Understanding Mortgage Default Insurance

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Understanding Mortgage Default InsuranceYour house will be the largest purchase you will ever make in your life. With that purchase comes a long list of questions that must be asked and decisions that must be made. When you begin preliminary discussions with a mortgage broker, you will need to discuss the size of your down payment as this will determine if you need to have mortgage default insurance. Here are some FAQs regarding mortgage default insurance (also known as mortgage loan insurance):

What is mortgage default insurance?

Simply put, it is an extra bit of insurance that mortgage lenders require from purchasers who put less than 20% of the purchase price down as a down payment toward the purchase of their house (known as a high-ratio mortgage). The insurance premium is calculated as a small percentage of your purchase price and added directly to your mortgage unless you choose to pay it outright. Its purpose is to protect lenders in the event you default on your mortgage payments. In Canada, mortgage default insurance is provided by insurers such as CMHC, Genworth Canada, and Canada Guaranty Mortgage Insurance Company.

Who requires mortgage default insurance?

Any purchaser who is unable to put down at least 20% of the purchase price as a down payment will be required to obtain mortgage default insurance.

How is mortgage insurance calculated?

Mortgage insurance rates vary based on the loan-to-value. If you borrow a higher percentage of the total home’s price/value, you will pay a higher percentage in mortgage premiums. The insurance premium is typically between 0.6% to 3.85% of the borrowed amount, though rates can vary.

Say you purchase a $260,000 home and put 15% down ($39,000). In this example, there is a mortgage amount of $221,000 and the insurance premium rate is 1.8%.

The mortgage default insurance premium will cost:

$221,000 x 1.8% = $3,978

The total mortgage loan would then be $221,000 + $3,978 = 224,978

As the mortgage loan is higher, you will also pay more interest over the term of the mortgage.

In Ontario, the premium is also subject to sales tax.

How do I pay mortgage default insurance?

It can be paid in two ways. One way is for it to be added directly onto your mortgage total and can be spread out over the term of your mortgage. The other way is to pay it outright in full. The benefit to paying it outright is that you are not charged interest on the amount, whereas if you add it to your monthly payment the amount is easier to manage. If you are able to pay the amount upfront, then possibly you can put down a higher deposit and avoid paying the mortgage default insurance all together. These are the types of discussions you will need to have with your mortgage broker.

Why does mortgage default insurance exist?

It can act as a deterrent for purchasers who do not have a large enough down payment on a property. If you save up a little longer and have a larger down payment to fund a conventional mortgage, then the added cost of default insurance is not required and you save yourself some money. Aside from a deterrent it also acts as extra insurance for the lender who is providing you with a loan for a very large sum of money. Should you default on any mortgage payments the payments can be taken from the default insurance.

Every purchase situation differs and for some people starting the process of home ownership earlier rather than later is the preferred way to go. Those are the purchasers who are subjected to mortgage default insurance due to not having at least 20% down payment in hand. Discuss your options with a mortgage broker and see what your best choice is!

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