What Is Mortgage Default Insurance

There are two types of mortgage insurance people often confuse. One is mortgage default insurance and the other is mortgage life insurance.

MORTGAGE DEFAULT INSURANCE
One of the first decisions to be made in the mortgage application process is whether or not the mortgage needs to be insured.

Mortgage lenders like banks, trust companies, credit unions and insurance companies are regulated by either the Federal or Provincial governments. Generally speaking, regulations state a maximum loan-to-value ratio of 80% or more.

This means that these institutional lenders cannot normally make a loan that is more than 80% of the market value of any property unless the mortgage is insured. Mortgage loan insurance may be available for loans up to 95% of the property value.

This mortgage insurance provides protection for the lender in case of the borrower default. Thus, mortgage insurance acts to transfer risk from the mortgage lender to the mortgage insurer. The mortgage lender pays a mortgage insurance premium to the insurer in exchange for assuming the risks of the borrower defaulting and generally passes that cost onto the borrower.

There are three mortgage insurance firms in Canada, Genworth Financial, CMHC (Canada Mortgage Housing Corporation and AIG United Guaranty.

In general, the process of obtaining mortgage loan insurance is similar for the mortgage insurance program offered by all three companies. The prospective borrower applies for a mortgage loan and loan insurance at the same time. If both applications are accepted, the lending institution will calculate the amount of mortgage premium the borrower pays.

High ratio mortgages are subject to a graduated mortgage insurance premium based on the loan-to-value ratio. The higher the loan-to-value ratio is, the higher is the premium.

The lender pays the insurer a single premium, the cost of which is generally passed on to the borrower. The premium is paid at the time of closing. The borrower either pays the premium in a lump sum payment, or more commonly, adds it to the loan amount and repays it with the regular mortgage payment.

If the premium is added to the loan amount, the amount of the premium is not included in the calculation of the loan-to-value ratio. However, the gross debt service ratio (GDS) applies to the full amount of the mortgage payments, including the amount that repays the insurance premium. As well, if the premium is added to the loan, the full face value of the loan, including the premium, is insured. No additional fees or premiums for loan insurance are charged annually, or upon renewal of a mortgage at the end of the term, even though the insurance is in force for the full amortization period.

If a borrower defaults on an insured mortgage loan, the lender begins the legal process of Power of Sale and makes a claim against the borrower on the personal covenant. Also, the lender makes a claim with the insurer. Once the Order for Sale is granted at the end of the redemption period, the lender lists the property for sale. If the sale proceeds are insufficient to repay the mortgage balance, the insurer pays the lender the difference. At that time, the lender assigns the personal claim against the borrower to insurer. (Note: the legal process may differ depending on the province where the property is situated.)

Genworth and CMHC both have default management programs to provide lenders with the necessary tools to make timely and cost effective decisions to assist their customers in dealing with temporary financial setbacks.

Joe Malek, AMP
Accredited Mortgage Professional
http://www.joemalek.com/