What Is Mortgage Insurance? Types of Loan Insurance for Homebuyers & Lenders

Posted by Dave Kotler on Tuesday, February 6th, 2018 at 8:08am.

How Mortgage Insurance Works in CanadaWhether it's your first time buying or you are an experienced homeowner, mortgage insurance is an essential factor. There are two main forms of mortgage insurance available in Canada: mortgage default insurance and mortgage protection insurance. The biggest between the two is that the former protects mortgage lenders, and the latter protects borrowers. Keep reading to learn more about each type of insurance, the additional costs they may bring to your homebuying experience, and how to avoid mortgage mistakes.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

Mortgage Default Insurance

Lenders Mortgage Insurance (LMI), also known as mortgage default insurance and private mortgage insurance, is required for Canadian home buyers who do not meet the suggested down payment of 20% on their home purchase. Minimum payment requirements allow buyers to provide a 5%-10% on homes with a purchase price lower than $1 million. Yet there are still buyers unsure of exactly how it works and what it means for their future finances. Are you buying a home with a less than 20% down payment? Here's what you need to know about LMI.

Why Is LMI Required?

LMI protects the lender if the buyer cannot pay their mortgage. In the case of a 20% down payment, the buyer builds up a substantial amount of equity, and the risk is much lower for the lender. Anything less than 20%, and the lender will take out insurance to cover the loan in case of default. In addition, the lender will usually insure the home for more than the buyer paid. This protects them from depreciation, real estate agent's fees, and closing costs.

What It Means for Buyers

The lender will be paying the insurance company for their policy, but they'll be passing down the costs of that policy to the buyer. But LMI is a way to protect the market as much as it protects the lender, so it's not all bad news. LMI halts rising interest rates in their tracks by putting the burden on those most likely to default on their loans.

While this may seem unfair, there are a few benefits that buyers should be aware of. For instance, it won't hurt a buyers' financial status or credit scores to take out LMI, which usually means that interest rates stay relatively comparable to buyers who could put down 20%. Plus, buyers stop paying for LMI entirely when they achieve 20% equity from their mortgage payments. 

How Much Are Mortgage Loan Insurance Premiums?

LMI can be anywhere from 2.8–4% of the borrowed amount of the home, with the payments typically tacked onto the monthly mortgage payments. The total amount paid will be based on the lender used, so it's essential to research their rates and processes before choosing one. Some lenders may make it difficult or cumbersome to cancel LMI.

LMI is not available for homes worth a million or more, nor for mortgages that last more than 25 years. In the case of a home sale worth between $500,000 and $999,999, buyers will be expected to put down at least 5% of the first $500,000 and then at least 10% on the remaining amount. So in the case of a $550,000 home, buyers would need to have $25,000 for the first half of a million and $5,000 for the remaining $50,000 (for a total of $30,000 as a down payment.)

Taking advantage of LMI is often the only way buyers can afford the home they want, but mortgage insurance premiums do add up over time. If you're set on the home of your dreams, the best advice is to put as much money as possible toward the mortgage until you can comfortably get out from under the LMI payments.

Mortgage Protection Insurance

Mortgage protection insurance is a type of policy that provides coverage in the event that the homeowner is no longer able to pay. After you apply for the policy, if you are unable to make your mortgage payments as determined by the provider's terms, then the benefit amount will be paid toward your balance and will help you get on track after late mortgage payments.

This coverage is especially helpful if unforeseen events such as death or disability suddenly arise, as they can cause major financial strain. By investing in mortgage protection insurance beforehand, homeowners can avoid the burden of an unpaid mortgage during difficult times and take comfort in knowing that their family will be taken care of.

These private mortgage insurance premiums are unlikely to adjust as you pay off your mortgage and increase equity. This means the programs have better value at the beginning of your loan term than at the end. Since this one of Canda's optional mortgage insurance products, it may not be necessary for all buyers.

Mortgage Default Insurance vs. Mortgage Protection Insurance

In Canada, there are two types of mortgage insurance: mortgage default insurance and mortgage protection insurance. Mortgage default insurance is a type of insurance that protects the lender in case the borrower defaults on their mortgage payments. Mortgage protection insurance is a type of insurance that protects the borrower in case they lose their job or become disabled and can no longer make their mortgage payments. Both have their own advantages and disadvantages, so it's important to understand home insurance basics before deciding which one is applicable to you.

For informational purposes only. Always consult with a licensed mortgage or home loan professional before proceeding with any real estate transaction.

Dave Kotler

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