Monday, August 12, 2013

Mortgage Insurance - What's it for?

Everyone has heard of Mortgage Insurance, but it often is confused with Homeowners Insurance when people initially start the mortgage process.  Because of that I want to clarify a couple types of insurance and then speak to the main point of Mortgage Insurance; what it is and what it is for.

The main insurance that any borrower is going to need when buying a home is "Homeowners Insurance".  This insurance protects the borrower against damage to the home via fire, robbery, etc.  It is necessary, when there is a mortgage, to carry Homeowners Insurance as it protects the owner and the lender in the event of a catastrophy (like a fire) to recoup the loss. 

Another type of insurance that is sometimes required is Flood Insurance.  This insurance protects against a flood.  The lender will require this, if during the home loan process, the lender discovers through the Flood Certificatet that the home is located in a flood zone.  Note:  Not all homeowners policies protect against flooding, so this is why the lender requires it if the home is in a flood zone.

The insurance in question - Mortgage Insurance.  Since you have a homeowners policy, and a flood policy (if required), why the need for extra insurance.  To start - not all loans require mortgage insurance.  Any loan that results in an equity position of 20% or more, does not require Mortgage Insurance.  (Essentially, if you buy a home with 20% down or more, 99% of the time the MI will not be necessary - the 1% of the time is if you are using FHA, but that is a story for a different day).

Let's say that the down payment is less than 20%, what happens next.  The lender will require Mortgage Insurance. 

  • Mortgage Insurance is a policy can be defined as follows: An insurance policy that protects a mortgage lender or title holder in the event that the borrower defaults on payments, dies, or is otherwise unable to meet the contractual obligations of the mortgage. 
Basically, the lender takes out an insurance policy (that the borrower pays for through monthly or single installments) to protect against the risk of default.  But the lender doesn't want to pay for the policy, so the borrower puts less money down and then makes monthly payments to cover the cost of the insurance.  Historically, when the value of the home gets to 78% LTV based on the Amortization schedule, the mortgage insurance policy is satisfied and the borrower no longer has to pay the monthly premium.  - This is the standard way people use MI.  There are other types of MI (Single Premium, Lender Paid, etc) but we will save those for a different post.

Quick Review:
  • Mortgage Insurance - protects lender against default when borrower puts less than 20% down towards the purchase
  • Borrower pays mortgage insurance monthly as part of the monthly payment
  • Once loan reaches 78% LTV based on the Amortization schedule MI automatically is removed (unless FHA loan - then continues for the life of the loan)
  • Can get MI up to 97% of LTV on a purchase (so 3% down payment required)

Is Mortgage Insurance a good option?  -- In short, yes.  When borrowers don't have the full liquidity to put 20% down, but can afford the monthly mortgage payment (including the MI), then Mortgage Insurance can help them begin their purchase process sooner rather than later.

I will explain the difference with FHA mortgage insurance in a different post later this week.

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