How Mortgage Insurance Impacts Your Borrowing Power
Depending on the size of your down payment, mortgage insurance could be necessary in order to close on your home purchase.
As a new homebuyer — and even as a seasoned one — there’s a lot to think about when buying a new home. From deciding on a budget, saving for a down payment, and coordinating financing, it’s easy to let other things slip through the cracks. One thing you don’t want to lose track of is insurance.
All homeowners with a mortgage are required by their lender to have home insurance. And some are required to have mortgage insurance, too. So, what’s the difference? Let’s get into it.
What is mortgage insurance?
Mortgage insurance is only required when purchasing a home with a down payment of less than 20% of the purchase price. So, if your down payment is more than 20%, you don’t have to worry about it.
Mortgage insurance is purchased by the homebuyer as a safeguard to the lender, from one of Canada’s three mortgage insurers: CMHC, Sagen (formerly known as Genworth), or Canada Guarantee.
If mortgage insurance is needed, your mortgage broker will work with your lender to set everything up. Your mortgage premium is then added to your total mortgage amount. This premium can cost anywhere between 2.8% to 4% and is based on the size of your down payment.
Your mortgage insurance policy will protect your lender (like your bank) in case your mortgage goes into default — they’ll step in to cover those costs, as well as any costs associated with foreclosing the property.
What is home insurance?
Home insurance protects the homeowner in case something unexpected or accidental happens to their property, home, or belongings.
In Ontario, home insurance is not mandatory by law, but virtually every bank and mortgage lender will request it before you close on your purchase.
Mortgage insurance vs. home insurance
Mortgage insurance protects the lender, not the borrower. It’s quite different from home insurance, which covers the homeowner, but the two can be confused as similar products.
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Does needing mortgage insurance affect my borrowing power?
Kind of. If you need mortgage insurance, that means your down payment is less than the recommended 20%.
Having mortgage insurance doesn’t directly affect your borrowing power, but it does reduce your options and potential flexibility to qualify you for financing. The down payment also influences your loan-to-value (LTV) percentage, which determines how much equity you have in your home. The LTV measures the size of the loan against the value of the purchased property. So, if you make a 20% down payment, the LTV percentage would be the remaining 80% of the purchase price. While you cannot refinance your property with 20%, you have more of a cushion for any drop in value to your home due to market forces.
Mortgage insurance could mean higher mortgage payments
While getting mortgage insurance increases your payment slightly, this is a great option for people who are looking to get into the market who don't have access to a 20% down payment
In short, you only need mortgage insurance if the down payment for your new home will be less than 20%. There are advantages to putting down 20% on a property: you can give yourself additional flexibility with the amortization — as well as additional flexibility with the lender overall — lower monthly payments, and higher ratios.
But a 20% down payment isn’t always an option for every potential homebuyer. Mortgage insurance is a tool that allows homebuyers to get into the market, and sometimes even buy their dream home if they can’t quite come up with a 20% down payment. It allows the homebuyer the ability to purchase a home without having to save the 20% down payment beforehand while protecting the lender from what’s considered a riskier loan.
Home insurance and mortgage insurance are two very different products, but depending on your potential down payment, they could be crucial to your next home purchase. While Onlia has you covered for all of your home insurance needs, Perch can help you get the best mortgage rate for your new home.