As a first-time homebuyer you must get mortgage default insurance on your new home purchase, it’s a federal requirement. However, don’t be mistaken mortgage insurance is not meant to protect the first-time buyer, it’s designed to protect the lender in case you default on your mortgage. Therefore, it’s important for you to understand what it is and how it works.
What exactly is mortgage insurance?
As previously mentioned when you get mortgage insurance it will protect your lender. The determining factor that decides whether or not you require it is the dollar amount of your down payment. This is how your level of risk is assessed, the lower the down payment percentage required, the lower the risk, and vice versa. This is also known as high and low ratio.
For instance, if you are able to paydown at least 20 percent of the property’s purchase price upfront, then mortgage default insurance is not mandatory and you will qualify for a conventional mortgage since your loan-to-value (LTV) ratio is low.
However, if your down payment amount is less than 20 percent, then your mortgage is considered to have a high LTV ratio. In this case, you will be required to have mortgage insurance. Without at least 5 percent saved, you won’t even qualify for a mortgage at all.
To calculate your LTV ratio:
Principal mortgage divided by Purchase Price/Market Value (if lower)
Essentially your lender is responsible for paying the mortgage insurance, but as the borrower you will be responsible to pay the cost of the mortgage insurance premium. This could be anywhere from one to three percent of your principal loan amount. Your premium is calculated by the insurance provider and the percentage depends on your mortgage’s LTV ratio.
Sometimes lenders may incorporate these premiums in your mortgage, but you also have the option to pay your insurance premium upfront with the rest of your closing costs.
The premium is generally rolled into the mortgage, but please be aware that you will also pay interest on the total borrowed amount, as well as the mortgage premium itself. However, you do have the option to pay insurance premiums upfront as part of the closing costs. In Ontario, these premiums are also subject to paying provincial sales tax, which is payable only upon closing.
How Mortgage Default Insurance Works
At the end of the day, think of it this way…If you default on your mortgage, someone has to be financial responsible to pay the amount left owing on your loan, and that responsibility falls on your lender. When you default, your lender will file a claim on your insurance policy. The insurance company will pay your lender, and you will still be required to payback the remaining balance to the insurance provider.
If you fail to pay altogether, your insurance company can take legal action against you to force a payment upon you. At this time, your property may be sold and if the sale amount doesn’t cover the balance of your mortgage, you may also be responsible to payback additional monies expenses as a result.
The bigger your down payment, the better it is for you, so if you have to save for an extra year we’d advise you to do so. You can save a lot of money in the long run. However, if you simply can’t wait, then mortgage insurance will assure your lender for quicker approval.
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