Congratulations – your new mortgage contract has been signed.
After the task of researching mortgage rates, speaking to a mortgage expert, weighing the options for fixed versus variable, length of term and payment schedules, gathering the appropriate documents and negotiating the details, you can now sit-back relax and forget about your debt for another 3-5 years.
Well, not exactly. Don’t start brushing your new mortgage under the rug just yet. There is one more very important piece to the mortgage puzzle that should not be forgotten – mortgage insurance.
After your mortgage has been approved, you should consider protecting yourself against the event that you are unable to make your payments. It’s natural not to want to think about this, but if something were to happen, you and your family will be glad you did.
To navigate the tricky world of mortgage insurance, we’re talking to Craig Ferguson, a licensed insurance broker with over 20 years of experience. He has a wealth of knowledge and hates to see Canadian consumers get taken advantage of by insurance agents selling unnecessary or overpriced products. We like his style.
RSM: Thanks for talking with us Craig. Why don’t you start off by telling us about the difference between default insurance and mortgage insurance?
Craig: When it comes to insurance, the terms alone can be confusing enough! Mortgage loan insurance or mortgage default insurance is typically required by lenders when you are buying a home or looking for mortgage refinancing and have less than a 20% down payment based on the property’s value. Mortgage insurance is typically offered by your bank or lender and it’s a form of mortgage protection if you are unable to pay your mortgage.
The bottom line is both products protect the lender, not the borrower’s family. There are other products out there, such as mortgage life insurance coverage that can better protect the borrower.
RSM: Can you tell us a bit more about the specific downfalls of mortgage insurance?
Craig: Well, I think there are 3 main points to cover here. Firstly, it’s expensive; second, you may need to re-qualify more often then you think; and finally, the application form leaves room for errors that could have serious consequences. Let’s look at each of theses issues in turn.
Mortgage insurance is expensive for a variety of reasons, one being the potential length of risk. If a plan covers 25 years versus say ten, the risk to the insurer is greater, and is reflected in a much higher cost. Given that the most common amortization period for a first time mortgage is 25 years, most people will take out a mortgage insurance plan that covers that period of time. It may seem great to have a 25 year plan, but reality does not match theory.
For the second point, the argument often made for mortgage insurance is that it will cover the outstanding mortgage balance for the duration of the mortgage. But this may not be the case.
In today’s economic climate, the odds of staying with one lender and/or one mortgage are unlikely. When a mortgage loan is paid off, renegotiated or refinanced, the mortgage insurance terminates at that point, and the borrower is faced with the challenge of re-qualifying for the coverage again. This is the case even if they were to stay with the same lender!
This presents the issue of increasing rates upon mortgage refinancing, and no protection if health issues make re-qualifying a problem.
And the final issue, since mortgage insurance is designed as an “easy application” product, it may only have six to ten very loaded health questions. Should the applicant answer “no” by mistake, when he/she should have answered “yes”, it could result in a claim being denied. And, this is why you hear of so many stories of mortgage insurance not paying out.
RSM: So what should consumers do in order to protect their mortgage?
Craig: A product that addresses all of the fallbacks of mortgage insurance is life insurance. This can be a cheaper alternative to mortgage insurance and offer additional benefits.
RSM: What are the benefits of life insurance?
Craig: The main benefit of life insurance is money when needed. It’s as simple as that. Other benefits include:
The beneficiary can decide what they want to do with the money, i.e. it doesn’t need to go against the mortgage, unlike mortgage insurance
Discounts are available based on your health and your family history
Premiums are taxed at a much lower rate
It’s more flexible – you can change mortgage lenders and take the coverage with you if you move homes or you can convert a term policy into a permanent policy.
Policy terms don’t change and in most cases the policy premiums are guaranteed
That’s just to name a few.
RSM: At what stage should someone look at protecting their mortgage? And how much coverage should they look to purchase?
Craig: This question is a good one, but shouldn’t it really be: at what stage should a person look to ensure protection of his or her family? It’s often a myth to assume a paid off mortgage results in easy street.
For example, let’s say we have a husband and wife, both working, and pulling in equal shares of income (not uncommon in today’s society). Let’s assume net after tax income is $5,000 per month.
Say their mortgage payment is $1000 per month, representing only 20% of the family’s net income. But usually, at the end of that month, there is little left over (again, not uncommon in today’s society). This would suggest that the loss of a loved one representing 50% of the family’s money each month would not be satisfied with the removal of only $1000 of total expenses. Where’s the other $1,500 coming from?
There’s a reason the banks operate on debt ratios – they understand that there are greater expenses than a mortgage that a family needs to consider. The banks and lenders act responsibly, but do we as borrowers think the same way?
You could look at covering the mortgage, or you could look at how much insurance is really needed. Most often, term insurance is a low cost way to not only save money over the cost of mortgage insurance through the lender, but the best bang for your buck to ensure your families lifestyle is protected.
And the time for this is really “yesterday”.
RSM: What is the difference between whole and term life insurance? And which option is best?
Craig: Whole Life insurance is designed to provide coverage for life, with, usually a guaranteed premium, but that is not always the case. Term insurance, provides coverage for set periods with a guaranteed premium (say for 10 or 20 years), and a guaranteed renewal premium at a higher rate. But, most term plans are flexible because they also allow for “conversion” to a whole life plan without providing a health check at that time. The rate will then be the rates for the age at conversion to the permanent (whole life) plan.
Which should you choose? It really boils down to need first, solution second.
For example, a doctor has at his disposal a prescription pad, and can order any drug he chooses for a given patient. Do all patients get prescribed the same drugs? Of course not.
The doctor should first assess the patient’s health, determine where it hurts, and look to provide a long-term goal to address the health issues.
Similarly, the insurance broker must assess the financial risk of the client. He must determine the amount of life insurance needed to cover off a good percentage of income over time (usually to retirement), and also consider pension fulfillment needs, which we should discuss more, perhaps in another session.
People without drug coverage need to pay out of their own pocket, and doctors usually make decisions on what to prescribe based on ability of the patient to pay the bill. The same consideration should be made for life insurance.
First, the amount of insurance to protect the client should be determined, and only then should the affordability of the plan type be addressed.
In my experience, based on need, clients that have mortgages, families and several years to retirement, should look at the lower cost, higher payout of term life insurance. And in most cases a ten year term is a good option.
RSM: So a ten year term policy is the best option?
Craig: It is important to understand that insurance needs change as life changes. For that reason, the average life insurance plan, whether bought as whole life or term tends to change every 5 to 7 years.
The extra premium paid to the insurer during that period (if the term was longer than what you held the plan for) would be lost. So the best option is to buy the plan that best represents the closest term before your needs change.
If you’ve had a whole life plan or say a 20 year term plan and have changed to another plan of insurance then you are a case in point. The additional premiums that you paid could have gone towards paying down your mortgage.
RSM: What health checks are required for life insurance coverage?
Craig: When you apply for a personal life insurance plan, the insurance company will ensure your health is good by conducting a form of checks and balances. They will often order a doctor’s report if there are any grey areas and also cross-reference the answers to the application. Depending on age and amount applied for, there will be a nurse called to perform other tests and ask questions related to health history. Additional health or avocation questionnaires will also be used to paint the proper picture. The process is relatively painless yet thorough in ensuring full disclosure.
The insurer is more likely to challenge the applicant up front for health conditions that may not even be known to the applicant, but in doing so, this ensures that at claim time there is little to be challenged. Often the insurer will suggest results are sent to the family doctor to be discussed and dealt with. A mini-physical is a complimentary byproduct for those that refuse to visit the doctor regularly.
Very important to the integrity of the process, there is less likelihood that the applicant’s answers alone will form the basis for the contract. That is the protection you want, trust me! I like to call it being put through the ringer for your own good. The technical term is called pre-claims underwriting.
Creditor/mortgage insurance is riskier because the process looks more closely at you only at claim time. The term is aptly named post-claims underwriting. It’s unfair to challenge insurability after the fact. Despite the fact that premiums have been paid in good faith, the coverage your family relies on may be at risk of not being there.
RSM: What types of questions do you recommend consumers ask an insurance agent before they make a purchase?
Craig: The first and most important is to ensure the agent can justify the reason for the amount of insurance suggested.
Second, did the agent take into account other insurance already in force, and make recommendations as to why they should be kept, or why they should be discontinued.
Third, and this is off topic but an important part of insurance planning, did the agent consider what would happen if you live? In other words, what if you were to become disabled? Is the agent concerned with ensuring your income will continue in all circumstances, disability or death?
If you’ve found a good insurance agent, you should expect to pull out all of your insurance documents including employee benefit books and pension statements.
Insurance selling should be in direct proportion to insurance planning.
RSM: Thanks for your insights Craig!
Next time, RateSupermarket.ca will talk to Craig about insurance requirements for the self employed.
Craig Ferguson Insurance Services has been providing Individual & Group Insurance solutions since 1991.
