What is Mortgage Default Insurance?

Default Insurance

Why do most lenders require mortgage default insurance for home buyers purchasing homes with less than a twenty percent down payment?

Canadian banks and most lenders are required by law to insure “high ratio” mortgages against default. “High ratio” refers to mortgages with less than a twenty percent down payment. Default insurance is provided by companies such as Canada Mortgage and Housing Corporation (CMHC), Canada Guaranty (CGI), or Sagen. Insurers provide a safety net for banks and lenders by assuming all the risks of mortgaging a property.

What does this mean? Mortgage default insurance protects lenders if a borrower defaults on their mortgage. It does not protect the borrower. If a borrower stops making their mortgage payment, the insurer will handle the legal proceedings and compensate the bank or lender if there is a loss after the property has been sold.

High-ratio mortgages have to be approved by both the lender and the chosen insurer. Since the risk falls onto the insurer, they provide rules and guidelines for lenders to follow. Lenders do not send pre-approved mortgages to the insurers; they only send live deals. Default insurance comes at a cost that the borrower is responsible for paying. The mortgage amount and percentage of the down payment determine the cost. The insurance cost can be added to the mortgage, so the borrower does not need to pay it out of pocket.

There are instances where default insurance may be required by lenders when a borrower has more than a twenty percent down payment.  This will apply if the property is considered a higher risk or the borrower is qualifying under a special program. A high risk may be that the property is in a remote location or does not follow the lender’s guidelines regarding property details (such as minimum square footage). A unique program could refer to homes located on leased land and therefore registered as a chattel loan.

Default insurance should not be mistaken for mortgage protection insurance or homeowner’s insurance. Mortgage protection insurance protects the homeowner in the event of death or disability. Homeowner’s insurance protects a homeowner’s house and belongings in the event they are damaged. It also provides the homeowner with liability coverage.

Basically, default insurance is a massive insurance policy that borrowers pay to protect the banks and other lenders. The insurers continually make new policies to protect Canada’s economy and ensure a stable housing market. A stable housing market is very beneficial to all homeowners across Canada.

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