As a homeowner, your house is likely the most expensive thing you own, and your mortgage one of your biggest financial responsibilities. For financial institutions, mortgages are also a major financial investment, carrying a lot of risk. That’s why mortgage insurance (both types!) is such a critical product.
When it comes to buying or selling your home, you need to consider how mortgage insurance will impact the finances of the transaction. This article will explain how the two types of mortgage insurance are used, and offer a few tips on how to minimize the impact on your finances.
What is mortgage insurance?
There are two products often referred to as mortgage insurance: Mortgage Default Insurance (also known as CMHC insurance), and Mortgage Life Insurance. They’ll both pay off your mortgage when you can’t, but that’s where the similarity ends!
Mortgage default insurance
Mortgage default insurance is a product that lenders purchase – it covers the risk of you defaulting on your mortgage. If you can’t pay back your mortgage, your lender will make a claim to recoup its losses. The cost of the policy is either paid by the lender or the borrower (more on that below).
Mortgage Default Insurance is sometimes called CMHC Insurance. This stands for Canada Mortgage and Housing Corporation, which is the largest of the three companies that provide these kinds of policies.
Some mortgages aren’t eligible for mortgage default insurance. A mortgage is uninsurable if:
- The property is worth over $1 million,
- The property is not owner-occupied (ie is a rental), or
- The amortization period is more than 25 years.
Because these mortgages can’t be insured, lenders take on all of the risk of borrower default. As a result, uninsurable mortgages tend to have higher interest rates.
Insurable loans are for owner-occupied properties valued under $1 million with an amortization period of less than 25 years. If you make a minimum 20% down payment, then the lender will pay the cost of mortgage default insurance, so you don’t need to worry.
Home loans with a down payment of less than 20% are known as high-ratio (or high-risk) mortgages. For these mortgages, lenders will charge borrowers the cost of mortgage default insurance – this arrangement is legally mandated, so borrowers have no choice in the matter!
The cost of the mortgage insurance will be added to the total value of the loan, and is generally between 2% and 4% of the purchase price, which your lender will charge you interest on over the term of your mortgage. Because of the reduced risk, you may get a lower rate, but rarely enough to actually save you money.
Using the mortgage calculator on Ratehub, you can see the difference between paying a 20% deposit and paying for mortgage default insurance with a lower down payment.
As you can see, it’s always better to have that 20% down payment if you can afford it.
Mortgage life insurance
Mortgage life insurance is a term life insurance policy that covers the outstanding debt of a mortgage if the borrower passes away. This gives the borrower peace of mind, as they know their family won’t need to sell their home to pay the outstanding debt.
Mortgage life insurance is typically sold to a borrower by a lender, though the policy is generally underwritten by a third party life insurance company. The borrower pays the premiums as part of their mortgage repayments, but the lender is named as the beneficiary. If a borrower was to die, their lender would make a claim on behalf of the estate, which would pay off the mortgage.
Is mortgage life insurance optional?
Mortgage life insurance is optional, but it’s a good idea to have some sort of life insurance that covers your outstanding debts. The alternative to buying mortgage life insurance is to have an individual life insurance policy with a death benefit large enough to cover your home loan. You can either add a rider to or increase your existing life insurance policy, or buy a new policy just for your mortgage – make sure you compare life insurance quotes to get the best rates.
Advice for home buyers
When buying a home, here are some key things that can reduce the financial burden of both types of mortgage insurance.
Save for a larger down payment. To avoid the additional cost of mortgage default insurance on your home loan, which you’ll be paying interest on, take some extra time to save a 20% deposit. Alternatively, use a mortgage calculator to work out how much you can afford with your current savings.
Find a better rate. If you can’t save a larger deposit, you can still try for a better rate. The lower your rate, the less mortgage default insurance will impact you. Start by comparing mortgage rates from multiple lenders, and negotiate with your lender. You can also save money by simply negotiating your home purchase, and paying less overall.
Update your mortgage life insurance. With a new home comes a new mortgage, so make sure your new home loan is covered with a life insurance policy. If you had mortgage life insurance on your old mortgage, it won’t transfer to the new one. You’ll either need to buy a policy from your new lender, or get individual life insurance coverage elsewhere.
Advice for home sellers
Mortgage insurance throws up a different set of problems when you’re selling a home, especially if you’re in the process of buying a new house as well.
Understand your current home value . Start your home selling journey with a free ProperPrice™ home value report.
Ask about your old CMHC insurance. Mortgage default insurance will normally follow you to a new mortgage with a new lender, but not always. There are rules around porting policies to a new lender, and not all lenders allow it. Check with your broker before you put your house on the market to find out.
Get a better price. This seems simple, but the best way to reduce the impact of mortgage default insurance is by having a smaller mortgage overall. Getting a better price for your home is the best way to do this. From avoiding realtor fees to preparing for an open house, there are lots of ways to boost the price of your property.
Update your life insurance. If you purchased mortgage life insurance with your home loan, your coverage will end with your contract. If you’re ending a home loan that has a mortgage life insurance component, it won’t carry over to your next mortgage. If you want to stay covered for your next mortgage you’ll either need to purchase mortgage life insurance from your new lender, or purchase a stand-alone life insurance policy.