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Insuring your mortgage provides peace of mind

For most people, the biggest purchase they'll ever make is a home. And chances are, much of that purchase will be financed by a mortgage.

While people are quick to insure hard assets like homes and cars, less attention is paid to insuring debt. But think about it: if you lost a car and were not insured, you could probably survive.

But if you became disabled or died, who would make your mortgage payments? Would your estate have enough assets to discharge the mortgage? Or, would your prized possession have to be sold to pay off the bank? And where would your family live then?

Insuring your mortgage is "absolutely crucial," says Don Blair, a mortgage broker at MortgageTech Corporation, in Newmarket, Ont. "Your single biggest purchase in life in your house. The thought of leaving that unprotected to save a few dollars a month in insurance payments is incredible."

Yet, people do it, he says, noting that about 50 percent of his clients reject his recommendation to speak to an independent insurance broker.

There are different ways homeowners can insure their mortgage. Most banks entice customers to sign on for mortgage insurance when they take out a mortgage to protect the bank against loss if the borrower defaults. The premium is based on the amount you borrow.

When mortgages must be insured - high-ratio mortgages require lender insurance

According to the Canada Mortgage and Housing Corporation, the federal agency responsible for affordable housing, certain mortgages must be insured to protect the lender. These are known as high-ratio mortgages. Mortgages with a loan-to-value ratio higher than 75 percent must be insured. What a high-ratio mortgage does is allow buyers with less than a 25 percent down payment to get into the housing game by mandating the mortgage be insured through either CMHC or GE Mortgage Insurance Canada Capital.

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But high-ratio mortgages are expensive, adding thousands of dollars to your mortgage. For example, if you only have 5 percent to put down, you will pay 3.25% of the mortgage value as a premium for the insurance, says Blair.

That means a buyer with $15,000 for a down payment on a $300,000 home will tack on $9,262.50 to their $285,000 mortgage. "It adds up in a hurry," he says.

However, that insurance only protects the lender in the event of default. It does not protect home buyers in the event of death or disability.

When mortgage insurance is voluntary - conventional mortgages and creditor insurance

Cathy Honor, senior vice president and head of creditor insurance at RBC Financial Group in Toronto, describes mortgage insurance as "creditor insurance." Her bank offers buyers a HomeProtector Insurance plan that protects against death and disability.

"More than half of mortgage defaults are due to a disability," largely stemming from accidents or illness, says Honor. The monthly premiums work out to about 12 to 17 cents for every $1,000 of mortgage covered.

However, the way the insurance works, the buyer pays a set fee over the life of the mortgage. So, while you might have a $185,000 mortgage today and pay $23 a month, you will still be paying $23 a month years from now when the amount you owe is much less.

However, Honor says the upside is the premium is stable throughout the life of the mortgage, so it's easy to budget for. It can also be canceled at any time.

"It's convenient with reasonable rates, [and] you don't have to go through the underwriting process. Most of it is immediate," she says. As well, it covers both spouses and can include death and disability. "To me what mortgage insurance is, is peace of mind.".

However, Blair says bank insurance can be expensive, and he encourages clients to get competing quotes for term life insurance from an insurance broker.

A term life policy may be a cheaper alternative to pricier bank mortgage insurance

He says his experience arranging mortgages in the Toronto area, one of the country's pricier housing markets, is that bank insurance averages about $40 a month for a year's worth of payments. He says homeowners can get a 10- or 20-year term life policy that covers the mortgage and then some for the same annual premium.

The advantage to a term policy, he says, is that if you die during the policy, it pays your beneficiary the full amount. So if you have a $250,000 mortgage and buy a term policy for that amount and die five years later, your beneficiary receives $250,000, letting him or her retire the mortgage and keep any additional funds.

A bank policy, on the other hand, only covers the current balance owing on the mortgage

If you opt for term insurance, Blair says you want to ensure it pays out in the event one spouse dies and that it isn't a last-to-die policy. If it is, the cost of carrying the home in addition to other expenses could cripple the surviving spouse.

You might also be able to leverage existing insurance more cheaply. For example, if your employer has a group life policy, you may be able to increase the amount of coverage to include your mortgage for only a few dollars a month.

However, Honor, whose firm also sells life insurance, says "we don't see it as one or the other. We believe a good financial plan covers both."

The problem with term plans, she says, is that most mortgages are amortized over 25 years, well beyond the length of a 10-year term. That means the homeowner is renewing at a higher rate in the middle of the mortgage. As well, a separate policy is needed to cover disability and it can be expensive.

Also, if homeowners depend on their work disability and life insurance policies, they could find themselves out in the cold.

"The biggest fallacy is relying on group insurance plans. They can be gone in a heartbeat," she says. All it takes is a bankruptcy, company merger or job loss.

Jim Middlemiss is a freelance writer and lawyer based in Toronto, Ontario. He's a frequent contributor to National Post, Investment Executive and Wall Street and Technology.

-- Posted: Sept. 20, 2004
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