What Is Mortgage Insurance (And Why Do I Need It)?
Mortgage insurance is typically required for borrowers who are unable to make a large initial down payment on their mortgage. This protects lenders in the event of a default, death, or inability to pay back debt. While mortgage insurance is paid for by the borrower, it usually benefits the lender. However, it also provides the opportunity to take out a mortgage with a much smaller down payment.
Although there are a few different types of mortgage insurances with different terms and requirements, the most common is Private Mortgage Insurance, or PMI. Get the answers to a few of the most common questions surrounding PMI and decide if it’s the right choice for you.
When is Mortgage Insurance Required?
Lenders typically require Private Mortgage Insurance for borrowers who put down less than 20% on a mortgage. This is because lower down payments are usually seen as higher lending risks. PMI is used to protect against default. Simply put, if a borrower were to make a down payment of 10% on a mortgage, a lender would require them to pay an insurance provider to cover the remaining 10%. In the unfortunate event that the borrower defaults, the lender would be able to collect the remaining 10% of the mortgage down payment from insurance, plus the initial 10% they put down, totaling 20%. While this may initially appear to be a good solution for borrowers who cannot afford a full 20% mortgage down payment, it usually comes at an additional cost.
How Does Mortgage Insurance Work?
After figuring out how much of a down payment PMI will have to cover, most borrowers want to determine just how much it will cost them. Typically, rates range between 0.5 and 1% of the total loan balance annually. This depends on a number of factors including the size of the initial down payment and mortgage, loan term and type, potential for property appreciation, and an applicant's credit score. When it comes to repayment, borrowers sometimes have the option to pay in one lump sum at the time of the mortgage. In most cases payments are made monthly. This can potentially add hundreds of dollars onto each monthly mortgage payment. However, borrowers can usually avoid doing this by putting down 20% initially on a mortgage.
Can Mortgage Insurance Be Canceled?
Borrowers can request a cancellation of mortgage insurance once their loan-to-value ratio drops to 80%. This means that both the initial down payment and loan principal payments have totaled to 20%. Additionally, according to the Homeowners Protection Act, lenders are typically required by law to remove mortgage insurance automatically once the loan-to-value ratio reaches 78%. Other options that may help cancel mortgage insurance include refinancing or remodeling. If there is an increased market value of the home, it may help bring the borrower closer to the minimum loan-to-value goal. Likewise, if a new addition to the home has increased its worth, the borrower may be able to cancel their mortgage insurance. While it might not be the easiest thing to accomplish, getting rid of mortgage insurance saves a lot of money in mortgage payments each month.
Understanding how mortgage insurance works is important, and borrowers should know where they stand financially. While it enables smaller initial down payments, it may end up costing more long term. Always remember to weigh options and take a look at the numbers to decide if mortgage insurance is necessary.