Once you begin shopping for a mortgage rates and comparing fees and terms for the different loan programs available to you, you will inevitably stumble upon the term "mortgage default insurance." This is a common expense that many mortgage applicants will be required to pay for at the time of closing. While the thought of paying an additional expense may seem unpleasant, this type of insurance can benefit the borrower in a number of ways. By understanding more about what mortgage default insurance is and how it works, you may discover that this is a type of insurance that could help you to achieve your financial goals regarding a home purchase in Canada.
What is Mortgage Default Insurance?
In Canada, mortgage default insurance is normally required when a homebuyer offers a down payment of less than 20 per cent of the price of the home. It may also be required in other situations where the lender's risk associated with extending the loan is higher. For example, if you are self-employed or are buying a rental home as an investment, you may be applying for a loan that is riskier for a lender to extend to you. When a borrower defaults on a loan, the lender ultimately may suffer financially. As such, mortgage default insurance protects lenders against default by a borrower.
How Lenders Benefit
It should be noted that the premium expense that you pay at closing for mortgage default insurance is not to profit the lender. This is a fee that is paid directly to the insurance provider, which is usually either Genworth Financial Canada or Canada Mortgage and Housing Corporation (CMHC). Lenders benefit from selling this insurance only if the borrower defaults on the loan, because the insurance can provide lenders with some financial reimbursement for losses they suffer if a borrower defaults.
The Benefit to Borrowers
Mortgage default insurance is generally required for all loans where the borrower places less than 20 per cent down on the purchase. As a result, this type of insurance normally allows you to qualify for a higher loan amount than otherwise would be available to you. For borrowers who do not want to spend additional time saving up a larger down payment amount, this type of insurance can be a true benefit. In fact, as long as the loan is taken out to pay for a primary residence, the borrower may qualify for a home with as little as five per cent down.
In addition, while a lender may still charge a higher rate for borrowers in "high risk" situations, the rate may not be as high as it otherwise would without the mortgage default insurance in place.
How is Mortgage Default Insurance Calculated?
If you are thinking about applying for a loan with mortgage default insurance in place, you may be wondering how much the insurance will cost you. The cost of mortgage default insurance will vary based on a number of factors, including the loan amount, the loan-to-value ratio, employment status of the borrower, what the property value is, and what the amortization period is. Each of these factors will affect the risk that you may default on your mortgage, and the riskier your loan request is, the more likely you may be to default-and the higher your insurance cost may be.
If you want to know exactly how much your insurance will cost, you can speak with your loan representative.
Is It Right For You?
When you are ready to apply for a loan request, it is important to carefully consider how mortgage default insurance will affect your specific loan. You should be aware of the different thresholds regarding premium increases for factors like loan-to-value, loan amount and more. If you are very close to one of the thresholds, it may be more cost-effective for you to adjust your loan terms slightly. By increasing your down payment, for example, you may eliminate the need for mortgage default insurance or may qualify for a reduced rate.
If you are thinking about applying for a mortgage in the near future, take the time to learn more about mortgage default insurance. Be sure to ask your loan representative for further information and clarification about your options, and inquire about different steps that you can take to decrease the cost associated with mortgage default insurance.
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