We already know that when you are going to buy a property using a mortgaged loan with less than 20% down payment, then you have to pay an insurance premium. We also know that these all default insurance is done just to get you the best (Prime) rate. What you may not know is – without these default insurances the lenders will have difficulties to securitize (sell them in the market) the mortgages.
This insurance is called default insurance. To offer you the best interest rate despite of a low down payment, the lenders need that insurance. If in case you fail to pay the mortgage installment then the lender can ask the insurer to pay them the money and the insurer will take care of the rest. That process is called power of sale.
There are three main mortgage default insurers in Canada; they are CMHC, Genworth and Canada Guaranty. If you have an insured mortgage then they cover the lender if a default occurs.
I hope that you already know about the premium amount, so let us go on.
Like any other insurance coverage, in this case the financial health of the borrower and the asset is carefully assessed by the lender and the insurer. You may know that they often requests for an appraisal to make sure the proper value of the property is taken. They also look into your credit records to judge the type of risk you may pose.
After a lender has issued a mortgage, it has the option to sell it to investors in order to access that fund again. Lenders use financial brokers and underwriters to do that. Investors who want to buy those mortgage papers (sometimes called as asset backed papers) evaluate the value of those bonds or papers based on the risks involved. If it is backed by an insurer then that becomes a vary secured investment (Only under normal circumstances. In the past, financial crisis claimed lives of default insurers in US).
Bonds are usually low yielding investments. People generally regard bonds as safe investments. Therefore buying bond which is backed by insurance just reinforces that ides. The appetite for insured bonds is higher among investors who are looking for safety.
Mortgages with higher than 80% loan to value (LTV) are generally default insured, they can be securitized easily. Some lenders, who securitize 100% of their mortgages often insists for default insurance for mortgage with lower than 80% LTV. In those cases the borrower has to fork the premium out – to insure the loan. Naturally the interest rates offered by those lenders are very low, to cater for that extra money.
Lenders, who do not require a borrower to pay default insurance premium on a lower than 80% LTV mortgage, often decide to insure the loan by paying the premium from their own pocket. That helps them to sell the securities easily. CMHC has a process for the lenders to do this and it is known as “Portfolio Insurance” or “Bulk Insurance”. The term bulk indicates that the lenders generally submit a lot of applications bundled together.
When a mortgagor requires all loans including low LTV loans to be insured by a default insurer then they can securitise those directly. Generally those are known as flow insurance.
These are just some simple facts of mortgage default insurances. The real process of securitizing them is much complex and lengthy. In Canada most of the mortgage insurance is done by CMHC. The average equity in CMHC’s insured portfolio is about 45% (65% Loan to Value). The average credit score of the CMHC insured high-ratio homeowners is 724. (source)
