How Does Mortgage Insurance Work? What Are the Benefits of It?

How does having mortgage insurance help

 The Benefits of Mortgage Insurance

Mortgage life insurance is a form of insurance designed to protect your mortgage.

A mortgage life insurance policy can be a low-cost option to ensure they have a financial safety net if you unexpectedly pass away.

This brings the question; do you need life insurance when getting a mortgage? The answer is no, you are not obligated to have coverage for your mortgage to buy a home. However, it should be an important consideration before purchasing your home.

How Does It Work?

You may not need to get a mortgage life insurance Canada policy if no one depends on your income to pay the mortgage. If your partner and/or children are earning a salary, you may not need a mortgage life insurance policy (or any other type of life insurance).

Alternatively, if you have a term life insurance policy, your dependents will receive a lump sum payment if you pass away, which can be used partially to pay off your mortgage.

So, how does mortgage insurance work? 

This type of insurance is a decreasing term because the sum insured is the amount you would receive if a claim was to be paid out. This declines each year in line with what’s outstanding on your mortgage.

If you do have an interest-only mortgage the amount you owe doesn’t decrease over time. It’s also paid off in one go at the end of the loan period. In this instance, for this reason, decreasing the mortgage life insurance wouldn’t be ideal. Instead, you would need level term insurance; this means that the pay-out is at a fixed rate.


Choosing the Right Policy

The life insurance policy you choose should be tailored to your needs. Mortgage life insurance may not suit you, but different policies could. For example, term life insurance pays out a fixed sum to your dependents if you die during the term. Or increasing term insurance, the cover will increase yearly in line with increasing inflation.

There are many pros and cons between a decreasing term mortgage life insurance policy vs. a level term standard life insurance. 

One benefit is a decreasing term mortgage life insurance policy may cost less than traditional term life. However, the payout from mortgage life can only be used to pay off a mortgage (not to pay for other living expenses). If your partner earns less than you, works from home, or might have to leave their job to look after children. Then, in this case, the better option would be to choose term life insurance that pays out enough to cover extra costs on top of the mortgage.

Mortgage protection
Protect your family's finances with mortgage insurance

Mortgage Default Insurance

If you're a Canadian looking to buy a home, you may realize that mortgage default insurance is something you'll need, especially if you plan to put down less than 20%. Canadian banks are only allowed to provide mortgage financing to suitable homeowners with at least this minimal down payment. While 20% may not seem like a lot of money, it may add up to a lot of money depending on the type of property you want, where you live, and what the local market requires. 

Learn more about the importance of having mortgage default insurance and what it implies from the standpoint of a buyer.

Mortgage default insurance protects your lender if you "default" on your loan – that is if you do not make your payments as promised when you signed your paperwork at closing. It's vital to understand that as the borrower, you're not covered by this policy. Its goal is to reduce the lender's risk by giving them something to fall back on if you don't keep up your part of the payment agreement.

To be eligible for mortgage default insurance, you must meet the following criteria: 

  • - Insured mortgages have a maximum amortization of 25 years.
  • - A greater down payment is necessary if the purchasing price is between $500,000 and $999,999.
  • - A minimum down payment of 5% of the first $500,000 and 10% of the remaining amount is to be paid.
  • Mortgage default insurance is not provided on residences valued at more than $1 million, necessitating a 20% down payment on these properties.

Other qualifications include a credit score of at least 680, a gross debt service ratio of 35 percent or less, and a total debt service ratio of 42 percent or fewer. You won't be able to get a loan if you borrow money for your down payment.

House Insurance
Purchasing a home and getting mortgage insurance

It is the insurer's responsibility to handle all legal procedures and payment enforcement if a borrower defaults. If there are any shortages after the property has been sold and all expenses have been paid, they'll try to repay the lender.

This implies that if you need to sell your home to repay your lender but the amount is insufficient. The mortgage default insurance payout will reimburse you. Any shortfall on the mortgage will remain the responsibility of the defaulting borrower (also known as you, the buyer), and the lender or mortgage insurance may pursue you for any deficiency after the property is sold.

Your mortgage default insurance costs are added to your mortgage. It does not need a big sum of cash to spend at the time of sale, unlike closing costs such as legal fees and property transfer tax. Rather, your mortgage default insurance payment is added to the principal amount of your loan and paid off over the life of the loan.

The only option to reduce your mortgage default insurance is to make a larger down payment as a proportion of the home's purchase price. To do so, you'll need to either increase your down payment or buy a less expensive home. When considering the first option, you might want to investigate other options for your down payment, such as a gift from a family member or a tax-free withdrawal from your retirement account if you're a first-time homebuyer.


The Bottom Line

Mortgage insurance can help to protect your loved ones from losing their home in the event you pass away. However, there are other options to consider like term life insurance (or mortgage default insurance) that may be a better fit for you.

Gregory Rozdeba

Author: Gregory Rozdeba is the founder and CEO of Dundas Life, one of the fastest-growing life insurance brokerages in Canada. He loves helping clients on a daily basis and Polish folk dancing on weekends.

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