Insuring mortgage loan within and out of the bank – Mortgage Insurance
Buying a property is a very important step in any family’s life, especially, if the house or the condominium is the first in Canada. Realtor, a specialist who you hire to buy or sell the property, can help with many questions associated with obtaining a home and will also provide a variety of useful and necessary recommendations. I would like to concentrate today on a very important subject, that may often be overlooked during signing of a contract, I am talking about insuring a mortgage.
During purchase of a property there are two types on mortgage insurance exist:
- Mandatory coverage with small down payment;
- Individual insurance of the mortgage at the bank, offered at the time of signing a mortgage contract.
Let’s look at each type of insurance in details.
Mandatory coverage can not be avoided, if the down payment is less than 20% of the purchase price. Today, this rule applies to buyers that are full-time employees and pay income taxes right away and those who work for themselves but after deductions show a good taxable income.
With smaller down payment, no bank will issue a mortgage loan if the desired amount is not insured by one of the three companies – CMHC (Canada Mortgage and Housing Corporation), Genworth Financial Canada or Canada Guarantee. The amount of premium is set and is same for everybody, depending only on the amount of the down payment. With the down payment of 5% the premium is 4% of the mortgage amount, with 10% down payment of the purchase value – 3.1%, start with 15% of down payment and the mandatory insurance premium is 2.8%. All numbers are provided with the assumption of a 25-year amortization period. There were times when the amortization period was longer, even with a smaller down payment, such option is not currently available. Today, the amortization period of over 25 years can only be used if you are purchasing a property with down payment of 20% or more.
The insurance works in the following way: if for some reason the client does not make regular payments to the bank, the bank has the right to sell the house and get the loaned money back. It may happen that the house will sell for lower amount, especially if the time between purchasing a house and sale of the house due to non-payment is very short. For example, house was purchased for $400,000 with 5% down payment and a few months later, for some reason, owner stopped making regular payments on the mortgage. Of course, the bank will sell the house, but have additional costs of a few months of maintenance fees, property taxes and others. On top of that, realtors will have to also be paid for their service (typically 5%). These are all expenses that may result in a loss for the bank and not getting the full loan back. In such situation mortgage insurance is triggered. The difference, not received back by the bank, will be paid out by the insurance company, for example CMHC. It is important to note that such coverage does not cover the family but the bank and can not be refused, no exception, has to be paid, but such insurance allows entry into the market with less assets and win in the end.
The insurance company receives the insurance premiums from the bank at the time of processing the transaction, and the bank adds this amount to the total amount of your loan, as result, the interest is calculated on the whole amount of the loan with insurance. At the time of the sale you pay out to the bank the full owing amount, which includes some of the insurance costs. Yes, this may seem like money in the wind, but without these conditions, you may not be able to enter the real estate market with small down payment.
If the individual is self-employed, owns a business and is not showing good income, almost all banks will request insurance on purchase with down payment less than 35% of the property value. Minimal down payment in a situation where a person does not show necessary amount of income is set at 10% and insurance premiums are higher. With a purchase of 10% of own money insurance company will charge 5.85% of the mortgage amount, with 15% down payment insurance premium will be 3.75% of the mortgage amount, with 20% – 3.3%, with 25% – 2.6%, and with 30% – 1.7% premium. With 35% down payment some institutions will still request insurance coverage but this can be avoided by finding a bank that can offer the loan without the insurance coverage.
The topic of the second insurance appears suddenly, at the time of signing a contract. Manager of the bank at the time of the signing explains:
“If you want to protect your family in case of death or serious illness of either of the spouse, and the remaining balance of the mortgage to be paid, please check this box.” Any rational people that values their close ones do not want to leave any debts to the family in case of death. Yes, protection is necessary, and the presented offer seems to be just that! Correct, but another question is that the discussion is simply about life insurance and a better coverage can be found separately, not with the bank.
Let’s look at examples, why two separate life insurances work better than the bank insurance:
- Beneficiary of the bank insurance – BANK, with individual – THE PERSON YOU CHOSE. This means, in case of death of either of the spouses, having bank coverage, you will not receive any of the funds in cash as all of the money will be sent to the bank to cover the outstanding balance of the mortgage. But often the money is needed today – to pay for the funeral costs (15-20 thousand dollars), to cover other funeral related expenses (9, 40 days; tickets for relatives; for some period to cover the employment income for the second spouse to sort out everything and other), to pay monthly expenses and bills. If a family has no money, it does not matter how much is not enough, there just isn’t any… With life insurance THE WHOLE INSURANCE AMOUNT is paid, with no tax, to beneficiaries, the money can be spent as you want – to pay off the full mortgage amount and live of the rest or keep the money, earn interest and continue with regular mortgage payments. Look at a situation where there is a family with two underage children and both parents die in a car accident (considering insurance involves looking at different scenarios). With bank insurance, there is no money – financial fiasco for the children, all the bills have to be paid. Can you imagine how this will look in practice? After a payout of two individual life insurances, which will be double the payout of the remaining balance, with no taxes, there will be enough resources – the house will be taken care of, help relatives take care of the children, etc.
- Your premiums, even for two individual life insurance will in most cases be less than the cost of one from the bank (depending on type of coverage). Bank coverage includes Life Insurance, Terminal Disability and Dismemberment (description is taken from the TD-Bank prospect, different banks may have some variations). Life Insurance – covers life, Terminal insurance – is not the usual insurance for being sick (income supplement), but the one that comes into effect when the person is so seriously ill that the doctor gives diagnosis of death within one year. Who can say this? Any doctor will try to cure the patient and who knows what the outcome will be? Dismemberment – loss of a body part (has to be two), hearing, speaking, etc. Rarely happens and usually such coverage exists through employment for free. For all these reasons, insuring mortgage through the bank is typically more expensive than Life Insurance.
- You are the owner of insurance contract:
- No one has the right to break the contract, which can be important when transferring the mortgage from one bank to another (with serious illness, insurance on the new mortgage may even be denied);
- You have the right to change the coverage amount at your will: pick temporary, permanent, universal insurance or create a combination of various types of coverage; insure two or more people in one contract; add a coverage for serious illness and with different options; name anyone as beneficiary.
These are the major points why individual life coverage works better for a family than the bank’s. If you already purchased a property, please check your contracts, is there a mortgage insurance or no. Often people do not remember that moment and it is hard to tell by current payments (bank includes the mortgage payment with property tax and insurance in one payment). You have the right to cancel this insurance at the time of signing the contract or after buying a property at any time, but this should only be done if you decide to change this coverage for another. Having no coverage is just not serious.