With costs rising, it’s more important than ever to make sure your money is well spent. For most people, when they purchase a home and take on a mortgage, they are offered coverage through the bank to ensure that their mortgage is covered for their loved ones in case they pass away. What most people don’t know is that you can actually get coverage with us that is much more robust and can save you a lot of money!
Whether you are a first-time homebuyer that is trying to get into the housing market or someone that is a more seasoned homeowner, it is important to be aware of the options out there for you when it comes to your finances and coverage.
Below you’ll find out more about the risks of mortgage insurance along with a comparison to life insurance:
What is Mortgage Insurance?
When you are in the market to buy a new home, the process can seem overwhelming, especially for first-time homeowners. There are many factors to consider when purchasing a home, including obtaining a mortgage to support your purchase.
Mortgage insurance is an insurance policy that helps protect the mortgage lender from defaulted payments by the homeowner. If the mortgage holder were to pass away or was somehow unable to meet their financial obligation to make their mortgage payment, mortgage insurance would fulfill that obligation. Mortgage insurance is traditionally broken down into three different types: Private mortgage insurance, mortgage title insurance, and qualified mortgage insurance premium.
While these three types differ in detail, they all essentially cover the same endgame obligation of protecting the mortgage lender. There is also a fourth type – Mortgage Life Insurance – which, just like typical life insurance policies, focuses its protection not on the mortgage lender but instead on the borrower’s heirs. Suppose the mortgage borrower passes away while owing mortgage payments. In that case, it can offer financial security to the borrower’s family members who, depending on the policy terms, possibly will not be held responsible for the unfulfilled payments.
What Risks are Involved in Private Mortgage Insurance?
Ideally, when shopping for a new home, you should have roughly a 20% down payment saved up before applying for a mortgage. However, it is more than expected for potential homeowners not to have such a hefty savings account readily available. If the prospective mortgage recipient does not have their 20% down payment, the lender will likely insist that the applicant have private mortgage insurance before they approve the mortgage.
While private mortgage insurance sounds like an ideal way to buy a new home without having to save as much money upfront, mortgage insurance comes with its fair share of risks.
1. The Cost of Mortgage Insurance Can Be Steep
A private mortgage insurance policy typically costs between 0.5% to 1% of the entire loan amount. That price tag is annual, so that means that the homeowner could be paying more than $85 per month on mortgage insurance. However, according to 2020 statistics, the average mortgage cost in Hamilton is over $300,000. That means that a 1% mortgage insurance payment could be more than $3,000 a year. While Canadian mortgage debt stabilized in 2019, the cost quickly accelerated during the 2020 pandemic, directly linked to higher mortgage insurance payments.
2. Mortgage Insurance May Not Be Tax-Deductible
In the early days of mortgage insurance, Canada did not consider the payments tax-deductible. However, in 2007 Canadian Congress passed a bill that made mortgage insurance payments tax deductible up to a possible 100%. That 100% tax deduction was only available to Canadian homeowners whose household income was under $100,000 a year.
Partial payments could be tax deductible if the household earned more than $100,000 but less than $109,000 annually. The deduction amount, if eligible, depended upon the premiums payable on the insurance, which can depend on the amount borrowed for the mortgage itself.
3. Your Heirs Could Be Left With Nothing
It is common for new homeowners to hear the word “insurance” and assume that their loved ones would receive some form of financial compensation if they were to pass away suddenly. However, this is not typically the case with the majority of mortgage insurance policies. Unless your mortgage insurance is a mortgage life insurance policy, the lender is the sole recipient of any mortgage insurance payout.
If the homeowner wants to aid their living loved ones after they pass financially, they will need to purchase an additional insurance policy, such as life insurance, that offers payments to their heirs. It is always safe to assume that your private mortgage insurance will only benefit your mortgage lender.
4. You Are Likely Just Giving Money Away
If a homeowner cannot afford the 20% down payment for their new home, a private mortgage insurance policy may be their only option to obtain their approved mortgage application. If a mortgage insurance payment is necessary for approval, they will need to pay their PMI premium until they achieve 20% equity in their home. However, achieving this amount of equity can take years, and during this time, the homeowner is paying money that does not benefit them.
To put this into perspective, a family that carries a mortgage of $250,000 could pay $200 a month into a mutual fund instead of a PMI and could earn nearly $29,000 with a 4% rate of return over 10 years.
5. Policies Are Difficult to Cancel
As previously stated, a homeowner would no longer need a mortgage insurance policy once they have earned 20% equity in their home. However, this does not mean that the policy is easy to cancel. The majority of lenders require a homeowner to draft a letter requesting the elimination of their mortgage insurance policy. The letter is usually met with the requirement of a formal house appraisal before approved policy cancellation. This process can take months, and during that time, you are still expected to pay your monthly mortgage insurance payments.
6. Payments may be Mandatory for a Long Time
In some instances, a lender may require the homeowner to pay into their mortgage insurance for a designated time. This means that payments may be needed to continue even after the 20% equity requirement is met.
Final Thoughts
Unless you can save 20% of the down payment, homeowners may be left with no option other than opting into a mortgage insurance policy. Mortgage insurance policies are costly and the only benefit the lender should the borrower default on their payments. A mortgage insurance policy does not protect the policyholder’s loved ones should they pass away, unlike a life insurance policy. If a mortgage insurance policy can be avoided, it should be.
How do I Learn More?
To learn more about the risks of mortgage insurance and the benefits of life insurance, contact the experts at Hometown Insurance at 289-606-0103. Our licensed professionals will answer any questions you may have.
Sources
- https://financialpost.com/news/economy/average-new-mortgage-tops-300000-for-first-time-as-consumer-debt-in-canada-hits-2-trillion
- https://www.canadainsuranceplan.ca/blog/insurance-blog/is-mortgage-insurance-tax-deductible/
- https://www.cmhc-schl.gc.ca/en/media-newsroom/news-releases/2020/cmhc-releases-residential-mortgage-industry-report
