Consequences for mortgage default

Do you think mortgage loan insurance will cover the bank’s losses if you default? Think again. The law can still hold you responsible.

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One of the benefits of working at MoneySense is getting to answer questions from readers and a recent question begged an answer and some clarification around mortgage loan insurance.

Now, mortgage loan insurance should not be confused with mortgage insurance, a fairly restrictive and (typically) not very cost-effective insurance product sold by banks to protect your housing investment should you become ill or pass on.

Mortgage loan insurance is the fee you pay anytime you buy a property in Canada with less than 20% down. The fee is calculated based on how big of a down payment you make on the investment in relation to your home’s purchase price (ie: as a percent, how much of a down payment did you make).

Unlike most other insurance products, mortgage loan insurance does not cover your losses, should you default on a home — it covers the lender’s losses.

And this is where one of our readers stepped in with an ethically sensitive question:

Since mortgage loan insurance was bought, performing a strategic default is simply collecting on the expensive insurance policy that was purchased for that very reason. The bank is not out any funds owed as it’s covered by this insurance. The CMHC [or one of the other two institutions that underwrites mortgage loan insurance] loses on this one, but still wins most—which is, of course, the model of the insurance business.

So why not default?

The simple answer: Because you could still be on the hook for a portion of the original mortgage.

Under Canadian law insurance companies can legally come after you to replace any lost funds due to the foreclosure of your home—it’s called subrogation, and it’s a well-used legal tactic where the insurance company will try and recoup some or all of its losses for a paid out claim.

Of course, then there’s the ethical dilemma: why force Canadian taxpayers to pay your debt through court fees and higher mortgage insurance loan premiums?

Thankfully, defaults are not common in Canada. According to statistics from the Canadian Bankers Association, the number of defaulted mortgages has never risen above 1% in the past 20 years.

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