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

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.

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.