The government of Canada requires you to have mortgage loan insurance if you are purchasing a home with a down payment of less than 20 percent of the total cost. This should not be confused with mortgage life insurance, which is another product often sold by lenders.
Read on to learn more about your insurance options and ways to protect you and your loved ones in a cost-effective way.
What does mortgage default insurance cover?
Here’s the bad news. This insurance does not actually protect you in the event that you are unable to pay your mortgage. It compensates mortgage lenders if you default. Therefore, even though you pay the premiums, you would not actually be compensated in the event of a payout.
Is mortgage default insurance mandatory?
Yes, if you don’t have the minimum 20 percent down payment. It allows individuals to buy a home with a down payment of as little as 5 percent. The Canada Mortgage and Housing Corporation (CMHC) has specific mortgage loan insurance rules.
Here’s how the minimum down payments work:
- For houses costing less than $500,000: You must put down at least 5 percent of the cost
- For houses costing more than $500,000 and less than $1 million: The minimum down payment is 5 percent on the first $500,000 and 10 percent on the remainder
- For houses cost more than $1 million: Mortgage default insurance is not available.
The cost of mortgage default insurance in Canada
How do you determine the mortgage default insurance premium? The premium is calculated as a percentage of the loan and is based on the size of your down payment. The higher the percentage of the total house price/value that you borrow, the more you will pay in mortgage default insurance premiums. Here’s a link to the Canada Mortgage and Housing Corporation CMHC mortgage insurance rates.
For example, let’s say you purchase a home valued at $525,000 and make a down payment of 5 percent or $25,000. That leaves you with a mortgage of $500,000. The CMHC charges 4 percent for mortgages where you are borrowing 95 percent of the value of the home. That means you would pay $20,000 in mortgage default insurance premiums.
You can pay a lump sum or have the insurance added to your monthly payments. If you add it to your monthly payments, you will be paying interest on the insurance. Yikes!
How do I avoid paying mortgage default insurance?
As you can see from the above example, mortgage loan insurance can be very expensive. So, it’s best to find ways to NOT have to purchase it. Many first-time home buyers are asking parents or grandparents for assistance by contributing to the down payment.
Every little bit helps. Even if you can’t get a 20 percent down payment, the closer you get to this amount the less mortgage default insurance you will have to purchase.
How does mortgage default insurance differ from mortgage life insurance?
These products are often confused, but they are actually quite different. As indicated, mortgage loan insurance pays your lender and the purchaser gets nothing. On the other hand, mortgage life insurance pays off your mortgage in the event of your death. So it protects your heirs (such as your spouse) by ensuring that your mortgage is zero if you die.
When you get a mortgage, a lot of lenders will try to sell you mortgage life insurance. However, you should consider whether this is the best option.
First of all, mortgage life insurance only pays off your mortgage. Upon your death, your heirs will still have many costs, including utilities, home maintenance, property taxes and daily living costs such as groceries. These are not covered by mortgage life insurance.
Instead of purchasing mortgage life insurance, you may wish to consider term life insurance. It offers several advantages:
- Your heirs control how the money is spent. Instead of paying off the mortgage, they may prefer to use the settlement for daily living expenses.
- Paying other debts, such as credit cards may make more sense. Mortgage interest rates are quite low so it may be better to pay off high-interest credit card balances.
- Term life insurance retains its value. If your purchase $100,000 in term life insurance, your heirs will receive this amount upon death. On the other hand, mortgage life insurance only covers the balance on the mortgage – as you make payments over the years, your balance owing gets closer to zero. Your actual insurance payout could be quite small.
Therefore, you may wish to consider purchasing term insurance rather than mortgage life insurance.
Mortgage default insurance providers in Canada
This insurance is often called CMHC mortgage insurance, but there are actually two private insurers in addition to the government-owned CMHC.
The main insurers are:
In summary – review your options
When making a home purchase, be sure to consider your down payment and insurance options well in advance. You don’t want to last-minute surprises when you are ready to sign on the dotted line for your mortgage. As discussed, try to assemble the largest possible down payment through your own savings and any help that relatives can provide. Ideally, avoid having to purchase mortgage default insurance. As well, instead of purchasing mortgage life insurance, consider term life insurance, which provides your heirs with much more flexibility about how the proceeds are spent.
