What is mortgage insurance?

Mortgage insurance exists not to protect you, but to protect the lender.  Any time you put less than 20% down on a home you either have to pay mortgage insurance (or split the loan into two separate loans – called 80/10/10).

 

Why would I pay mortgage insurance?

The reason you’d get mortgage insurance is because you don’t have, or prefer not to put at least 20% down when purchasing a home. In essence, you are covering the extra risk the lender is taking by paying an insurance policy that makes the lender ‘whole’ if you default on the loan.

 

Here’s how it works

Let’s say you buy a home with 20% down and finance the remaining 80%. In order to lend you the 80%, the lender requires some paperwork to be filed that says if you fail to repay they’ll foreclose on the home in order to be repaid. However, the foreclosure process is expensive and lenders try to avoid this at all costs. On average, about 20% of the homes value is eaten up by the foreclosure process. Meaning, if you put 20% down and get foreclosed on, the lender would be lucky to get their initial principle investment back. 

 

All those homes back in 2008 that were foreclosed on, the lender lost a lot of money unless they had mortgage insurance – then the mortgage insurance company covered the loss.

 

How it’s structured

Mortgage insurance can be paid either in a onetime lump sum or on a monthly recurring basis. About 90% of all borrowers with mortgage insurance pay monthly, but that shouldn’t stop you from investigating if up front insurance makes most sense. Also, some loan types such as FHA or VA have mandatory insurance no matter how much money you put down

 

The two most common loan types (with mortgage insurance) are: 

  1. FHA
  2. Conventional

An FHA loan would have both upfront mortgage insurance and monthly mortgage insurance. The insurance is typically more expensive than a conventional loan. However, because there is more insurance you can typically put less money down (i.e. 3.5%), have lower credit scores and qualify for more than a conventional loan. 

 

A Conventional loan has stricter guidelines then it’s FHA counterpart but will typically have less mortgage insurance as well. Unlike FHA, the mortgage insurance will go away at a future date (more about that here).

 

Like any important life decision, talking with a trusted advisor is crucial. There are many people where mortgage insurance means the difference of being able to buy a home or not. 

Article courtesy of Drew Frampton 02 Mortgage 

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