Purchasing Real Estate – very important step in every family’s life, especially, if the house or a condominium is the first one in Canada. Realtor, a specialist in buying and selling real estate, is able to assist you with many questions associated with buying a property as well as provide you with a useful and important advice. Today, I would like to focus on a very important question, which may be overlooked at the time of signing the contract. We will be talking about insuring your mortgage
When buying a property, there are two types of insurance:
- Insuring mortgage due to small down payment
- Individually insuring mortgage at the bank, usually offered at the time of signing the mortgage contract.
Let’s take a look at each type of insurance in detail.
Mandatory insurance (we will call it that) has to be processed, if the down payment is less than 20% from the purchase price of the property. This condition is updated, up to April of 2007, the government insurance was mandatory on all purchases with down payment of less than 25%. Today, the new condition applies only to those who are full-time employees and self-employed who are showing a good taxable income.
With low down payment, no bank will be able to offer us a mortgage if it is not insured with one of the three companies – CMHC (Canada Mortgage and Housing Corporation), Genworth Financial Canada or Canada Guarantee. The premiums are set and are the same for everyone, it only varies by the amount of down payment. For a 95% purchase the insurance premium is 2.75%, 90% of purchase – 2%, if your down payment is 15% – the premium is 1.75%. All number are presented with an assumption of a 25-year mortgage. There was a time when the amortization periods offered were longer, even with a small down payment. For the amortization periods of 30, 35 and 40 years these numbers were different. For every additional 5 years of amortization we would increase the premium by 0.2%. So if someone was buying a property with a 35 year amortization period, with, for example, 10% down payment, the insurance premium added to the mortgage would have been 2.4% (2% plus 0.4%). Today, it is possible to offer an amortization period of longer than 25 years, but only if you are buying with a good down payment of 20% or more.
Here is how this insurance works: if for some reason we are unable to make our monthly payment, the bank has the right to sell our property in order to recover the money that we owe them. It is very possible that the house will sell for less. Let’s look at an example: the house was purchased for $400,000 with 5% down payment. Unfortunately, in 5 months, the person lost their job and in a few other months was not able to continue making mortgage payments to the bank. Of course the bank will have to sell the property, but it does not want to incur extra costs for the next few months such as property tax, landscaping and others. Additionally, we cannot forget the costs associated with hiring a realtor to sell the property. In other words, it is clear that the bank will have a loss and will not be able to recover them. This is the case when the government mortgage insurance will step in. The difference, the loss incurred by the bank, will be recovered by the insurer, for example, CMHC. Important to take away, this type of insurance does not protect the family, it protects the bank! But we cannot waive it! NO options, it must be paid. However, this insurance allows us to enter the real estate market, with less financial means, which in the end benefits us.
We could increase the down payment. If the down payment is 10% from the purchase price, the government insurance premium will go down to 2.00%. In order, the relation between the down payment and insurance is as follows: 15% – 1.75%; 20% – 1.00%; 25% – 0.65%; 35% – 0.50%. The bank has the right to not request CMHC insurance with a 20% down payment, but the bank may request such insurance with any down payment. Different banks have different conditions, some will request insurance on a condominium even with a 20% down payment, some want to insure mortgages even with 25% down payment and if an individual is self-employed and is not showing a very high taxable income almost all banks will want to insure mortgages with any down payment less than 35% of the purchase price. However, even 25% is a very significant sum. Saving is hard (the more we make – the more we spend) but we want to buy a house (don’t feel good about paying rent, or maybe we are expecting relatives to move from overseas…). So we go look for conditions that may be not so favourable. What can we do? Such is life.
The second type of insurance comes into our sight when we are signing the contract. When we are about to sign the contract, bank manager asks:
“If you want to protect your family in case of death or serious illness resulting with disability of any of the spouses, so that all the rest of the mortgage will be paid, please tick off here.” No one wants to leave his or her family with debts after death. Of course, it is important to protect them! And it looks like the wording is correct and this is what we need! Of course, we are buying such insurance – decides the family. And you are right, it is important to protect your family. But there is a different opportunity to protect the family more advantageously than it is done in the bank. We talk here about Life Insurance.
Let us look at the examples, showing us why 2 individual kinds of insurance work better than one Bank Insurance:
- The heir in the bank insurance is YOUR BANK, and in the individual insurance is YOUR FAMILY. It means, that in case of death of any of the spouses the family, which has Bank Insurance, will have no cash, because the money will cover the rest of the mortgage. But the family need money today – to cover funeral expenses ($10,000-$12,000), to cover all other expenses connected with the death of the person, (9-th, 40-th memorial days, air tickets for relatives, some reserve money to help widow/widower, who maybe does not work at the moment, recover after grief, etc.), to cover monthly expenses and pay bills. If the family has no money for living, it makes no difference how much they need if there is no money. In individual type of insurance ALL THE SUM is paid to the family without being taxed, i.e. the family will always have cash, which they can spend the way they decide: to cover the mortgage, and keep the rest to live on; or to keep all the money, earn interest and pay mortgage with monthly installments. Look at the situation of the family, which has minors and the parents die in car accident (we have to look at all kinds of situations when we think to sign insurance contract). If the family has Bank Insurance and the children are left with no cash – it is financial catastrophe! They must pay all the bills. Can you imagine, how it is going to look in practice? But in case of 2 kinds of Individual Insurance, as heirs they receive the sum, which is twice as big and tax free; it gives them an opportunity to deal with mortgage and to sponsor their relatives for immigration to be their guardians, etc.
- In most cases your two individual kinds of Life Insurance will cost less than one Bank Insurance (depending upon the type of insurance).
Your Bank Insurance consists of Life Insurance, Terminal Disability Insurance and Dismemberment Insurance (quotation is taken from TD-Bank description. Insurance policy with other banks may have slight differences). Life Insurance – is purchased for the case of death. Terminal Disability is not the kind of insurance for the case of critical illness and compensation. This kind of insurance works in case the doctor diagnoses such serious illness, that the patient has no more than a year to live. Who can get such diagnose? Any doctor will do his or her best to treat the illness, and who knows what the result may be? Dismemberment – is loss of members of the body (two limbs), hearing, speech, etc. Such cases are quite rare, at the same time in most cases we get free insurance of this kind at work. Because of all these reasons Mortgage Insurance costs more than Life Insurance.
- You are the owner of insurance contract:
- none can break your contract; it can be very important if you transfer the Mortgage from one bank to another (in case of serious illness you may be refused the insurance);
- You have the right to change your contract in accordance with your desires: get temporary, permanent, universal kinds of insurance or combine different kinds of insurance; you can include 2 and more persons in the contract; you may add the insurance for critical illness and other details; you may assign anyone as your heir.
We listed the reasons why Individual Insurance works better for the family than Bank Insurance. If you already bought your home, please, check your contracts to see if you have Mortgage Insurance. It often happens so, that people do not remember this detail and cannot distinguish from the monthly bills what they pay for (the bank includes mortgage payments, property tax and insurance into one bill). You have the right to refuse from this kind of insurance at any time, at the moment of signing the contract or at any time after purchasing your home. But you should do it only if you want to change one kind of insurance for another kind. It is unsafe to stay without insurance at all.
By the way, I hope you have not forgotten about RRSP. This is a program, which will help you to save 20-30% more money for your down payment, than you ever thought (depending upon your annual income). Your money must stay in an RRSP account for minimum 3 months, which means that you should get ready to buy your home in advance.