What is mortgage insurance?
Mortgage insurance is in place to protect your mortgage lender in the event that you default on your mortgage. Whether or not you need mortgage insurance depends on the amount of money you have upfront for your down payment. If you have more than 20 per cent of the purchase price of the property to pay upfront in cash as a down payment, then you will get a “conventional” mortgage and don’t need mortgage insurance. If you have anything between five per cent and 20 per cent, then your lender will require you to get mortgage insurance. (If you have less than five per cent down, then you won’t be able to get a mortgage at all, so keep saving!)
The percentage of money you need upfront as your down payment is what determines whether or not your mortgage is high risk or low risk, more commonly known as high ratio or low ratio. If you have less than 20 per cent as a down payment, then the mortgage is considered having a high loan-to-value (LTV) ratio; that means that the ratio of the amount of the loan to the value of the property is high.
Conversely, if you have more than a 20 per cent down payment, the amount of the loan relative to the value you have in the property is lower. The lower the LTV ratio, the less risky your loan appears to your lender, and so if you have a high LTV ratio it’s seen as a risky loan, requiring private mortgage insurance. The LTV ratio is calculated as your principal mortgage amount divided by the purchase price or market value, if lower.
Technically the lender pays for mortgage insurance, but that cost of those premiums – anywhere between one per cent to upwards of three per cent of the total amount of the loan – is passed onto you, the borrower. The insurance provider calculates the premium as a percentage of the loan principal amount, and that percentage is based on the LTV ratio of your mortgage. The premium is generally rolled into the mortgage but can be paid upfront as part of the closing costs. If the insurance premium is added to the mortgage amount, then you will pay interest on the total amount borrowed, including the mortgage insurance premium. Premiums in Manitoba, Ontario and Quebec, however, are subject to provincial sales tax, and this tax cannot be added to the loan amount; it’s due at closing.
In Canada, there are three bodies responsible for providing mortgage insurance: Canada Mortgage and Housing Corporation (CMHC), Genworth Financial Canada, and Canada Guaranty. CMHC is a federal Crown corporation, while both Genworth and Canada Guaranty are private insurers. CMHC is the primary insurer for housing in small and rural communities, and the only insurer of mortgages for multi-unit residential properties, including large rental buildings, student housing and nursing and retirement homes. It is the largest provider of mortgage default insurance by far.
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As a borrower, you generally wouldn’t have any contact with the mortgage insurer because your lender selects the mortgage insurer, not you. Each mortgage insurer has its own criteria for evaluating the borrower and the property, and it decides whether or not a mortgage can be insured. Because of this, it’s possible that your lender may approve your mortgage application, but the mortgage insurer won’t. In that case, you won’t be able to get a mortgage unless your lender decides to try another insurer.
How it works
When you default on your mortgage, someone has to pay off the remainder of your loan. If you have mortgage insurance for the property, the lender can make a claim on the policy and the mortgage insurer will pay the lender, but you’re still responsible for any balance remaining to the insurer.
“If a borrower defaults, the insurer may oversee all legal proceedings and payment enforcement. In addition, the insurer compensates the lender should there be a shortfall after the property has been sold and expenses paid. The defaulting borrower remains responsible for any shortfall on the mortgage and the lender or mortgage insurer may pursue the borrower for any deficiency following sale of the property,” according to Scotiabank.
In other words, if the sale of the property isn’t enough to cover the balance of the mortgage owing to the lender, then you won’t get away scot-free – your lender or insurer are able to pursue legal avenues to come after you personally for the remainder of the balance.
Mortgage insurance exceptions
If you are buying an investment property, that property won’t be eligible for mortgage insurance. Because of this, you will need at least 20 per cent for a down payment to buy an investment property.
The amortization period of your loan must not be more than 25 years.
If you’re buying a home that’s worth more than $1 million, then that home is not eligible for mortgage insurance.
Even if you have more than a 20 per cent down payment, there are some circumstances when your lender may require you to get mortgage insurance, depending on the location and type of property.
Is mortgage insurance necessary?
Apart from being federally required to get mortgage insurance if you have less than a 20 per cent down payment, mortgage insurance does have a benefit to you, the home buyer. If mortgage insurance doesn’t exist, then lenders wouldn’t be able to offer competitive mortgage rates to borrowers who are getting high ratio mortgages. Rather than assuming all of the risk, lenders share the risk with mortgage insurers. So although you’re paying mortgage insurance, you’re benefitting from paying less interest on the total mortgage amount.
Obviously having as big of a down payment is the best option if you’re buying a home, as it ends up saving you money in the long run. But if you can’t wait to save all of that cash – or don’t want to use all of your available cash up front, then mortgage insurance allows your lender to rest easy that they’ll be taken care of should you not be able to afford your mortgage.
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