When mortgage insurance makes sense

05/02/2014 15:05

 

Lenders often recommend that homebuyers buy an insurance policy that will repay their mortgage in the event of their death. But choose carefully, experts warn.

 

In recent years, the federal government has made several changes to the rules for mortgages backed by the Canada Mortgage and Housing Corporation (CMHC), the government-owned agency that insures mortgages against default.

 

By law, Canadian mortgages that have less than a 20 per cent down payment must be insured in this way.

 

Essentially, this means that if you can't make your mortgage payments, and the bank can't get all its money back after selling your property, the CMHC will make up the shortfall. Without it, mortgage rates would be higher, since the risk of default would increase.

 

At the same time, most lenders encourage homebuyers to buy supplementary insurance programs — often labelled as mortgage balance protection — designed to pay off or reduce your mortgage balance in the event of death or critical illness.

 

While these plans are convenient, it’s important to realize that there are other options available when it comes to protecting yourself in the event of your death.

 

In fact, while it sounds like a sensible choice at the time, insuring your mortgage this way can be more expensive than buying insurance sold separately through individual agents or brokers.

 

Typically, mortgage insurance pays off the loan’s outstanding balance — which is good for the lender, but creates little value for your family.

 

A more customized policy, on the other hand, will pay the benefit directly to your family and they can then decide if they want to pay off the mortgage debt in full or deploy the funds towards more pressing needs.

 

Here’s another consideration: With mortgage insurance obtained from a bank, coverage decreases with each monthly payment — but the premiums don’t follow the same pattern.  When you own life insurance directly, however, the level of protection remains fixed throughout the term of policy.

 

The mortgage market has become more competitive in recent years — and that’s a good thing. But if you change banks when your mortgage is up for renewal a few years later, keep in mind that you’ll have to reapply for coverage through the new lender.

 

This means submitting new medical evidence and paying rates based on your current age. If your health status has changed significantly since you last took out your mortgage, your new mortgage lender may not want to insure you.

 

Here’s another caveat: The mortgage insurance you buy through lenders usually terminates when the mortgage is paid off or when you reach a certain age, generally 70 years old. An individual policy can be held for as long as you want.

 

So, having determined that you might be wise to consider alternatives, there are a few options. The primary one is a term policy where the monthly premiums are guaranteed for a fixed period of time — say, over the next decade.

 

If you purchase a 10-year term policy, then in 10 years we’ll broker a new policy to cover the balance of the mortgage. If you still have your health, we can usually do it for about what you’re paying for the first 10 years as the principal to cover is less, having paid some of it off.

 

Those who don’t want to take the risk of being uninsurable in 10 years and having to pay a significantly larger premium on renewal might opt for a 20-year term — by which time many will see their mortgage essentially paid off.

 

If you go this route, expect to pay 25 to 35 per cent more in the first 10 years for this security.

 

Because mortgage life insurance obtained through a bank is usually offered based on a brief questionnaire and not a medical, there’s always the risk of “post claim underwriting”. This means that medical issues are explored only after a person dies. If you pass away, your medical records would be obtained and a claim could potentially be denied because of something not disclosed properly on the questionnaire.

 

In contrast, dealing with an insurance advisor or broker means all due diligence is performed up front. Thorough medical questions are asked and, if required, a nurse visits your home or office to perform a physical.

 

This way, barring fraud, you know that the claim will be paid out when needed according to the terms of your contract.

 

Give us a call to discuss your options.