What is Mortgage Insurance?

For many homebuyers, the mention of Mortgage Insurance causes them to scowl, but for some, it is a must. For First Time Homebuyers or those who simply aren’t able to afford a large 20 percent down payment, it is a viable option allowing for homeownership with as little as a 3 percent down payment.  This is especially true in high cost areas like San Diego County and throughout California.

What is Mortgage Insurance?

Mortgage Insurance (MI) is an insurance policy which compensates lenders or investors for losses due to the default of a mortgage loan. It is typically required when down payments are below 20%.  Mortgage insurance can be either public (government loans) or private (conventional loans).

It’s important to understand that the primary and only real purpose for mortgage insurance is to protect your lender—not you. As the buyer of this coverage, you’re paying the premiums, so that the lender is protected.  Mortgage Insurance is required by lenders due to the higher level of default risk that is associated with low down payment loans. Its only benefit to you is a lower down payment mortgage.

How Much Does Mortgage Insurance Cost?

Private Mortgage Insurance:  Rates can range from .32% – 2.00% of the principal of the loan per year based upon loan factors such as the percent of the loan insured, loan-to-value (LTV), fixed or variable, and credit score.  The rates may be paid in a single lump sum, annually, monthly, or in some combination of the two (split premiums).

For example, Mr. Smith decides to purchase a house in San Diego with a 30 Year Fixed Conventional Loan.  The purchase price is $325,000. He has 10% ($32,500) for a down payment and takes out a $292,500 purchase loan.  The mortgage insurer provides insurance coverage at 25% of the 292,500, or $73,125, leaving the lender with an exposure of $219,375.  The mortgage insurer will charge a premium of .49% of the loan amount for this coverage.  That will add $119.44 per month to the buyer’s total payment or $ 1,433 per year.  If the borrower defaults and the property is sold at a loss, the insurer will cover the first $73,125 of losses.

Government Mortgage Insurance:  To obtain public mortgage insurance from the Federal Housing Administration (FHA), Mr. Smith must pay a mortgage insurance premium (MIP) equal to 1.00 percent of the loan amount at closing. This premium is normally financed by the lender and paid to FHA on the borrower’s behalf. Depending on the loan-to-value ratio, there may be a monthly premium as well. If Mr. Smith buys the same San Diego house as above, using an FHA 30 Year Fixed Loan he is only required to put 3.5% ($11,375).  That would give him a loan amount of $313,625 and he would be required to have an annual mortgage insurance premium of 1.15% of the loan amount.  That would add $300 to his monthly housing payment.

Private Mortgage Insurance VS.  Mortgage Protection Insurance 

Private mortgage insurance and mortgage protection insurance are often confused.  Though they sound similar, they’re two totally different types of insurance products.  Mortgage protection insurance is essentially a life insurance policy designed to pay off your mortgage in the event of your death. Whereas, private mortgage insurance protects your lender, allowing you to finance a home with a smaller down-payment.  These two products should never be construed as substitutes for each other.

When Can You Get Rid of Mortgage Insurance? 

The US Homeowners Protection Act of 1998 allows for borrowers to request Mortgage Insurance cancellation when the amount owed is reduced to a certain level. The Act requires cancellation of borrower-paid mortgage insurance when the loan is scheduled to reach 78% of the original appraised value or sales price is reached, whichever is less, based on the original amortization schedule for fixed-rate loans and the current amortization schedule for adjustable-rate mortgages. FHA Mortgages require the homeowner to keep the Mortgage Insurance for at least 5 years.  Private Mortgage Insurance can be cancelled earlier by the homeowner by paying the loan down sooner or ordering a new appraisal showing that the loan balance is less than 80% of the home’s value due to appreciation.