sure. we got it for our cars. we get it for our health. we get it for our homes. why? for peace of mind. having insurance helps us sleep a little better and worry a little less about unexpected mishaps in life. We pay our premiums every month so that if something happens, we can file a claim, fix the problem, and get on with our lives. So, let’s talk about mortgage insurance. Going by the thinking above, it would be easy to think that the purpose of mortgage insurance is to protect your mortgage in the event that you are unable to make your payments. Unfortunately, that is not the case with mortgage insurance.
Mortgage insurance protects your lender if you can’t make your mortgage payments.
When your lender lends you the money to buy a home, they put a lien on the property in case you stop making payments. they can then legally take the property to offset the unpaid balance of the loan if you default. that’s called foreclosure, and lenders don’t like to pursue foreclosure because it’s expensive and time consuming.
When they give you the loan, they anticipate that you will be making payments throughout the term of your loan. however, sometimes things happen and you can’t make payments. lenders take risks when they lend money. One of their biggest fears is that their house won’t be worth enough to cover the outstanding balance if they foreclose. one of the ways they get some peace of mind is mortgage insurance.
Mortgage insurance works like regular insurance in that you pay monthly premiums to an insurance company and then, when something happens, your lender can file a claim to recover some of the cost of the foreclosure proceeding.
How is mortgage insurance determined?
When you apply for a conventional home loan, the lender looks at a few things to determine if you need mortgage insurance. it is not automatic for all loans. First, they look at how much your property is worth compared to how much you want to borrow compared to how much of a down payment you can afford. Comparing the value to the loan amount is called loan-to-value and is represented as a percentage. This percentage is what determines whether or not you will need mortgage insurance.
In most cases, any loan-to-value greater than 80% will require private mortgage insurance for a conventional loan program.
Let’s say you want to borrow $95,000 for a house that, for simplicity’s sake, costs $100,000. this would put it at exactly 95% loan-to-value. this is very risky for the lender. if they had to resell the property as a result of foreclosure, they may not be able to get all of their money back. in this case, they would advise you that the loan needs private mortgage insurance.
how does down payment help?
Your down payment reduces the amount you need to borrow and the likelihood you’ll need mortgage insurance. that is why it is optimal to put at least a 20% down payment. The further away from 100% loan-to-value you can get, the better off you are when it comes to needing private mortgage insurance. Your credit score can also have an impact on your overall need for private mortgage insurance. credit scores are an indicator of potential risk. Once it is determined that you need private mortgage insurance (PMI), the lender contacts an insurance provider and a policy is created, just as with life insurance. PMI companies have set rates based on loan-to-value ratio and credit rating. They also factor in borrower default rates, which they get from agencies like Fannie Mae and Freddie Mac.
how much does it cost?
This is a rough idea of how much you could pay for private mortgage insurance, based on a credit score of 740-759. The PMI amount is added to the principal, interest, property taxes, and property insurance to make up the total monthly mortgage payment. If you don’t get a subprime loan, you may be able to cancel your PMI once your loan-to-value ratio reaches 80% or less.
The Homeowners Protection Act requires lenders to automatically remove PMI once a non-subprime loan reaches 78% loan-to-value.
You will receive notice from your lender when this happens. If you are in a position to make additional mortgage payments each year, it will help you get there a little sooner. my payoff is usually dependent on a certain number of payments made and balance reduction, not just property value increase. usually my companies want you to pay the premium for a certain amount of time. If you got your home loan after January 1, 2007, you may also be able to deduct PMI when you file your taxes. check with your tax professional about that because this could change from year to year.
what about fha mortgage insurance?
If you get a Federal Housing Administration (FHA)-backed loan, mortgage insurance is handled a little differently. The premium is paid directly to FHA and is required for all FHA loans, regardless of your credit score or down payment. fha mortgage insurance includes an initial premium that is included in your closing costs and a monthly premium, which is in addition to the principal, interest, property taxes, and homeowners insurance that make up your mortgage payment. it still works the same as private mortgage insurance and protects your lender in the event you default on your mortgage loan. For FHA, if you can’t afford the initial premium, you can roll it into your loan, but you’ll still have monthly premiums. fha insurance rates are based on your term and down payment. Talk to your lender about what the current rates are for FHA loans.
unless you got your fha mortgage before June 3, 2013, fha mortgage insurance does not have automatic cancellation once you reach 78% loan-to-value.
As with any insurance, we all hope we don’t need it, but it’s a way to put your mind at ease. If you have any questions or concerns about mortgage insurance, talk to your lender.