What is mortgage insurance and how does it work?

You've spent weeks looking through online listings. You've gone to countless open houses. You've finally found the home of your dreams and are applying for a mortgage and your advisor mentions something you have never heard of, mortgage insurance.

What is mortgage insurance? Do you need it? How much will it cost?

We'll tell you what you need to know about mortgage insurance, including the differences between mandatory and optional insurance, to help you take care of this step so that you can start planning your move into your new home.

When people talk about mortgage insurance, they're talking about either mortgage default insurance or optional mortgage protection insurance.

Mortgage default insurance is mandatory if you want to buy a residential property with a down payment of less than 20% of the purchase price.  This type of insurance protects the mortgage lender if you default on your mortgage and there is a shortfall after the lender forecloses on the property. 

Optional mortgage protection insurance, like Scotia Mortgage Protection, is an optional product that can help protect the outstanding balance on your mortgage or your regular mortgage payments. Scotia Mortgage Protection insurance offers four coverage options to choose from based on your individual needs: life, critical illness, disability or job loss coverage (job loss coverage is available only if disability coverage is also selected). We’ll explore more about the differences between mortgage insurance and optional mortgage protection insurance later in this article.

In order to help new homebuyers have access to the real estate market, mortgage default insurance allows people with down payments of less than 20% of the purchase price to take out a mortgage that is insured against borrower default by an insurer.

This insurance means that if you default on your mortgage loan and your lender forecloses on the mortgaged property, the mortgage default insurer will cover the bank’s shortfall. This insurance provides your lender with more confidence by decreasing their risk so they're able to feel more confident lending to you when you have a smaller down payment. 

The cost of mortgage default insurance is calculated based on a percentage of your mortgage amount and the size of your down payment.

Mortgage default insurance works out to cost an average of 2.8% to 4.0% of most people's mortgage amount depending on their particular financial situation and loan-to-value ratio (a.k.a. the amount of a loan you want to borrow compared to the value of the property you want to buy). 

A down payment is the amount of money that you need to pay upfront towards the home purchase price before you get your mortgage loan. The minimum down payment is between 5% and 20% of the purchase price.

What you need to put down initially depends on the amount of the purchase price. Here is the breakdown of the minimum down payment requirements effective Dec. 15, 2024: 

• For homes priced $500,000 or less: 5% minimum down payment
• For homes priced greater than $500,000 and less than $1,500,000: 5% on the first $500,000 and 10% on the remaining amount
• For homes priced at $1,500,000 and over: 20% down payment

Note: Effective December 15, 2024, if your home is priced at less than $1.5 million and your down payment is less than 20% of the purchase price, you will need to buy mortgage default insurance.

The good news is that it doesn't take any longer to get an insured mortgage than it would take to get a non-insured mortgage from your lender as the financial institution you're borrowing from will apply for the mortgage insurance on your behalf.  In addition to meeting your lenders credit criteria, you will also need to meet the requirements of the mortgage default insurer.

Mortgage protection insurance is an optional insurance product that can help pay off your outstanding balance or help cover your payments during times of financial hardship as a result of certain unexpected life events.

An example of this optional insurance is Scotia Mortgage Protection insurance. There are different coverage types, including life, critical illness, disability and job loss coverage. You can select which options are right for your needs. Life insurance protection can help pay off the outstanding balance of your mortgage up to $1 million in one lump sum if you pass away. In addition, critical illness protection can also pay off the remaining mortgage balance up to $500,000 if you’re diagnosed with a covered critical illness, like a heart attack or stroke. Disability and job loss protection can maintain your mortgage payments up to $3,500 per month (including property tax and interest) for a period of time if you were unable to work due to an injury or impairment, or if you involuntarily lose your job. This coverage can help provide financial support and allow you to concentrate on your needs; whether it is improving your health, or concentrating on finding a new job and possibly upgrading your skills. 

Mortgage default insurance and optional mortgage protection insurance are different in important ways.

Mortgage default insurance:

• Is mandatory if your down payment on your home purchase is under 20%
• Protects your bank in case you default on your loan; it does not protect you or your interest in the property
• Your lender automatically applies for it for you (if needed) and normally incorporates the cost of the premium in your mortgage payment amount
• The premium cost is calculated based on a percentage of the principal amount of your loan (the percentage is determined by your loan to value ratio); learn more about how that is calculated in our mortgage default insurance guide

Optional mortgage protection insurance:

• Offers you protection during times of financial hardship by paying off the remaining balance of your mortgage if you pass away or become critically ill, or by maintaining your mortgage payments for a period of time if you if you’re unable to work due to a disability or experience involuntary job loss
• You can add it at any time through your lender
• The premium cost will depend on certain variables, such as the amount of  your mortgage at the time you apply for insurance, your age, and the amount of your monthly payments

Mortgage default insurance can help you to buy a home sooner if your down payment is less than 20%. While you might need to get mortgage default insurance, it's important that you also consider protecting your biggest asset by purchasing optional mortgage protection insurance. 

Mortgage insurance is an important aspect of homeownership that you may need to consider and budget for. Whether you need to get mortgage default insurance because your down payment is less than 20% or if you want to get optional mortgage protection insurance in order to protect your investment, mortgage insurance is critical to consider during your homeownership journey.

And once you figure out what kind of insurance you need or want, you can move onto some of the more exciting parts of your new home, like deciding which colour will look best in your new master bathroom.