Pros And Cons to Consider
Buying a home can be challenging. It’s one of the biggest decisions and purchases you will going to make and it’s important to gather as much information on the options you have. Saving up for a down payment is a challenge of its own, especially because it might be connected to another thing you must have heard about – mortgage insurance. When you decide to buy a house and you put down less than 20% of your new home’s price as a down payment, chances are you will be required to get mortgage insurance. Keep on reading to find more about what it is and why is it required in the first place.
What Is Mortgage Insurance?
The term mortgage insurance is used very loosely and can mean different things. The two most common topics of reference are either mortgage default insurance or mortgage protection insurance.
The mortgage default insurance is used to protect the lender. It is mandatory when your potential home costs less than $1 million and you cannot afford the 20% down payment. The default insurance cost is added to your loan amount and embedded in the loan. The purpose of it is if you default on your mortgage loan, the bank will take your house and give it to the insurance company. The insurance company then gives the bank their mortgage money back.
However, not all home buyers are eligible for it. To qualify, you must have a credit score of at least 680, a home located in Canada that costs less than a million dollars, and a mortgage for a maximum of 25 years. There are also restrictions about the down payment you can provide – it must not be borrowed but can be a family gift. Also, it’s important to know that the premium doesn’t decline as you’re paying it off. This is because the insurance cost was embedded in your loan at the beginning and now forms part of your mortgage balance.
Canadian Mortgage and Housing Corporation (CMHC), Sagen and Canada Guaranty are the only three providers of mortgage deafult insurance. However, mortgage protection insurance can be offered by a wide range of insurance providers. For example, mortgage protection insurance can be offered by the the lender, but other insurance companies too – like the well-known Canada Life, Sun Life, etc.
Is It The Same As Mortgage Protection Insurance?
Mortgage Protection Insurance is a bit different from the default insurance. In the event of your death, mortgage protection insurance will pay off your remaining loan to the bank. With mortgage protection insurance you will also be paying the same premium, but the benefits will go down. For example, at the beginning of your insurance, the benefits will cover your entire mortgage, but later that would not be the case. A much better option is to opt for life insurance – it would cost less and cover more.
How Much Does it Cost?
Of course, mortgage default insurance isn’t free. It is usually paid by the lender, but the cost is passed down to you.
The premium is calculated as a percentage of the total mortgage amount, and the percentage depends on your down payment. According to the CMHC, this insurance usually costs around 0.6% to 4% of their mortgage amount, depending on the amount they provided as a down payment.
More commonly, borrowers don’t pay for insurance coverage if they have more than 20% of the purchase as a down payment. Therefore, the insurance premium is usually 2.8% to 4% of the loan amount.
For example – let’s say you are buying a home that costs $500,000 and you put a down payment of 10%. That means you need a mortgage of $450, 000 or 90% of the purchase price. Since your home’s price is less than a million dollars and the down payment is less than 20%, you have to pay mortgage insurance, too. The premium of the loan will be 3.10% of the mortgage amount, or $13 950. Since the lender will pass that premium down to you, that makes your total mortgage amount to $463 950. The more money you put down as a down payment, the lesser the insurance premium is.
Use CMHC’s mortgage calculator and find out how much would it cost you.
How to Avoid Mortgage Default Insurance
Unfortunately, the easiest and the only way to avoid mortgage insurance would be by putting 20% of the purchase price as a down payment. Sometimes, that’s easier said than done.
Can You Still Obtain It If It isn’t Required?
In certain cases, mortgage default insurance may still be required if you are putting more than 20% of the purchase price as a down payment. For example, a lender might be willing to lend you money but only if the insurer is also comfortable with the file.
Mortgage life, disability or critical illness insurance is not required but you can choose to pay for the coverage. With a mortgage life insurance, you’re paying for protection in case of your death and leaving your loved ones with fewer things to worry about.
With mortgage disability insurance, you’re paying for protection in the event you have a disability that does not permit you to work. In that case, the insurer will pay your mortgage payments for you on your behalf.
With critical illness protection, you’re paying for coverage in the case you develop a critical illness. There is a specific set of illnesses which will be included or excluded from the insurance policy. If your illness is an acceptable illness type on your list, then the insurer will pay off the mortgage loan.
Pros Of Mortgage Default Insurance
Even if it does sound terrifying, some benefits come with default mortgage insurance:
- You can buy a house without a 20% down payment and lets you keep more money in the bank for extra home purchasing costs
- It doesn’t last forever like some other insurances
- The bigger the down payment, the lower the premium is
- The premium is added to your total mortgage amount so you can pay it off monthly along with the mortgage itself
Cons Of Mortgage Default Insurance
Still, there are downsides as well:
- It protects the bank, not you
- In case of death, your family is not protected and may have to find other ways to pay off the mortgage
- It’s an extra cost to your total mortgage amount
- Only available for homes with prices lower than $1 million
- If you live in Ontario, Quebec, Saskatchewan or Manitoba, you must pay provincial sales tax on the mortgage default insurance premiums.
Pros of Mortgage Protection Insurance
- In the event of your death, your family doesn’t have to worry about paying off the biggest debt
- In the event of your death, it pays off the remaining debt
- The premium is added to your monthly mortgage payments
Cons of Mortgage Protection Insurance
- Expensive – life insurance is the better option
- Benefits go down with time – in covers your entire mortgage only at the beginning
- You have to renew it at the end of your term and the premium can get higher
While it may come with downsides, default mortgage insurance does come with a few benefits. Buying a home costs much more than the original cost of the house – there are moving costs, taxes, furniture, etc. so it might be useful to lower the down payment and use the money for covering those costs. Still, getting the default insurance is a big commitment and leaves you without protection. Before taking the leap and opting for a small down payment home purchase, think about other options and consult with a broker. They can give you advice based on your financial situation and offer you options you can opt for.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Smart Debt Mortgages, independently owned and operated. Smart Debt broker #12236.