What Is Mortgage Insurance
In the mortgage and real estate world, most people discuss interest rates, payment terms, and sales price. Without a doubt, those are all extremely important topics to consider. However, the topic of mortgage insurance gets less attention even though it can play a major role in deciding what loan to use for a purchase or refinance. The following article will explain how mortgage insurance works and why it can be a benefit to borrowers.
Brief History Of Mortgage Insurance
In the United States, companies offered mortgage insurance starting in the 1880s. When the Great Depression occurred in the late 1920s to mid-1930s, all of the organizations that formerly offered mortgage insurance were out of business. The federal government stepped in and developed the Federal Housing Administration (FHA) to provide guaranteed mortgage loans to qualifying individuals. These loans included federally provided mortgage insurance.
In the mid-1950s Mortgage Guaranty Insurance Corporation (MGIC) received its charter to begin offering private mortgage insurance separate from the FHA mortgage loans. MGIC business model was different from the mortgage insurance carriers that had previously gone out of business. MGIC would only insure 20% of the loan’s value. Using this mortgage insurance, banks felt more comfortable extending home loans to more people and thus home boom of the 1960s and 1970s was born.
Insurance that Protects Investment
We will use car insurance as an analogy to explain the basics of mortgage insurance.
For example, suppose you own a vehicle with no liens or loans. The vehicle is currently worth $22,000. If you were driving down the road and suddenly had a flat tire that caused you to swerve into a guard rail on the interstate, it would likely do some damage to your car. You would likely contact a tow service to get your vehicle to a repair shop and then contact your insurance agent. The agent would inspect the vehicle, confer with the mechanic and decide on the amount needed to fix the vehicle. Thankfully, all the premiums that you have paid on the car are now benefitting you. The insurance company will oversee getting the car fixed, thus protecting your investment in the car.
When a person buys a home and pays less than 20% down on the home, this is considered a risk for the lender. After all, the lender is providing a check to the seller of the home on your behalf. You are then agreeing to repay that amount, plus interest, over a determined number of years. Therefore, the mortgage insurance is designed to protect the lender’s investment in YOU. If your financial situation changes, and you are not able to repay the home loan, the lender will foreclose on the home. The mortgage insurance company will pay the lender for 20% of the home. The lender will then sell the home in hopes of receiving enough to pay off the balance of the existing loan.
Always remember: the amount that a borrower pays for mortgage insurance is earmarked to protect the lender, not the borrower.
Just as car insurance rates vary based on the type of car and the owner’s driving history, private mortgage insurance rates will vary based on the loan term, the down payment provided at purchase and the borrower’s credit score.
Rates for mortgage insurance usually range from a minimum of 0.20% all the way to 1.5% for a conventional loan. Here is how the rates are applied and how borrowers pay the premium.
Suppose a married couple has an average credit score of 720. They make a 5% down payment on a home valued at $300,000. They choose a 30-year fixed term for their home loan. Their private mortgage insurance provider determines that their yearly rate is 0.44% of the loan.
This means that the first year of the loan, the borrowers will pay $104.50 per month. This is calculated as follows:
|Minus down payment||$15,000|
|Equals Loan amount||$285,000|
|Loan amount multiplied by 0.0044||$1,254.00|
|Divided by 12||$104.50|
However, what if the borrowers had a lower credit score and all the other factors were the same? If the mortgage insurance company decided that the lower credit score required borrowers to pay 1.5% in insurance, the monthly amount would be $356.25. Obviously, it is wise on the borrower’s part to inquire about mortgage insurance with their lender and consider different loans before making an offer on a home.
Loan Type Also Factors into Mortgage Insurance Rate
The type of mortgage loan also affects the mortgage insurance rate. For example, in the previous section, it was discussed that mortgage insurance rates start at 0.20%. This is true for conventional loans. However, for borrowers that are considering a 30-year FHA loan, the starting rate for FHA mortgage insurance is 0.85% if the borrower pays less than 5% down.
FHA also charges a fee at the time the loan is finalized. This particular fee can be added to the total loan amount so that the customer can pay the fee over time with the regular mortgage payment.
For a USDA loan, the mortgage insurance rate is very similar to FHA.
The VA mortgage, designed for qualified veterans as well as active duty military, is the only mortgage that does not require a monthly mortgage insurance amount. The VA does charge a funding fee when the loan is closed, but this is a one time fee and it can be added to the total loan amount in order to save the borrower money at closing.
Mortgage Insurance is not Forever
The good news is that mortgage insurance does not last forever. When the loan balance reaches 78% of the home’s value federal law states that the mortgage insurance premium must end and the borrower no longer has to pay it.
It is also possible that other factors can raise a home’s value to the 78% threshold. For example, if you have performed efficiency updates like better windows, doors or a new roof, the value of the property could rise significantly. Furthermore, if the home prices in your general area have increased faster than other parts of town, your home’s new value could be less than 78% of the mortgage balance. If you find yourself in either of these situations, talk to your real estate agent. An agent can prepare a list of comparable home sales in your area to determine your home’s current value and give you data to use when you ask your lender to drop the private mortgage insurance.
HOWEVER, that is not the case with FHA loans. FHA made a change in recent years concerning mortgage insurance. If a borrower buys a home using FHA financing with less than a 20% down payment, the mortgage insurance will remain in place for the life of the loan. The simple answer to remedy this is to refinance the loan when the balance has dropped to at least 78% of the home’s value.
Summing Up What Is Mortgage Insurance And How Does It Work
If you are in the market to purchase or refinance a home, make sure to speak to your lender about your loan to value ratio and the different types of loans that are available to you. It could be worth your while to consider a different loan, or even a larger down payment, in order to save money in the long run.
Additional Home Buyer Resources:
First Time Home Buyer Mistakes via Sharon Paxson
The Importance Of The Septic Inspection by Joe Boylan
Struggles Of First Time Home Buyers by Geoff Southworth
About the author: This article on “What Is Mortgage Insurance and How Does It Work?” was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of their social media profiles as well as generating new leads from his website.
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