life insurance is cheaper than mortgage insurance
- Life insurance vs mortgage loan insurance
- How can I buy mortgage life insurance?
What is mortgage insurance?
In Canada, mortgage insurance is a protection product, typically offered by your mortgage lender. In the unfortunate event of your death with your mortgage loan still outstanding, this insurance will pay off the debt of your mortgage loan.
For example, let’s say you are purchasing a house for $100,000. First of all, nice price! Can we get your realtor’s number?
You put together a 15 per cent down payment, and the amortization period is 25 years. That leaves a $85,000 mortgage loan that you need to pay off over the next 25 years – ignoring for the moment the interest rates, fees, and other variables which come with home ownership.
If something happens to you within this 25-year period, your lender still expects to be paid back that $85,000 mortgage loan or whatever part of it they are owed at that point. To do this, your family, loved ones, or estate are expected to come up with that cash, be it by dipping into their savings, or selling the property to settle the mortgage loan.
So what is mortgage insurance? It is insurance that insures that mortgage loan is paid off in these circumstances; some plans can even cover the mortgage loan in case of a disability or a serious illness.
It should not be confused with mortgage default insurance or mortgage loan insurance, which we’ll talk about later below.
This is a common misconception. If your initial down payment for your mortgage is less than 20 per cent of your purchase price, and your potential home price is below $1-million (the maximum allowed price to qualify for default insurance), you are required to purchase mortgage default insurance (also known as mortgage loan insurance). Mortgage default insurance is offered by providers such as the Canada Mortgage and Housing Corporation (CMHC), a crown corporation or private mortgage insurers like Genworth Financial Canada and Canada Guaranty.
CMHC insurance pays out the lender (you read that correctly – the lender) if the borrower (in this case you) defaults on their payments for whatever reason (not just death) – there is no payout to you, and the CMHC can later come after you or your estate for these costs, as you are still liable for them.
So why are you paying it? Bigger picture, it enables banks and lenders to offer mortgages and lower interest rates to first-time home buyers with less than 20 percent for a downpayment and other potentially riskier borrowers. It protects the lender incase these borrowers default and it lets a larger number of people become homeowners.
CMHC insurance protects the lender. Your mortgage and bank are covered, but you are not.
Let that sink in before you sign up for those skydiving lessons this evening…
The insurance premium for CMHC’s mortgage default insurance ranges from 0.6 to 4.5% of your mortgage amount if your downpayment is less than 20 percent of the purchase price. The good news – your lender pays for this insurance premium. The bad news – they pass this cost straight onto you.
Can I avoid paying for CMHC insurance?
Yes, but it’s easier said than done. If your initial downpayment for your home is less than 20 percent, try to increase it so that it is above 20 percent. This is no small sum given Canadian housing price trends and the competitoin that a low interest rate brings.
If you have paid more than 20% for your downpayment, then default mortgage insurance premium is no longer mandatory or required. However, it is still prudent to protect what is most Canadian families’ biggest asset. For a typical Canadian family, their home contributes to approximately 33 percent of their assets.
You worked hard to create a home for yourself and your loved ones. In the event of your death, you don’t want to jeopardize the life (and the home) you built for them if a mortgage loan defaults.
However, we will let you in on a secret – your lender may not be offering the type of mortgage insurance that’s best for you – for several reasons.
For starters, the payout from lender-provided mortgage insurance can only be applied to your mortgage loan. And the coverage amount remains the same– whether you owe hundreds of thousands of dollars as you may at the start of your mortgage, or just $900 at the time of the final monthly instalment.
About that … don’t bet on it. All else equal, the mortgage insurance premium agreed to based on the initial mortgage amount at the time you take the loan. Even as your mortgage loan reduces over the term, you still pay the same original insurance premium.
Essentially, the policy’s value diminishes over time – it will never be more valuable than in the first few years of your mortgage, despite you paying the same high mortgage insurance premium throughout.
No – but you might have noticed your lender making it almost seem like it.
Hmmmm, that’s funny, isn’t it? Nonetheless, the security homeowners look for through lender-provided mortgage insurance is much better served by the benefits and flexibility of other products.
Can I use life insurance to replace my mortgage insurance?
Yes, mortgage protection through term life insurance can provide the same security as traditional mortgage insurance plus all the benefits you rightfully assumed would come with it but are now seeing is not the case.
With lender-provided mortgage insurance, as we explained above, you get the security of knowing your mortgage loan is covered throughout the life of your mortgage – but that’s it. Despite the long checklist of needs that would accompany your loss of life, traditional mortgage insurance strictly services only a mortgage loan and solely protects the lender.
Alternatively, mortgage protection through term life insurance (also referred to as mortgage life insurance, and private mortgage insurance) offers the same security throughout the riskiest years of your mortgage loan, with several additional flexibilities that aren’t offered in lender-provided mortgage insurance.
For starters, you can get coverage well beyond the amount of your mortgage loan (more on that later). You also get to pick your own beneficiary, instead of paying for insurance to protect the lender.
Through term life insurance, your beneficiaries are entitled to a lump-sum payment they can use however they want – the amount never reduces.
Instead of a diminishing payout linked to your remaining mortgage loan, through term life insurance your beneficiaries are entitled to a tax-free, lump-sum payment which never reduces and can be applied to whatever they choose.
There are many more benefits to mortgage protection through this method, which we’ll get to below. In each case, we compare and contrast those benefits with the lender-provided alternative – so you at least come away informed and able to make the right choice for you and your loved ones.
Options are limited – you can only get it from the lender who provided your mortgage loan. With 73 percent of mortgages coming from Canada’s Big 5, it mostly ends up being your favourite bank – ok maybe favourite is a strong word.
However, mortgage life insurance is available from several companies nationwide, and we happen to know a simple, quick way to check out the best quotes and find an insurance company.
How do I pay for mortgage insurance?
With the lender-provided option, you pay the insurance premium alongside your mortgage payments. Term life insurance can similarly be paid monthly, with an added flexibility of paying for it yearly. You even get a healthy discount for your prudent behaviour of paying it annually – thank us later for the tip.
Unfortunately, you don’t get much of a choice if you go through your lender – the insured amount is tied to the value and term of your mortgage loan. However, mortgage protection through term insurance lets you expand the coverage for other needs (such as child care, education needs, your family’s future living expenses, funeral expenses and more).
Do mortgage insurance and mortgage protection have to cover the length of the mortgage?
With lender-provided mortgage insurance, yes. You renew your lender’s mortgage insurance when you renew your mortgage rate, and just as rates change over time, so do insurance premiums.
What may have started as an easy (but not so cheap) way to insure your mortgage in your early 30s, may get even more expensive when you are trying to renew it in your mid-40s.
Your mortgage insurance premium is a consistent, predetermined payment for the length of coverage you choose – no surprises. And if you want, you can potentially increase the length of the coverage to cover your entire life.
With the lender-provided conventional mortgage insurance, your lender offers you an inflated price because there is no underwriting – the process an insurance company goes through to determine the appropriate fees for taking on the financial risk of (in this case) your premature death.
Without this stringent evaluation process, they are taking on the risk of your policy paying out, you suing them in the rare case it doesn’t, and paying percentages and finders fees to whatever other parties were involved in selling you the policy.
Why is private mortgage insurance through term insurance cheaper than bank-offered mortgage insurance?
With mortgage protection through term insurance, underwriting goes in full effect. The potential payout is bigger and more consistent, so an insurance company does their due diligence to make sure you are as insurable as possible. If insuring you is less risky, then they pass some of those savings on.
Ok, so mortgage insurance is more expensive than mortgage life insurance – does that mean it’s guaranteed?
We hate to be so constantly negative here, but no. With lender-provided conventional mortgage insurance, the claim is evaluated at your death to see if there is any reason why it should not be paid out. For instance, if you had a health condition at the time of getting the mortgage insurance and it was not disclosed (since you may have been unaware at that time), your claim can and most likely will, be denied.
Not only does that mean a lack of security, but an added stress on your loved ones and estate should they have to fight for a claim they feel is rightfully theirs, at a time they really shouldn’t have to deal with it.
Mortgage insurance is expensive. Luckily, mortgage life insurance is not.
Term life insurance in most cases is guaranteed coverage, which means a higher probability of your claim being paid without any hassle. And if insuring you is less risky, they pass those savings on to you.
In the case of lender-provided mortgage insurance, it is understandably tied to the lender. If you sell your house, switch mortgage providers, or anything else that ends your relationship with that particular debt, the corresponding mortgage insurance policy is rendered moot.
You no longer have to pay into it, but you also have to ensure a new means of protecting either yourself or a new mortgage if that’s the path you’ve chosen.
Term insurance offers consistent protection throughout your housing situation. The agreement is independent of your property.
Whether you stay in the same house for 30 years or sell it in 3, your mortgage is still covered through term life insurance.
It’s true! If you stay in the same exact house for 30 years, or pack it all up 10 years in, sell it, purchase a captain’s hat, and move the family to your brand new houseboat, you’re still covered with mortgage protection through term life insurance.
With the lender-provided option, you don’t have any say in the matter. Once the policy is activated, all transactions are handled by the suits at the bank or lender’s office until they deliver a deed to your family or estate – no matter what the size of the debt.
Term life insurance instead gives your beneficiary the freedom to do what they want with the payout. They may want to pay off the mortgage, take over the mortgage and use the funds on other needs at that time, or something in between those two choices given their financial situation. Ultimately, you are leaving them the choice.
What do I leave behind for my family or loved ones?
In the lender-provided scenario, property. Should the claim be approved, your estate or heir gets to keep the condo or house you’re insuring. Like we said: it protects the lender.
With term life insurance, they get a cash payout corresponding to the amount you initially choose.
And if you only skimmed the checklist too, and now want another shorter takeaway, then here it goes:
We laid out a pretty good case for why we believe mortgage protection through term life insurance is the right choice for Canadian homeowners. That said, everyone’s situation is different and we can’t make that decision for you.
However, armed with the above knowledge and our life insurance calculator, we know you’re now capable to make the right decision for you, your family, and your home.