These two insurance products have similar sounding names, but are used for two different purposes. Both are obviously concerned with your mortgage, but if you’re not sure how they’re different, allow me to explain.
Mortgage Default Insurance
If you’re looking to buy a home, you should already be familiar with mortgage default insurance – perhaps under its more commonly-known name, CMHC insurance. Mortgage default insurance is a requirement for home purchases with a down payment between 5 and 19.99%, and protects your lender in the event you aren’t able to pay back your mortgage. The benefit for you is that it allows you to enter the market with as little as 5% down. With the current high housing prices in areas like Toronto and Vancouver, being able to buy with only 5% down helps people who would otherwise be priced out of the market.
If the worst happens, and you default on your mortgage, you still face the full consequences. Since mortgage default insurance protects the lender, not you, you will still be held accountable for any losses incurred by the bank.
“What losses?” You might ask.
When you go into default, the bank sells the property to get its money back. If the amount they sell it for isn’t enough to cover the remaining mortgage, they submit a claim to the mortgage default insurance provider (i.e. Canadian Mortgage and Housing Corporation (CMHC), Genworth Financial, or Canada Guaranty) to get the remainder. That remainder can and will be then repaid by you – the defaulter. If the value of your home has dropped, either through market changes or neglect of the property, then you can still be on the hook for tens of thousands of dollars, even after purchasing insurance for that very instance.
If that sounds scary, remember that the mortgage default rate in Canada has never risen above 1%, and is currently at 0.24%.
Mortgage Life Insurance
Mortgage life insurance is not a legal requirement. Instead, it is a product offered by the lender itself. In the event you die or become disabled, mortgage life insurance will cover the remainder of your mortgage, however much that is.
This sounds like a good deal, but there are disadvantages. The biggest is that the beneficiary for a mortgage life insurance policy is the lender, not your family. Also, since mortgage life insurance only covers the remainder of your mortgage, and not a specified amount, your coverage shrinks as time goes on and you pay down your mortgage. If you go your entire amortization without ever having used your policy, the money is gone, as there is nothing left to cover.