December 29, 2021 | 9-minute read
Imagine this: You’re about to buy a house. Plans are underway and everything’s going great. The mortgage is arranged, the purchase closes on time and, ready for this new chapter, you move into your home with your partner and start to settle down.
Then tragically, a few months later, your life circumstances take a turn for the worse. Your partner suddenly passes away, and you find yourself not only grieving the loss of your loved one but facing financial difficulties alone. You’re not sure you’ll have enough resources to keep up with the mortgage payments; you’re pretty certain you’ll face selling your home when the mortgage becomes unaffordable.
But thinking back to when you bought the property and arranged financing, you remember the mortgage broker saying something about insurance. But back then, spending another penny on payments seemed too much. Besides, maybe they were just trying to sell you something you didn’t really need. And what were the chances something bad would happen anyways? Next to nil, right?
How life insurance can help with your mortgage
Finding oneself alone, holding a large mortgage with the responsibility to pay for it can be a scary thought. But it doesn’t need to cost a lot to protect yourself from that ever happening to you. Purchasing insurance when you buy a house may be something to seriously consider. The funds it provides can help protect your family, your loved ones, and your estate in the event the unthinkable happens.
Different kinds of – and names for – mortgage insurance
There are two kinds of insurance that can protect you from the challenging situation described above. There’s another one that protects the lender. It’s very different and, in some circumstances, required by law.
|Protects you||Protects the lender|
|Mortgage protection insurance (may also be called mortgage life insurance or, depending on the policy, mortgage disability insurance)||Mortgage loan insurance|
|Life (term or permanent) insurance|
We tackle each type separately below.
Mortgage protection insurance serves an important role in our marketplace. It protects the home buyer/mortgage holder from being burdened with a large mortgage debt – pays off the balance, or a specified maximum amount, directly to the lender – should you (or a joint mortgage holder) pass away.
Typically, you buy mortgage protection insurance when you buy a house, arrange financing and sign mortgage commitment papers. It’s optional and ‘separate and apart’ from the mortgage contract. Monthly premium costs are usually added to monthly mortgage payments, and they stay the same throughout the life of the mortgage.
Mortgage protection insurance can include one, two or all four of these options:
- life insurance – it may be called ‘mortgage life insurance’ (i.e., proceeds are paid to the lender to eliminate debt burden if a mortgage holder passes away)
- disability protection – it may be called ‘mortgage disability insurance’ (i.e., the insurer makes monthly mortgage payments for a pre-determined length of time, often up to 24 months, if the mortgage holder becomes disabled)
- critical illness protection (i.e., the insurer pays according to the policy terms [e.g., makes all or a part of the mortgage payments], if the mortgage holder is diagnosed with a critical illness)
- job loss protection (i.e., the insurer makes monthly mortgage payments for a pre-determined length of time, often six months, if the mortgage holder becomes unemployed)
In some instances, mortgage protection insurance is portable – it can go with you to new circumstances if you move to a different home or change lenders. This is possible when the insurance is purchased through a mortgage broker. To have this flexibility, it’s important to ask the mortgage broker for portable mortgage protection coverage.
Life insurance is different from mortgage protection insurance, but it can serve the same purpose. When a mortgage holder passes on, if they own life insurance, the policy proceeds may be used by the beneficiary(ies) to pay any debts or other financial needs (e.g., funeral costs, expenses, education), including the mortgage.
With life insurance, beneficiaries have the flexibility to decide how they wish to use the policy proceeds, which may equal more than the outstanding mortgage balance. Also, a life insurance policy (i.e., term or permanent) also allows policy holders to change their beneficiary(ies) at any time in the future.
Proceeds from a life insurance policy are tax-free and distributed outside the policy holder’s estate. They’re exempt from estate taxes, and typically distributed soon after the policy holder’s date of death.
Also, depending on timing, it may not make sense to pay off the mortgage with insurance proceeds. Each circumstance is different, but beneficiaries may wish to keep the property as an investment rather than selling it.
In any decision around purchasing insurance, you should discuss your options with your advisor, the provider, and any other relevant experts to confirm if it’s in your best interests to buy insurance, and which kind. Making a checklist of your goals, resources, and options can help you sort through all the information to help you make the best decision possible.
You may hear the term ‘mortgage loan insurance’ during conversations about buying a house. It’s not the same as mortgage protection insurance or mortgage life insurance.
Mortgage loan insurance is sometimes also called “mortgage insurance” or “mortgage default insurance”. It’s designed to protect lenders, not purchasers, and comes into effect if a purchaser has less than a 20 per cent down on the house they want to buy.
Insurance premiums for mortgage loan insurance range from about 2.8 to 4 per cent of the mortgage principal. Some provinces also charge provincial sales tax on the premium. In addition, there are rules about down payments to be mindful of, as described on the CMHC site.
|Property value||Down payment||Mortgage principal amount||2.8% Premium||Mortgage + mortgage loan insurance cost|
Even with a down payment of less than 20 per cent, it’s often worth the extra cost to become a homeowner. Mortgage loan insurance opens the door to home ownership that, for many, would otherwise remain closed. It makes buying a house possible to a greater number of Canadians. And the benefits of home ownership generally far outweigh the additional premium cost.
The total mortgage loan insurance charge (i.e., premium) gets added to your mortgage principal, which ultimately the mortgage holder pays off along with the mortgage. Sales tax due in provinces that charge it must be paid in full on closing as part of real estate closing costs.
That’s why it’s best, if possible, to have a down payment greater than 20 per cent of the purchase price. Then mortgage loan insurance isn’t required.
The following provinces charge sales tax on mortgage loan insurance premiums:
|Province||Tax payable on mortgage loan insurance premiums||Sales tax rate|
|Manitoba||No||Removed in 2020 as part of COVID-19 pandemic relief|
|Newfoundland and Labrador||No||n/a|
|Prince Edward Island||No||n/a|
Life insurance policies pay out to the designated beneficiary(ies) on that policy. Depending on the circumstances, the beneficiary may wish to use the proceeds to pay off the balance on a mortgage after the policy holder passes away. However, they may also wish to use the proceeds for other matters, to cover estate costs, funeral expenses, or to pay off other outstanding debts.
Essentially, life insurance proceeds don’t have to be used to pay off a mortgage. However, depending on the plans of those involved, it may be prudent to use the proceeds to do so. Advice from an independent financial advisor can help you decide how best to manage the proceeds in their circumstances.
Mortgage protection insurance covers the mortgage balance in case of death, sometimes to a maximum amount, as agreed between you and the insurance provider. Proceeds of mortgage protection insurance are paid directly to the mortgage company. In policies that include disability, critical illness or job loss protection, mortgage protection insurance will cover monthly mortgage payments, or a portion thereof, usually for a set period of time.
Life insurance proceeds pay out to policy beneficiary(ies) independent of any other financial commitment. So, if a mortgage has been paid off before the policy releases funds, then those funds are distributed to the beneficiary(ies) for their personal use. Some may have both mortgage protection insurance and life insurance. If that’s the case, the mortgage protection insurance will cover any outstanding mortgage balance, and the life insurance proceeds may be helpful with other expenses.
The information in this article is not to be relied upon as legal, tax, financial, or insurance advice for specific situations.
Individual circumstances may vary. You may wish to contact one of Manulife's licensed insurance advisors or your licensed insurance agent if you need advice about your insurance needs.