Understanding mortgage insurance

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When it comes to home loans, there's plenty of talk about mortgage rates, but far less about mortgage insurance. While not as exciting as fluctuating interest points, mortgage insurance is still a vital part of the homebuying process for most Canadians. It's with this in mind that prospective homeowners should do all they can to understand what mortgage insurance is and how it works.

What is mortgage insurance?
Typically, if a homebuyer takes out a mortgage loan with less than a 20 percent down payment, mortgage insurance is required. This insurance protects lenders in case a borrower is incapable of making mortgage payments and defaults on a loan. It's important to remember that this coverage is only for lenders, not homeowners. In most cases, if a homebuyer is able to pay a minimum of 20 percent on a down payment, mortgage insurance is not required.

How much mortgage insurance is necessary?
The amount of mortgage insurance required varies on the size of a homebuyer's down payment. The more money put down, the less mortgage insurance needed. This also affects the price of mortgage insurance premiums. The higher the down payment, the less the premiums will cost.

Amortization rates also affect pricing. Longer amortization rates will typically result in more expensive insurance premiums.

How does a buyer qualify for mortgage insurance?
Since mortgage insurance is necessary for buyers who pay less than 20 percent on a down payment, it's important to make sure they qualify for it. In order to qualify for mortgage insurance, a borrower must typically have a down payment of at least 5 percent of the purchase price of a single-family or two-unit property. However, three- and four-unit properties generally require down payments of at least 10 percent.

Total monthly housing costs, which include principal, interest, property taxes and heating, should not exceed more than 32 percent of gross household income. Meanwhile, a homebuyer's total debt load should not exceed more than 40 percent of gross household income.

Of course, the property must also be located within Canada.

Different mortgage insurance options
While mortgage loan insurance concerns protection for lenders in the case of a default, other types of insurance exist relating to home loans.

Mortgage life insurance offers coverage in the form of monetary compensation to lenders in the event of a homebuyer's death. This type of insurance will protect dependents and spouses from taking on the burden of mortgage payments in the event of a homebuyer's death, allowing them to stay in a home instead of having it repossessed by a mortgage lender in an attempt to pay off a loan.

Meanwhile, mortgage disability insurance offers coverage in the form of mortgage payments if a homebuyer is injured or ill and cannot work.

How to avoid purchasing mortgage insurance
The most straightforward way to avoid the costs of mortgage insurance is to make a minimum 20 percent down payment. Not only will this do away with the need for mortgage insurance, but it will reduce the amount of interest paid in the long run since more of the loan's principal has been paid off.

Another option is to take out two home loans instead of one. While the interest rate on the second loan may result in greater costs over the long run, the combination of the two loans can do away with the need for mortgage insurance and save homebuyers money upfront.

It's also important to keep an eye on the value of a property. Once a homebuyer's loan-to-value ratio dips below a certain amount, they can cancel their mortgage insurance policy.

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