If you’re planning to use a mortgage to finance the purchase of a home, it’s important that you understand how mortgage insurance works. What is mortgage insurance? Who does it benefit? Who has to pay it, and why are so many people eager to avoid it? Understanding mortgage insurance can help you make smart decisions about your loan options.
What Is Mortgage Insurance?
What is mortgage insurance? As The Balance reports, it’s an insurance policy for home loans. Basically, this insurance steps in to pay all or part of the outstanding balance if a borrower defaults on their home loan. While the borrower is the one who makes the premium payments for this insurance, they do not get a payout if they default on their loan obligations. Instead, the insurer pays out to the lender.
Who Benefits from Mortgage Insurance?
Since the lender receives the payout in the event of a default, it’s pretty obvious that the lender benefits from mortgage insurance. However, the lender is not the only one to benefit. While it’s subtler, mortgage insurance also gives borrowers a welcome advantage. As The Street points out, the use of mortgage insurance reduces the risk of loaning money and enables lenders to take more chances. As a result, they can make more loans available and offer them to borrowers who would otherwise be turned down.
A Mortgage Insurance Breakdown
How does mortgage insurance work? Who has to pay for it? The answers to those queries depend in part on the type of loan. As NerdWallet reports, conventional, FHA, and USDA loans all have their own versions of mortgage insurance:
- Borrowers who opt for a conventional loan and make a down payment of less than 20 percent will be required by their lenders to pay for private mortgage insurance, or PMI. The cost of PMI is determined by the size of your loan, your credit, and various other factors. The monthly premium is tacked onto your mortgage payment. In many cases, you can request to cancel the PMI once you have at least 20 percent equity in your home, but you have to formally request the cancellation.
- Borrowers with an FHA loan don’t pay for PMI. That’s because the FHA has its own version of mortgage insurance. Borrowers pay an upfront mortgage insurance premium and an annual mortgage insurance premium, which is divided into monthly chunks and added to their regular mortgage payment. People who put down less than 10 percent will pay this annual fee for the entire life of the loan. Those who put down more than 10 percent only have to pay the annual fee for 11 years.
- Borrowers with a USDA loan also pay an upfront fee for the program’s own version of mortgage insurance and an annual fee that is owed each year over the life of the loan. Once again, the annual fee is broken down and included in the monthly mortgage payment.
The Trouble with Mortgage Insurance
Mortgage insurance may help boost the availability of mortgages, but it gets little love from homebuyers. Why are people eager to avoid it? Quite simply, mortgage insurance is an additional cost. While the premium is split into monthly segments, it adds up and can amount to thousands of dollars each year (source).
How to Avoid Mortgage Insurance
What can you do to avoid mortgage insurance? As SmartAsset notes, using a conventional loan and making a down payment of at least 20 percent will generally free you from the requirement for mortgage insurance. Can you cobble together a 20-percent down payment through savings, gifts, and down payment assistance programs? If not, taking out a second loan for the amount needed to bring your down payment to 20 percent might be an option. Explore your options with your accountant or a licensed financial advisor.
Mortgage insurance is just one of the factors that you’ll want to weigh when plotting your path to homeownership. At PrimeLending of Wichita, we listen carefully and work with you to help you identify the right loan product for your needs. Contact us today to get started.