What Is Mortgage Insurance?
Mortgage insurance is an insurance policy that protects a mortgage lender or titleholder if the borrower defaults on payments, passes away, or is otherwise unable to meet the contractual obligations of the mortgage.
Mortgage insurance can refer to private mortgage insurance (PMI), qualified mortgage insurance premium (MIP) insurance or mortgage title insurance. What these have in common is an obligation to make the lender or property holder whole in the event of specific cases of loss.
Mortgage life insurance, on the other hand, which sounds similar, is designed to protect heirs if the borrower dies while owing mortgage payments. It may pay off either the lender or the heirs, depending on the terms of the policy.
If you can’t pay your mortgage, mortgage insurance protects your lender from financial loss. It doesn’t provide any coverage for your home; it only protects your mortgage lender.
If you put less than 20% down on a home purchase, the lender considers your mortgage to have a higher risk. Therefore, mortgage insurance protects their investment if you stop making loan payments.
- Mortgage insurance refers to an insurance policy that protects a lender or titleholder if the borrower defaults on payments, passes away, or is otherwise unable to meet the contractual obligations of the mortgage.
- Three types of mortgage insurance include private mortgage insurance, qualified mortgage insurance premiums, and mortgage title insurance.
- It should not be confused with mortgage life insurance, which pertains to the protection of heirs if the borrower dies while owing mortgage payments.
How Mortgage Insurance Works
Mortgage insurance may come with a typical pay-as-you-go premium payment, or it may be capitalized into a lump-sum payment at the time of mortgage origination.
For homeowners who are required to have PMI because of the 80% loan-to-value ratio rule, they can request that the insurance policy be canceled once 20% of the principal balance has been paid off. Here are three types of mortgage insurance:
Private Mortgage Insurance (PMI)
Private mortgage insurance (PMI) is a type of mortgage insurance that a borrower might be required to buy as a condition of a conventional mortgage loan.
Like other kinds of mortgage insurance, PMI protects the lender, not the borrower. The lender arranges PMI and it’s provided by private insurance companies.
PMI is usually required if a borrower gets a conventional loan with a down payment of less than 20%. A lender might also require PMI if a borrower is refinancing with a conventional loan, and equity is less than 20% of home value.
Qualified Mortgage Insurance Premium (MIP)
When you get a U.S. Federal Housing Administration (FHA)-backed mortgage, you will be required to pay a qualified mortgage insurance premium, which provides a similar type of insurance.
MIPs have different rules, including that everyone who has an FHA mortgage must buy this type of insurance, regardless of the size of their down payment.
Mortgage Title Insurance
Mortgage title insurance protects against loss in the event a sale is later invalidated because of a problem with the title. Mortgage title insurance protects a beneficiary against losses if it is determined at the time of the sale that someone other than the seller owns the property.
Before mortgage closing, a representative, such as a lawyer or a title company employee, performs a title search. The process is designed to uncover any liens placed on the property that would prevent the owner from selling.
A title search also verifies that the real estate being sold belongs to the seller. Despite a thorough search, it isn’t hard to miss important pieces of evidence when information is not centralized.
Mortgage Protection Life Insurance
Borrowers are often offered mortgage protection life insurance when they fill out paperwork to start a mortgage. A borrower can decline this insurance when it is offered, but you may be required to sign a series of forms and waivers verifying your decision. This extra paperwork is intended to prove you understand the risks associated with having a mortgage.
Payouts for mortgage life insurance can be either declining-term (the payout drops as the mortgage balance drops) or level, although the latter costs more. The recipient of the payments can be either the lender or the heirs of the borrower, depending on the terms of the policy.
The average down payment for first-time homebuyers was 6% in 2019, according to the National Association of Realtors. Among all home buyers, it was 12%. If you’re like the average homebuyer and plan to put down less than 20%, you should budget for an extra expense—mortgage insurance.
With all of the other costs involved in buying a home, you’ll want to understand when mortgage insurance is required, how long you have to have it, and how much it will cost.
When Are You Required to Have Mortgage Insurance?
Different mortgage types and lenders have varying mortgage insurance requirements. While some may require mortgage insurance as a monthly payment, others may require an upfront fee or a combination of both.
Conventional Loan Mortgage Insurance Requirements
If you have a conventional loan through a private lender and put less than 20% down, the lender can require you to purchase private mortgage insurance (PMI). While some lenders require the borrower to pay for the mortgage insurance, other lenders offer lender-paid mortgage insurance.
In other words, instead of directly paying for the mortgage insurance, the lender increases the interest rate to account for the additional risk of the loan.
There are several ways you can pay for your PMI if it’s a requirement:
- Pay the entire amount in full
- Make monthly payments
- Or combine the two options
- Most borrowers choose to make monthly payments.
You’ll continue paying for PMI until your mortgage balance reaches 80% or less of the home’s value and you have made timely payments. At this point, you should request the removal of PMI. Some lenders will automatically remove PMI when your loan balance reaches 78% of the original value of the home.
It’s important to point out that it’s your responsibility to keep track of the loan balance and payments. So when you reach a sufficient amount of equity, it’s up to you to request a cancellation of PMI. If you don’t, you could end up paying more premiums than you need to.
Some conventional lenders don’t require PMI, even if you put less than 20% down. So before applying for a mortgage, ask the lender about the PMI requirements.
FHA Mortgage Insurance Requirements
Suppose you choose a Federal Housing Administration (FHA) loan. In that case, you’re required to have mortgage insurance and pay it as an upfront mortgage insurance premium (UPMIP) and annual mortgage insurance premium (MIP) regardless of your down payment amount.
Similarly, if you choose a U.S. Department of Agriculture (USDA) loan, you pay mortgage insurance in the form of a guaranteed fee and an annual upfront fee.
With an FHA loan, there are some circumstances where you can’t cancel your mortgage insurance when you reach 20% equity. MIP will remain on your loan indefinitely if you put less than 10% down. On the other hand, MIP can be removed after 11 years if your down payment is over 10%.
How to Get Mortgage Insurance
Your lender will select your mortgage insurance from a private company if you have a conventional loan. The payment is included in the monthly payment to your lender. Other lenders increase your interest rate to account for the mortgage insurance payment.
Unlike conventional loans, FHA loans require an upfront mortgage insurance payment as part of your closing costs. But like conventional loans, the other portion of your mortgage insurance is added to your monthly payment. Both payments are paid to the FHA.
How to Avoid Mortgage Insurance
If possible, you can avoid mortgage insurance since it covers your lender, not you. To avoid paying this additional expense, here are a few options.
- Put down 20% or more. If you can put more than 20% down on a conventional loan, you probably avoid paying for PMI.
- Take out a piggyback loan. With this type of loan, you can put 10% down and get another loan to cover the other 10% of the down payment.
- Apply for a VA loan. If you qualify, you could buy a home with a VA loan, which doesn’t come with mortgage insurance requirements.
- Compare lenders. Before you decide on a home, compare loan options and offers from various lenders; some may not require mortgage insurance. Review all costs involved to find the most suitable option for your needs.
If you do end up purchasing a home with mortgage insurance, make sure to keep track of the equity built in your home. This way, once your loan is less than 80% of the home’s value, you can either refinance or request a cancellation of your mortgage insurance if your lender allows it.
Some state first-time homebuyer programs offer low-down-payment mortgages with no or reduced mortgage insurance requirements.
But generally, you’ll need to get a conventional mortgage and put at least 20% down toward a home to avoid mortgage insurance.
If that’s not possible, then budget in the cost of mortgage insurance or VA or USDA fees when calculating how much home you can afford.
The Bottom Line
Mortgage insurance costs borrowers money, but it enables them to become homeowners sooner by reducing the risk to financial institutions of issuing mortgages to people with small down payments. For lifestyle or affordability reasons, you might find it worthwhile to pay mortgage insurance premiums if you want to own a home sooner rather than later.
Adding to the reasons for doing this: Premiums can be canceled once your home equity reaches 80% if you’re paying monthly PMI or split-premium mortgage insurance.
However, you might think twice if you’re in the category of borrowers who would have to pay FHA insurance premiums for the life of the loan. You might be able to refinance out of an FHA loan later to get rid of PMI.
On the other hand, there’s no guarantee that your employment situation or market interest rates will make a refinance possible or profitable.
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