Mortgage Insurance is an insurance policy that protects a title owner in case of an event where the borrower evades payment or defaults to honor the contractual obligations of the mortgage. The main purpose of Mortgage Insurance is to protect the lender or titleholder in the event of loss or foreclosure. It is different from Mortgage Life Insurance which is mainly designed to reimburse heirs of the title holder in the event that a borrower dies while owing payments. It is reported that foreclosures can cost lenders a steep rate of 30 to 60% outstanding loan balance. Mortgage Insurance lowers this risk, subsequently giving buyers access to loans that they otherwise might not qualify for.
How Does Mortgage Insurance Work?
Mortgage Insurance comes in different forms which are available to a home buyer with low down payments. The payment plan depends on what type of loan is given. These include Private Mortgage Insurance (PMI), Government Loans and Mortgage Title Insurance.
Private Mortgage Insurance (PMI)
This is a form of mortgage insurance that is available for non-government mortgage loans. It is provided by private insurance companies and is usually arranged by the lender. Applicants have to be approved by both the mortgage lender and insurer. PMI protects the lender of the loan, not the borrower. PMI costs of coverage vary depending on the down payment, the type of coverage, the mortgage program and the credit score of the borrower. The monthly premium is the most common option. It is usually cheaper at the outset, and it can be cancelled under circumstances where the loan balance drops to 80%of the property’s original price.
PMIs are more affordable than Federal Housing Administration (FHA) loans for buyers with good credit scores. They are calculated by dividing an annual rate by 12. Annual rates are mostly about 1-2% of the outstanding principal loan.
Another option available is the single premium policy. It can be bought upfront by the buyer, agent, lender, seller or builder. There is also an option for a split premium, which combines a less costly upfront payment with a cheaper monthly fee. It is more ideal to get the seller to pay the single premium during negotiations.
Lastly, lender-paid PMI is also a viable route. The lender may buy the coverage from an insurer and in return charge a higher interest rate. They could also charge a higher rate to self-insure. It can provide a better tax write-off for borrowers with higher incomes. Although, the downside is this option cannot be cancelled.
Government-backed home loans including Federal Housing Administration(FHA), Veterans Affairs (VA) and U.S Department of Agriculture (USDA) usually require an insurance known as Qualified Mortgage Insurance Premium (MIP).
FHA mortgage insurance premiums are paid to the Federal Housing Administration. A vital condition of MIPs is that everyone who has FHA mortgage is mandated to buy this type of insurance regardless of the amount of their initial down payment and credit score. FHA loan insurance has both an upfront premium and annual premium that is divided by 12 and added to the borrowers’ monthly payments.
There is a slight increase in price for down payments of less than 5%. Unlike the PMI, FHA insurance cannot be cancelled. If the buyer does not have enough money on hand to pay the upfront fee, they have the option of rolling the fee into their mortgage instead.
The USDA is quite similar to the FHA but usually cheaper. The borrower is required to pay for the insurance both at the closing and as a part of their monthly payments. The option to roll the upfront part of the insurance premium into the mortgage is also available.
The Veterans Affair (VA) loan are loans targeted to help veterans, service members, and their families. The VA guarantee replaces mortgage insurance. There is no monthly MIP, although a payment for an upfront funding fee is required. The amount of the fee varies depending on: type of military service,
disability status, whether a home is being bought or refinanced and lastly, whether it is the first VA loan for the buyer. VA loan functions similarly to the FHA and USDA loans by providing the option to roll up the upfront fee.
Mortgage Title Insurance
This type of insurance protects the lender against loss in cases where a sale contract is annulled due to a problem with the title. The beneficiary is fully protected if it is discovered that there might be multiple owners of the title at the time of sale. An essential precaution to take before any mortgage closing is to perform a thorough investigation of the title by a lawyer or a representative. This process can expose any obstacles placed on the property that could hinder the sale. A title search also confirms that the property being sold belongs to the seller.
Overall, mortgage insurance is vital when considering a home loan. The cost can affect the overall price of the loan, and not all lenders divulge it in the same way. Another alternative is a second money mortgage, also known as a piggyback. It could be cheaper for the buyer as it decreases the first mortgage to 80% and eliminates the use of home loan insurance. It is advisable always to compare total cost to make an informed decision. Lastly, increasing down payment and improving credit score can generally lead to lower PMI rates.