The Difference between Mortgage Life Insurance and Life Insurance

We're getting closer to that light at the end of this INSURANCE tunnel!  We are now down to learning about the last two types of INSURANCE that you may encounter when dealing with mortgages: MORTGAGE LIFE INSURANCE AND LIFE INSURANCE.

Both MORTGAGE LIFE INSURANCE AND LIFE INSURANCE insure others if something ever happens to you.  Because of the similarity between the names, these two types of insurance are very often confused with one another.  Again, DO NOT get these confused with MORTGAGE DEFAULT INSURANCE. 

The general idea behind both Mortgage Life Insurance and Life Insurance is that you pay a certain amount of money per month and, if you die, your loved ones will receive a lump sum of money.  I am not going to profess to know a lot about these different types of insurance as it is not my area of expertise.  It is best to speak with a professional to go over your options to suit your insurance needs.  I will, however, explain the general differences.

MORTGAGE LIFE INSURANCE, or MORTGAGE INSURANCE, or MORTGAGE PROTECTION INSURANCE, or MORTGAGE PROTECTION PLAN, is generally offered to home-owners by the bank and protects others for the life of your mortgage.  When you sign the mortgage papers to commit to your mortgage, your mortgage broker or bank will include a document offering you the opportunity to buy Mortgage Life Insurance.  The premiums (the amount you pay per month) vary depending on the size of your mortgage and your age.  If you die and you still owe money to the bank for your mortgage, the policy will pay out the remaining balance of your mortgage.  One of the biggest selling points for Mortgage Life Insurance is that your premiums will always remain the same, regardless of how old you are.  However, keep in mind that as you make your mortgage payments, your mortgage balance declines but you will still be paying the same premium amount.

LIFE INSURANCE is offered by Insurance Brokers, Insurance Advisors/Professionals, and Financial Planners.  You can obtain this type of insurance at any time, though it is recommended that you do it close to when you obtain your mortgage so that the value of your property and debt is secure.  Life Insurance can be structured so that, in the event of your death, your loved ones can benefit from more than just having the balance of your mortgage paid off (ie. You can set your coverage to whatever dollar amount you choose).  There are many different options for Life Insurance - for example, there are term insurance policies and permanent insurance policies, and each one can be tailored according to your needs.  In this respect, Life Insurance offers much more flexibility than Mortgage Life Insurance.

Again, I am by no means an expert on Mortgage Life Insurance or Life Insurance – I just wish to explain the general differences between the two since their names are so similar and thus so confusing.  As a general rule of thumb, remember:

Mortgage Life Insurance = offered by the bank and mortgage professionals

Life Insurance = offered by insurance professionals

I believe that it is important for home-owners to have some sort of coverage so that your loved ones will receive benefits in the event of your death.  Your home is your biggest asset and it is always best to be prepared.

If you would like to learn more about your insurance options, I highly recommend that you do a bit of research beforehand (there are many different sites that weigh the pros and cons of each).  I would like to remain impartial in this blog, as my writing is solely for educational purposes.  Speak with a professional in the mortgage industry and/or a professional in the insurance industry to explore your options.  However, keep in mind that professionals in the mortgage industry will benefit from selling you Mortgage Life Insurance and professionals from the insurance industry will benefit from selling you Life Insurance.

INSURANCE “Half-way there” Recap

Are you still with me?  I know…all this talk about insurance is extremely confusing and there are so many different types!  If you’re still confused, rest assured – you’re not alone.  I will do a full recap of all the types of insurance we’ve discussed in an upcoming post.  In the meantime, please try to keep going and please feel free to post any questions under the comments section!  We’re almost done with INSURANCE.  Here is a quick review of the different types of Insurance that we have learned about so far:

MORTGAGE DEFAULT INSURANCE

·         Mandatory for High-Ratio Mortgages

·         Protects the lender if you ever miss payments

·         Cost is added to your mortgage loan amount and, thus, into your mortgage payments

·         CMHC, Genworth, and Canada Guaranty

TITLE INSURANCE

·         Nowadays, often Mandatory for all types of mortgages (depending on the lender)

·         Protects the lender (and you, a bit) from any defects in title

·         Cost is paid for by you at the lawyer/notary public’s office on completion of your house purchase

HOME INSURANCE

·         Fire Insurance is Mandatory for all mortgages

·         Protects the lender and you if anything ever happens to your house (i.e. It goes up in flames)

·         Cost is paid for by you and can be paid monthly

CONTENTS INSURANCE

·         NOT mandatory but is highly recommended

·         Protects you if anything ever happens to the contents of your house

·         Cost is paid for by you and can be paid monthly with the rest of your Home Insurance payment

Home Insurance and Contents Insurance

So far, you have learned about two different types of insurance: Mortgage Default Insurance and Title Insurance.  Aside from Mortgage Default Insurance and Title Insurance, there are also other types of insurance that are available for home-owners to protect you if something should ever happen to you or your house.  DO NOT get these types of insurance confused with Mortgage Default Insurance.

To ensure that you understand the different types of insurance and do not get them all confused, I am going to briefly explain the other four main types that you will likely encounter during your home-buying process:

·         HOME INSURANCE and CONTENTS INSURANCE

·         MORTGAGE LIFE INSURANCE (or Mortgage Protection Insurance) and LIFE INSURANCE

I will explain MORTGAGE LIFE INSURANCE and LIFE INSURANCE in my next blog entry.

HOME INSURANCE, sometimes called Homeowners Insurance, insures you and the lender if something ever happens to your property.  Home Insurance is a requirement of the bank when you get a mortgage.  There are many different facets to Home Insurance and you can pick and choose what kind of coverage you would like to get for the house.  However, you must obtain fire insurance payable to your lender for all mortgages (for the full replacement cost).  The reason for this requirement is because the bank wants to know that if your house goes up in flames, the property will still be covered and they will be able to recover the money they have lent to you.  Home Insurance can be obtained from a number of companies across Canada, including BCAA (in BC) and Canadian Direct Insurance.  Home Insurance is paid for by you and is usually paid on a monthly  basis.

CONTENTS INSURANCE can be added to a standard Home Insurance plan and I highly recommend this to all home-owners.  However, this is just a recommendation and Contents Insurance is not mandatory.  Getting insurance coverage for your contents (anything that is not attached to the house, such as televisions, computers, jewellery, etc) will provide you with peace-of-mind in case anything ever happens to your house.

Remember:  Home/Fire Insurance is mandatory when obtaining a mortgage and Contents Insurance is recommended.  The above information is a very general overview of Home Insurance and Contents Insurance and you should contact a Home Insurance provider for more detailed information on your options and for rates.

What is Title Insurance?

Nowadays, TITLE INSURANCE is required by many lenders when you obtain a mortgage.  When you buy a house, your ownership is registered in the Land Title Office and your name is put onto the property’s Certificate of Title.  The lender’s name is also put on title as a mortgage holder. 

Title Insurance protects the lender and you against any losses that may occur relating to your property’s title (ie. Your ownership of the property).  Title Insurance is paid for upon the completion of your purchase (at your lawyer’s or notary public’s office) and generally costs around $200-$300. 

To make things simple, here’s a quick list of what Title Insurance may cover:

·         Title defects (ie. Any issues with title that keep you from having clear ownership of the property, such as liens, charges, etc.)

·         Title fraud, forgery, or duress

·         Errors in survey certificates

·         Any other title-related issues that may hinder your ability to sell, mortgage, or lease your property in the future

Again, not all lenders require Title Insurance but it is good to know that you may be required to pay for it when you buy a house.

The Three Mortgage Default Insurers

In Canada, there are 3 entities that offer Mortgage Default Insurance:

1.      Canada Mortgage and Housing Corporation (CMHC)

2.      Genworth Financial

3.      Canada Guaranty (formerly AIG)

The cost for all of them is the same.  However, they all have slightly different guidelines, depending on what kind of high-ratio mortgage you are obtaining (a few examples: primary residence, rental, refinance, business for self, new immigrant, etc.).  This brings me to an important note:  When you apply for a High-Ratio Mortgage, you must first meet the guidelines set out by the Mortgage Default Insurers.  Only after you have been approved for Mortgage Default Insurance can you move onto the next step, which is to meet the guidelines of the bank.  Banks generally follow the guidelines set out by the Mortgage Default Insurers, although they all offer different mortgage products.  Thus, if you are applying for a High-Ratio Mortgage, the most important thing is for you to do is to qualify for Mortgage Default Insurance.

Guidelines for Mortgage Default Insurance include things such as the maximum amount of money you are able to borrow (determined through what is called a Loan to Value Ratio), the minimum down-payment required, minimum credit scores, and the maximum amount of other debts permitted.

Typically, you do not have to choose which Mortgage Default Insurer to use – your mortgage broker and bank will usually do this for you.  This is because many mortgage brokers, banks and/or underwriters have their own preference of which Mortgage Default Insurer they like to work with, usually due to existing relationships and/or similar rules.

What is Mortgage DEFAULT Insurance and why is it mandatory?

 (CMHC, Genworth, and Canada Guaranty explained)

The subject of mortgage insurance is one of the most common areas of confusion when it comes to mortgages.  It is important for you to know that there are many different types of insurance that are associated with the word “mortgage”.  I’m going to make it very easy for you by explaining the main type of insurance that you need to be aware of – and I am going to call it MORTGAGE DEFAULT INSURANCE.

Mortgage Default Insurance is mandatory if you are getting a HIGH-RATIO MORTGAGE.  Remember, a high-ratio mortgage is a mortgage where you put less than 20% down as a down payment. 

There are many other names for Mortgage Default Insurance – some other common names for it are:

·         Mortgage Lender Insurance

·         Mortgage Loan Insurance

·         Mortgage Insurance

I feel that these terms are too general and they are very often confused with other types of insurance, like mortgage protection insurance and life insurance (I will explain more on these later but do not confuse them with Mortgage Default Insurance).  If you stick with the term MORTGAGE DEFAULT INSURANCE, you should be okay.  Just remember that anytime you hear names like CMHC, Genworth, or Canada Guaranty, you are dealing with the subject of Mortgage Default Insurance.

So why is it mandatory?  Mortgage Default Insurance is not to protect you.  Basically, Mortgage Default Insurance protects the bank if you miss one or more payments.  Missing a payment is called “defaulting”, hence why I like to call it Mortgage Default Insurance.  The bank covers its butt by obtaining mortgage default insurance whenever they lend for a high-ratio mortgage - and then they pass these costs onto you.

How much does it cost?  Premiums for Mortgage Default Insurance vary.  Here’s an example: If you are putting 5% down and you would like a 35 year amortization, the premium is 3.15%.  This means that if the house you want to buy is $500,000, you would subtract the 5% down payment ($25,000) and multiply this number by 3.15% to find out how much you will have to pay for your Mortgage Default Insurance.

$500,000

-$25,000

x 0.0315 (or 3.15%)

$14,962.50

It is important to note that you do not have to pay for your Mortgage Default Insurance immediately/up front.  It can be added to your total loan amount and, thus, into your payments so that you do not really notice the extra amount.  In other words, for a $500,000 house with 5% down, your total loan amount will be $489,962.50. 

$500,000

-$25,000

=$475,000

+$14,962.50

$489,962.50 is your total loan amount

What is Amortization?

AMORTIZATION is the act of amortizing.  According to the Merriam-Webster dictionary, this is the definition of the verb amortize:

am·or·tize

verb \ˈa-mər-ˌtīz also ə-ˈmȯr-\

am·or·tizedam·or·tiz·ing

Definition of AMORTIZE

transitive verb

1

: to pay off (as a mortgage) gradually usually by periodic payments of principal and interest or by payments to a sinking fund

In other words, the term AMORTIZATION is used to describe the act of paying back your borrowed money.  The length of years that you often hear associated with amortization (for example, “35 year amortization” or “20 yr amort”) tells you the amount of time it will take you to completely pay off your loan.

The general idea is this: the shorter your amortization, the higher your payments will be.  As an investment, the goal is that you want to pay off your balance as quickly as possible so that you can build more HOME EQUITY in your house and eventually own your house CLEAR TITLE.  Clear title means that you do not owe any money for the house (ie. It is completely paid off) and, for many, this is the ultimate objective of home-ownership.  By shortening your amortization, you pay less interest and build up your equity more rapidly.

Here’s an example of the difference between a 35 year amortization and a 25 year amortization, based on a 5% interest rate for a $100,000 mortgage.  Of course, this example is completely hypothetical because it assumes that your interest rate will remain at 5% for the entire amortization period.  As you may know (I’ll write more about this later), mortgage rates will change every time you renew your mortgage; therefore, this example is not 100% accurate in the amount of total payments and interest paid. However, it will provide you with a general understanding of the differences between the two different amortizations.

35 year amortization                                                  25 year amortization

$501.42/month                                                          $581.60/month

Amount of interest paid: $110,597.32                       Amount of interest paid: $74,482.96

Total Payments: $210,597.32                                    Total Payments: $174,482.96

I often recommend longer amortizations for young, first-time home buyers who are just establishing themselves in their careers and who are earning minimal income.  It is reasonable to expect that as we get older and gain more experience and/or seniority, our income will continue to grow with us.  If income is tight, it is best to only commit yourself to a reasonable payment amount each month.  As you get older, you can shorten your amortization and increase your payments to an amount that you are comfortable with.

In Canada, the maximum amortization period is 35 years for a HIGH-RATIO MORTGAGE.  40 year amortizations are still available from some lenders for CONVENTIONAL MORTGAGES.

How to use your RRSPs as a Down Payment

The Federal Government has a Home Buyer’s Plan that lets First-Time Home Buyers withdraw money from their RRSPs to use towards a down payment for a home - without being penalized.  However, there are some restrictions:

·         You must be a First-Time Home Buyer.  According to the fine-print of this plan, a First-Time Home Buyer is anyone who has not owned a home that has been used as a principal residence within the last 5 years. (Note: the defini tion of a First-Time HomeBuyer differs when talking about Property Transfer Tax, which I will explain later)

·         The maximum withdrawal is $25,000 per person (max. $50,000 per couple)

·         You must live in the home (ie. It must be your principal residence)

·         You must repay the money withdrawn from your RRSPs within 15 years

·         The money that you take out of your RRSPs must have been invested into your RRSPs for more than 90 days before withdrawal

Withdrawing your RRSPs is a great way to access cash that you’ve already saved up.  Just make sure you pay the money back within 15 years.

Acceptable Sources of Down Payments

A Down Payment may come from a variety of sources, including:

1.      Savings

2.      Home equity

3.      A gift from an immediate family member

4.      RRSPs

The first source, savings, is pretty straight-forward.  The bank* may want to see a history of your savings to ensure that the money you are using for your down payment is coming from your own resources (earnings) and that you will not have to pay anyone back.  This can usually be proven through bank statements.

I wrote about home equity earlier, so you should be familiar with the term.  If you are transferring your mortgage or refinancing, you can use the equity in your home as a down payment.

A gifted down payment must come from an immediate family member.  The bank will want to see a signed agreement between you and the family member stating that the family member is giving you the money and he/she does not expect you to pay him/her back.  The gift letter should also include the full name, contact information and relationship of the donor. 

*A note/disclaimer: I realize that I have been using the term “the bank” quite often in my writing and this may seem misleading to some.  To clarify, when I say “the bank”, I actually mean this to represent any number of lenders.  These lenders could be banks, credit unions, mortgage investment companies, private lenders, etc.  In my day-to-day dealings, I have noticed that most people just refer to lenders as “the bank”, since this term is used so often in our daily conversations and since “the bank” was where people traditionally used to get their mortgages in the past.  I will continue to use the term “the bank” in this blog for ease of explanation.

What is a Down Payment?

A Down Payment is a lump sum of cash that is given to a bank to show that you are seriously committed to your home purchase.  A down payment demonstrates to the bank that you have been responsible enough to save up this amount of money and that you are confident enough in the property (the house) to invest your money into it. 

The amount of your down payment is subtracted from your purchase price to determine the full amount of money needed for your mortgage.  In other words, if you buy a house for $100,000 and put $20,000 down (as your down payment) you will need an $80,000 mortgage ($100,000-$20,000=$80,000).

In Canada, you may put as little as 5% of your purchase price down as your down payment.   ie. If the house you want to buy is $100,000, make sure that you have at least $5,000 in savings to use as your down payment.  (If you wish to buy a house but you have no money at all to use as a down payment, there are other options as well, which I will write about at a later date.  For the time being, so that we do not complicate matters, I will say that the best option for all home buyers is to have at least 5% to put down.) 

There are two classifications of mortgages: High-Ratio Mortgages and Conventional Mortgages.

If you put less than 20% down, your mortgage is considered a HIGH-RATIO MORTGAGE.

If you put 20% or more down, your mortgage is considered a CONVENTIONAL MORTGAGE.

Stay tuned for more information on these two classifications.

What is Home Equity?

I’m sure you’ve heard words similar to these in advertisements: “Use your equity to pay down your debt” or “Let your home equity lend a hand”.  What is this equity that all these lenders speak of?  There are a few different definitions for equity but the one definition that is most important to you is that of HOME EQUITY. 

Simply put, home equity is the difference between your home’s market value or purchase price and your mortgage balance. 

In other words, HOME EQUITY = MARKET VALUE or PURCHASE PRICE – MORTGAGE BALANCE

Let’s go through a fairly easy example. 

1. You buy a house for $100,000.
2. You put down a down payment of $10,000.
3. Therefore, your mortgage balance is $90,000.
4. 5 years later, because you have been making regular payments, your mortgage balance will be $85,000.
5. Also 5 years later, because your neighbourhood has become a desirable place to live and property values have gone up, the value of your house has gone up to $150,000.

$150,000

-$85,000

$65,000

ie. 5 years later, your home equity amount is $65,000!

Building up equity should be the #1 goal for homeowners.  The more your property value increases and the faster you pay down your mortgage balance, the more equity you have!

Home Equity can be used as collateral to borrow money from the bank (perhaps for renovations or to consolidate debt).  This is often done through home equity loans or home equity lines of credit, which I will explain further at a later time.

What is a Mortgage?

Let’s start from the very beginning.  What is a Mortgage?  Some people may feel that this is a silly, easy question – a mortgage is a big sum of money that the bank gives you so that you can buy a house, right?  Wrong.  In order to understand why a bank would help you buy a house (what's in it for them?), one must first understand the real definition of a mortgage.

Mortgage: a (written) promise that is given by the borrower (you) TO the lender (the bank) stating that you owe the bank money.

(From here on in, for ease of explanation, I will assume that you=borrower and the bank=lender)

When you buy a house, your mortgage is registered in the Land Title Office (an office that keeps track of who owns all the properties in the area).  This registration transfers “ownership” of your house to the bank so that the bank has security for the money that you owe them.

What does this all mean?  When you buy a house using money obtained from a bank, you do not actually “own” this house – the house is actually the property of the bank.  So to answer the question above about why a bank would want to help you buy a house (apart from the money that they will make off of interest) – the banks feel secure in lending you this money because if you ever break your promise to pay back the debt, the house is already registered in their name and is theirs to sell in order to gain back the money owed.

A somewhat comparable example: 

Your little sister asks to borrow your video camera worth $500. 

You’re not sure how reliable and responsible she will be because there’s a chance she will be partying. 

You ask her to give you a promise and collateral (ie. a mortgage). 

She lets you hold onto her diamond engagement ring worth $1000 until she brings back the video camera in good condition.

If she ruins your video camera, you can keep the diamond engagement ring.  If you wish to sell the engagement ring, you can, and this money can be used to buy a new video camera.

Easy stuff, right?

What the heck is this blog about?

We’ve all heard it time and time before: “I’m just no good at math” and “numbers don’t make sense to me”.  Frankly, I am just as guilty as the next person for admitting these things aloud.  I vividly recall an instance where I was in a meeting sitting around a table full of women and we were all laughing about not being able to come up with the answer to a simple equation (“What’s 30% off of $2000.00?”).  Around the table I heard remarks such as, “math just isn't my strongest subject”, and, “I’m so stupid when it comes to calculations”, followed by a sea of approving nods and the overwhelming consensus that this is the reason why we were in our current professions.  I even chimed in with this statement: "I've always been bad at math - that's why I was an arts student in university".  At that moment, it dawned on me that the dismissal of being unable to calculate numbers is a collective acceptance that has penetrated deep within our culture.  It is socially acceptable to claim that we are afraid of numbers and are bad at math.

I’m sure you’re wondering…is this blog about math?  The answer is…not really.  I know, I know, I just spent my entire opening paragraph talking about math and numbers.  However, it was all to provide a bit of background as to where I’m heading, which is this:  If you have the capability to know something, why not try?  Not knowing one thing can close so many doors to knowing other things.  Accepting ignorance is not a good enough excuse when that energy could be put to arming oneself with knowledge.

My name is Jennifer Loh and I am formerly what one would call “a literary type”.  These are the folks who hide their noses in old books and profess to know everything – except numbers.  I have a Bachelor of Arts degree in English Literature and a Certificate in Liberal Arts from Simon Fraser University.  Previously, I taught English as a Second Language, tutored in English Literature, and worked in media sales in the publishing industry.   I was 26 years old when I realized that I had never really tried to get acquainted with numbers, let alone get intimate with them, and that this fear had kept me from learning about so many other important things in this world.  I was also 26 years old when I realized that this fear of numbers had kept me from knowing about two of the most vital subjects of our modern society: home buying and residential mortgages.  

The world of mortgages had always had a wall of numbers surrounding it that kept me from entering.  You might be thinking - "why would she associate mortgages with numbers"?  The answer is quite simple - I knew that the mortgage world was tied to the finance world and in my mind, finance=math. It’s not that I didn’t want to know what a mortgage was, what was involved in purchasing a house and obtaining a mortgage, or how to make money from this type of investment.  The problem was that every time I tried to read about or listen in on conversations about these subjects, a word would be thrown in that I didn’t fully comprehend and then the rest of the conversation was indecipherable.  I automatically attributed this to my lack of knowledge of math and finance. I was not the kind to admit that I didn’t understand (remember: former literary type that knew everything) because the words seemed so commonplace.  After all, they were used in thousands of newspaper articles and in everyday conversations around the office.  Eventually, I think I gave up trying to understand.  Every time I watched or listened to the news and information about the housing market, mortgages, or finance came on, I immediately changed the channel, zoned out, or glazed over.  The words “home ownership”, “mortgage”, “interest rates”, “equity”, and “lending” meant nothing to me because they had no context.  Sound like you?  You’re not alone.

As I was saying above, my new life began at 26.  This is when I decided that I was tired of not knowing about something that affects nearly every person in our society who has a home – regardless of whether they rent or own.  I was stuck in a profession that I didn’t enjoy and the idea of finding a new career sounded enticing.  One of my best friends was (and still is) a mortgage broker and she seemed to be content. When my partner, Brad, saw this, he recommended that I look into this industry.  As you can guess, I initially laughed and scoffed at the idea.  After all, I hadn’t done a mathematical calculation for years (unless there was a calculator handy)!  However, I began to think about it later and came to the very realizations about math, my fear of numbers, and my acceptance of ignorance that I illustrated above.  It was time to stop accepting my lack of knowledge and lack of confidence and turn the tables.

This blog is meant for any and all people who have ever felt even a small taste of what I’ve felt in the past about numbers, math, mortgages, housing, accepting ignorance and gaining knowledge.  Herein lies the premise of my blog: “Mortgages, Math & More for the Literary Types”.  I firmly believe that I am not the only person out there who needed/needs to start the education process from the very beginning and I pledge to do just that.

Oh, and I stated that my new life began at 26…did I mention that I’m only currently 27?  That’s right…we’re on this journey together.

My name is Jennifer Loh and I am a Mortgage Broker serving the Lower Mainland and Fraser Valley.  I will gladly explain everything about mortgages to you in plain English.