What is Mortgage Insurance and How Does it Work?
If you’re applying for your first mortgage, you’ve probably heard the term “mortgage insurance” or “CMHC insurance.” You probably understand that it’s an extra fee that you’ll have to pay, but it’s better to get a deeper understanding of what this means. You can then use the information to make better decisions for your family.
What Is Mortgage Insurance?
Mortgage insurance protects the bank’s interests in case you default on the loan. If you fall behind on payments and the bank is forced to repossess your home, the mortgage insurance will help them cover their losses.
Is Mortgage Insurance the Same as Homeowners’ Insurance?
No. Homeowners’ insurance protects your interests in the home. It will cover the costs of damages to the home from things like fire, robbery, or inclement weather. Mortgage insurance benefits the bank. Most homeowners have both types of insurance.
Do I Need Mortgage Insurance?
Banks require homebuyers with less than a 20 percent down payment to get mortgage insurance. They also occasionally require those who have a higher down payment to pay for mortgage insurance if the applicant has poor or fair credit. Your mortgage lender will tell you whether you need the insurance based on your personal situation.
How Much Does Mortgage Insurance Cost
Lenders tend to use a standard formula for calculating the cost of the mortgage insurance, so it isn’t hard to estimate how much you’ll pay for a particular house.
The first thing they do is look up the premium percentage. All the institutions that provide mortgage insurance charge with the same rates. Currently, the rates are 4.00 percent for those who put between 5 and 9.99 percent down; 3.10 percent for those who put between 10 and 14.99 percent down; and 2.80 percent for those who put between 15 and 19.99 percent down.
Once you have the premium percentage, you multiply that by the amount of the mortgage. Remember that the mortgage amount is the cost of the home minus the down payment. For example, if a person was purchasing a $350,000 home and had a $50,000 down payment, they’d need to take out a $300,000 mortgage, and the premium percentage would be 3.10 percent because the $50,000 down payment is 14.3 percent of the cost of the home. The bank would calculate the mortgage insurance premium by multiplying $300,000 by 3.10 percent. The mortgage insurance premium would be $9,300.
This amount gets added to the mortgage balance. Rather than taking out a mortgage for $300,000, the homebuyer would actually be taking out a mortgage for $309,300. The bank would then calculate monthly payments based on the borrower’s credit score.
Mortgage insurance typically adds less than $50 to the monthly payment of the average homebuyer.
What Are Some Special Circumstances?
Lenders do not offer mortgage insurance on homes that cost more than one million dollars. If the home you want to buy is more than this, you’ll have to have at least a 20 percent down payment to finance your purchase.
How Can I Avoid Mortgage Insurance?
You can avoid paying mortgage insurance by saving up a down payment that’s 20 percent or more of the cost of the home you want to buy. If you're close to that 20 percent, it’s beneficial to wait a few more months before making your purchase. You could also consider purchasing a less expensive home so the money you have saved up would equal 20 percent.
However, we’ve mentioned that the cost of mortgage insurance is a small part of the mortgage payment. Most people don’t worry about paying this fee because it gets them into the house they want sooner.
Is This the Only Added Expense?
As you determine how much you can afford when applying for a mortgage, it’s important to remember that your monthly payment will also include partial payments for homeowners’ insurance and property taxes. In some cases, these fees add a few hundred dollars to the monthly payment, and that can easily make a home far less affordable. Be sure to factor these numbers into your calculations.
Most homebuyers have to pay mortgage insurance to get their homes, so you shouldn’t go out of your way to avoid it. This small payment allows you to buy the home you want with a down payment that’s affordable for you. If you have any additional questions about mortgage insurance, be sure to talk to a lender before house hunting.
