Understanding Mortgage Insurance
Mortgage insurance is often an important part of the mortgage loan process. In some cases, it can mean the difference of getting the mortgage approved or denied. Learning more about mortgage insurance, and when it’s required, can speed up the lending process and help you become an informed buyer getting the most for your money.
What is Mortgage Insurance?
Mortgage insurance, also known as home loan and mortgage guarantee insurance, is a type of insurance that can make it possible for a home buyer to be approved for a mortgage loan for which they might not otherwise be approved. It decreases the chance of the lender losing money if a home buyer defaults on the loan. It’s typically used when the potential home buyer cannot come up with at least a 20 percent down payment.
Mortgage insurance guarantees that lenders will get a return on their money even if the borrower can’t make the payments. Mortgage insurance is usually required on both USDA and FHA loans. If you get a VA loan, the VA already guarantees the loan, so a mortgage insurance is not required. Mortgage insurance may also be referred to as private mortgage insurance (PMI).
How Does Mortgage Insurance Work?
When a potential home buyer applies for a mortgage loan but cannot provide at least 20 percent of the loan amount as down payment, the borrower is required to purchase a PMI policy. Say you borrow $150,000, but can only put down a $15,000 (10%) down payment, leaving a balance of $135,000. Your lender will purchase a PMI policy for $135,000.
Since PMI insurance generally covers the top 25 to 30 percent of the loan, your lender is guaranteed at least that much money back. The amount and cost of the policy is determined by the amount of the loan and the down payment.
For How Long is Mortgage Insurance Required?
The good news is the mortgage insurance is typically not required for the entire term of the loan. Once you’ve made enough mortgage payments to decrease the balance to less than 80 percent of the home’s value, you can request that the lender remove the mortgage insurance. Once your balance gets below 78% of your home’s value, the mortgage lender is required to eliminate the need for mortgage insurance.
How Much Will Mortgage Insurance Cost?
The cost of PMI is typically .05 to 1.0 percent of the loan. Using the $150,000 mortgage loan mentioned above, the mortgage insurance will be for $135,000. If you’re being charged 1 percent of the loan, your mortgage insurance will cost you about $1,350 or $112.50 ($135,000 X 1 percent = $1,350/12 = $112.50). Borrowers also have the option of purchasing the mortgage insurance upfront with one lump sum payment, which may be paid at closing or financed into the loan.
Mortgage Insurance vs. Homeowners Insurance
Mortgage insurance and homeowner’s insurance are often confused; however, they are two very different types of insurance. Homeowner’s insurance is an insurance policy that provides coverage in case your home suffers loss due to covered perils like fire, storm, etc. Mortgage insurance is a policy that protects the lender from loss if you fail to make your mortgage payments. While the lender may require them both, it’s important to not confuse one with the other.