It might seem like a straightforward question, but if you ask, “What is mortgage insurance?” you’re bound to get more than one answer.
This is because there are different kinds of mortgage insurance: namely mortgage default insurance and mortgage protection insurance. There are also other types of insurance that can be helpful when you have a mortgage, such as life, critical illness and disability insurance. Some types of mortgage insurance are mandatory while others are optional.
Mortgage default insurance
Mortgage default insurance (sometimes referred to as mortgage loan insurance) doesn’t protect you, rather it protects your lender in the event you default on your mortgage. It is required when your down payment is less than 20% of the home’s purchase price, which is considered a high-ratio mortgage.
The advantage of mortgage default insurance is that it allows you to buy a home even if they have less than 20% of the purchase price saved for a down payment. This makes the housing market more accessible for Canadians.
There are three providers of mortgage default insurance in Canada: the Canadian Mortgage and Housing Corporation (CMHC), Genworth Financial and Canada Guaranty. CMHC, which is the market leader in Canada, sets the standards for this type of insurance so all three providers work the same way.
Not all borrowers are eligible for mortgage default insurance. To qualify for CMHC insurance, you need:
- A credit score of 680 or above
- To meet debt service ratio requirements: a gross debt service (GDS) less than 35% and a total debt service (TDS) ratio that is less than 42%
- A home located in Canada that costs less than $1 million
- A mortgage with a maximum amortization period of 25 years
Your down payment can not come from borrowed funds, but gifts from family are allowed. Down payment minimums vary based on the purchase price of your home.
- For homes $500,000 or less, a 5% down payment is required
- For homes $500,000 – $999,999, you’ll need to put 5% down for the first $500,000 and 10% for the remaining purchase price.
- Homes that cost $1 million or more require a 20% down payment and are not eligible for mortgage loan insurance.
» MORE: How much mortgage can I afford?
Cost of mortgage default insurance
Since mortgage default insurance premiums are usually built into the mortgage loan, it also increases your mortgage carrying costs.
Though your mortgage lender technically pays the premium on this insurance, the cost is passed on to you. There is the option to pay the premium upfront, but most people add it to their mortgage loan.
Mortgage insurance premiums vary from 0.60% to 4.50% and are calculated as a percentage of your mortgage loan amount. That percentage depends on your loan-to-value ratio, based on the size of your down payment.
You can get a refund of up to 25% of your premiums if you purchase an energy-efficient home or renovate your home to be energy-efficient.
In Ontario, Quebec, Saskatchewan and Manitoba, you must pay provincial sales tax (PST) on mortgage default insurance premiums. The PST must be paid upfront, along with your other closing costs, as it cannot be added to your mortgage loan.
Mortgage protection insurance and other insurance
While mortgage default insurance covers the lender if you default on your mortgage, mortgage protection insurance pays off your remaining mortgage balance in the event of your death.
Mortgage protection insurance, which is usually sold to borrowers by their mortgage lender, are declining payout policies. This means you may start out paying premiums for a benefit that covers your entire mortgage, but as you pay down your mortgage, your benefit goes down, even though you’re paying the same monthly premium.
Plus, because this type of insurance covers only your mortgage and nothing more, and it is paid directly to your lender without your family seeing a dime, other insurance policies — like life insurance, critical illness insurance and disability insurance — are usually better options. These policies are more flexible and can provide money for you and your beneficiaries outside of that mortgage expense. Your premiums may also be cheaper than mortgage protection insurance, depending on your health, age and other variables.
As such, it’s recommended you consult an independent insurance broker who is not affiliated with any specific insurance company to review your options. A term or permanent life insurance policy can cover your mortgage and other expenses, with significant money left over for your beneficiaries. Critical illness insurance can do the same if you are diagnosed with a serious illness, as can disability insurance if you end up with a disability and can no longer work.