Mortgage Insurance

What is mortgage insurance and how does it work?

Mortgage insurance is a financial product designed to protect lenders in the event that a borrower defaults on their mortgage loan. It serves as a risk mitigation tool, allowing lenders to extend financing to borrowers who may not meet the conventional down payment requirements.

In Canada, mortgage insurance is typically required for homebuyers who have a down payment of less than 20% of the purchase price of the property. This type of insurance is provided by mortgage insurance providers, such as the Canada Mortgage and Housing Corporation (CMHC), Genworth Canada, and Canada Guaranty Mortgage Insurance Company.

Here’s how mortgage insurance works:

1. Lender Protection: When a borrower obtains a mortgage with less than a 20% down payment, the lender requires mortgage insurance to protect their investment. In the event of default, the insurance provider reimburses the lender for a portion of the outstanding loan balance, reducing the lender’s financial risk.

2. Borrower Responsibility: Although mortgage insurance protects the lender, it’s the borrower who pays for it. The cost of mortgage insurance is typically added to the borrower’s mortgage payments or paid as a lump sum upfront. The insurance premiums are calculated based on the loan amount, down payment size, and other factors.

3. Coverage Limits: Mortgage insurance doesn’t cover the entire loan amount. Instead, it typically covers a percentage of the loan, such as 15% or 25%, depending on the insurance provider and the specific terms of the policy. This coverage provides a buffer for the lender in case of default, but it’s not a guarantee against losses.

4. Risk Assessment: Before approving mortgage insurance, the insurance provider assesses the borrower’s creditworthiness and the property’s value. This helps determine the level of risk associated with the loan and the appropriate premium to charge. Borrowers with lower credit scores or higher debt-to-income ratios may face higher insurance premiums.

5. Policy Duration: Mortgage insurance policies have a finite term, typically spanning the first few years of the mortgage. Once the borrower’s equity in the property reaches 20% or more (either through principal payments or appreciation), the mortgage insurance may no longer be required, depending on the lender’s policies and the type of mortgage.

Overall, mortgage insurance plays a vital role in facilitating homeownership by reducing the barriers to entry for borrowers with limited down payment savings. It provides lenders with the confidence to extend financing to a broader range of homebuyers while offering borrowers the opportunity to achieve their homeownership goals with less upfront capital.

Types of mortgage insurance

In Canada, there are primarily two types of mortgage insurance: government-backed mortgage insurance and private mortgage insurance. Let’s delve into each:

1. Government-Backed Mortgage Insurance:

   • Canada Mortgage and Housing Corporation (CMHC): As a crown corporation, CMHC is the most well-known provider of government-backed mortgage insurance in Canada. It operates under the authority of the federal government and plays a significant role in facilitating access to housing finance for Canadians. CMHC-insured mortgages are commonly referred to as “CMHC mortgages.”
   • Genworth Canada: Genworth Canada is another major provider of government-backed mortgage insurance in Canada. It is a private company that operates independently but is regulated by federal and provincial governments. Genworth-insured mortgages are often referred to as “Genworth mortgages.”
   • Canada Guaranty Mortgage Insurance Company: Canada Guaranty is a private mortgage insurance provider that offers government-backed mortgage insurance similar to CMHC and Genworth. It is also regulated by federal and provincial authorities. Mortgages insured by Canada Guaranty are known as “Canada Guaranty mortgages.”

2. Private Mortgage Insurance (PMI):

   • In addition to government-backed mortgage insurance, some borrowers may have the option to obtain private mortgage insurance through financial institutions or private insurers. Private mortgage insurance functions similarly to government-backed insurance but is not backed by the government.
   • Private mortgage insurance may be required for conventional mortgages with a down payment of less than 20% of the purchase price. It serves the same purpose as government-backed insurance, protecting lenders against borrower default and facilitating access to financing for homebuyers with limited down payment savings.

Both government-backed and private mortgage insurance provide lenders with a layer of protection in the event of borrower default, enabling them to offer mortgage financing to a broader range of homebuyers. While government-backed insurance is more common and often required for high-ratio mortgages with down payments below 20%, private mortgage insurance may offer additional flexibility for borrowers who do not meet the criteria for government-backed insurance or prefer to work with private insurers. Understanding the differences between these types of mortgage insurance is essential for borrowers navigating the Canadian housing market and selecting the most suitable financing options for their needs.

How long do you need to pay mortgage insurance?

The duration for which you need to pay mortgage insurance depends on several factors, including the type of mortgage insurance, the size of your down payment, and the terms of your mortgage agreement. Here’s a breakdown of the typical scenarios:

1. High-Ratio Mortgages (Down Payment Less Than 20%):

   • For borrowers who make a down payment of less than 20% of the purchase price of the property, mortgage insurance is usually required. This type of mortgage is often referred to as a high-ratio mortgage.
   • If you have a high-ratio mortgage with government-backed mortgage insurance from providers like CMHC, Genworth Canada, or Canada Guaranty, the insurance premiums are typically added to your mortgage payments.
   • The duration of mortgage insurance payments for high-ratio mortgages varies but is typically required until the loan-to-value (LTV) ratio reaches 80%.
   • Once your equity in the property reaches 20% or more (either through principal payments or appreciation), you may no longer need to pay mortgage insurance, subject to the terms of your mortgage agreement and the policies of your mortgage insurer.

2. Conventional Mortgages (Down Payment 20% or More):

   • If you make a down payment of 20% or more of the purchase price of the property, mortgage insurance is generally not required. These mortgages are known as conventional mortgages.
   • However, some borrowers with conventional mortgages may still choose to obtain private mortgage insurance (PMI) from private insurers or financial institutions, particularly if they prefer to make a smaller down payment or have lower credit scores.
   • The duration of PMI payments for conventional mortgages varies depending on the terms of the mortgage insurance policy and the lender’s requirements. Some lenders may allow borrowers to cancel PMI once they reach a certain level of equity in the property, while others may require PMI for the full term of the loan.

In summary, the duration of mortgage insurance payments depends on whether you have a high-ratio mortgage or a conventional mortgage, as well as the specific terms of your mortgage agreement and insurance policy. It’s essential to review your mortgage documents and consult with your lender or mortgage insurer to understand how long you’ll need to pay mortgage insurance and any options for canceling or adjusting your coverage over time.

Can you avoid paying mortgage insurance?

In Canada, mortgage insurance is typically required for homebuyers who make a down payment of less than 20% of the purchase price of the property. However, there are several strategies you can consider to potentially avoid paying mortgage insurance:

1. Make a Larger Down Payment: The most straightforward way to avoid mortgage insurance is to make a down payment of 20% or more of the purchase price of the property. With a down payment of 20% or higher, you can secure a conventional mortgage, which generally does not require mortgage insurance.

2. Explore Lender-Sponsored Programs: Some lenders offer programs or incentives that allow borrowers to avoid mortgage insurance, even with a down payment of less than 20%. These programs may have specific eligibility criteria and requirements, so it’s essential to inquire with your lender about any available options.

3. Consider Piggyback Mortgages: A piggyback mortgage, also known as a combination loan or second mortgage, involves taking out two separate loans to finance the purchase of a home. The first loan covers 80% of the purchase price (thus avoiding mortgage insurance), while the second loan covers the remaining portion. While this strategy may allow you to avoid mortgage insurance, it’s important to carefully consider the terms and implications of both loans.

4. Build Equity Quickly: If you initially obtain a high-ratio mortgage with mortgage insurance, you can work to build equity in the property as quickly as possible. Making extra principal payments, increasing your monthly mortgage payments, or taking advantage of home price appreciation can help you reach the 20% equity threshold sooner. Once your equity reaches 20% or more, you may be eligible to request the cancellation of mortgage insurance.

5. Refinance your Mortgage: If you have already purchased a home with mortgage insurance, you may have the option to refinance your mortgage once you have built sufficient equity in the property. Refinancing to a new loan with a lower loan-to-value (LTV) ratio may allow you to remove the requirement for mortgage insurance.

It’s important to note that the specific options available to you for avoiding mortgage insurance may vary depending on factors such as your financial situation, credit history, and the policies of your lender or mortgage insurer. Be sure to consult with a qualified mortgage advisor or financial professional to explore the best strategy for your individual circumstances.

FAQs about mortgage insurance