What Is Mortgage Insurance, And How Does It Work?

What Is Mortgage Insurance, And How Does It Work?

When talking about a home purchase, we usually hear about price, interest rates, and payments. Did you know that mortgage insurance plays a major role in your decision on what loan to use when purchasing or refinancing? We will explore how mortgage insurance works.

The History | The federal government developed the Federal Housing Administration (FHA) to provide guaranteed home loans to individuals that qualified. These FHA backed loans included mortgage insurance. In the 1950s, the Mortgage Guaranty Insurance Corporation (MGIC) received a charter to begin offering private mortgage insurance that was separate from the FHA mortgage loans. MGIC would only insure 20% of the mortgage loan value, this made banks more comfortable extending home loans to more people and resulted in the housing boom in the 1960s and 70s.

Protecting Investment | Let’s use auto insurance as an analogy to explain the basics of mortgage insurance. If you have an accident and do damage to your vehicle, you would likely contact your insurance company to get it repaired. The company representative will oversee the process, thus protecting your investment in the vehicle. Your paid premiums are now benefitting you. Conversely, when you purchase a home with a down payment less than 20%, the lender can consider this a risk. Mortgage insurance is designed to protect the lender’s investment in you. If you become unable to make your mortgage payments, the lender will foreclose, and the mortgage insurance company will pay the lender for 20% of the home. Your premiums in this case protect your lender. 

Insurance Cost | Your mortgage insurance rates will vary depending on your down payment, the loan term, and your credit score. Rates usually range from 0.20% to 1.5% of the loan amount.

Here is an example for:

  • Married couple with an average credit score of 720. 

  • 5% down payment on a home valued at $300,000. 

  • Choose a 30-year fixed term for their home loan. 

  • Private mortgage insurance provider determines a yearly rate of 0.44% of the loan.

Calculated as follows:

  • Home Price $300,000

  • Down Payment $15,000

  • Loan Amount $285,000

  • Multiplied By .0044 $1,254

  • Divide By 12 For Monthly Payment $104.50

Remember that a lower credit score may require a higher percentage of loan amount, and a higher monthly payment. It is wise to inquire about mortgage insurance with your lender, and to compare the different loan types. 

Type Of Mortgage Loan | The type of mortgage loan that you select will affect your mortgage insurance rate. Conventional loan insurance rates start at 0.20% of loan amount. Mortgage insurance for 30-year FHA loans start at 0.85%, if you are paying less than 5% down. Additionally, FHA insurance charges a fee at the time that the loan is finalized. This fee can be added to the loan amount, allowing you to pay it over time. Insurance costs for USDA loans are very similar to FHA. The VA mortgage is the only type not requiring a monthly insurance amount. It does charge a funding fee at the time of closing, which can be added to the total loan amount to save you money at closing. 

It’s Not Forever, Or Is It? | When your loan balance reaches 78% of the home’s value, federal law states that your mortgage insurance premium must end. Multiple factors can contribute to a home’s loan balance reaching the 78% of value ratio. Improvements and increasing home prices in your area can be factors. A REALTOR® can be helpful by providing you a list of comparable home sales in your area to determine your home’s current value allowing you to request your lender drop your private mortgage insurance. FHA loans with less than a 20% down payment now require mortgage insurance to remain in place for the life of the loan. To get around this, you can refinance when your loan balance reaches 78% of your home’s value. 

So, when you are in the market to purchase a home, it is important to discuss different loan types that are available to you. Your REALTOR® can connect you with home mortgage lenders in your area that will provide you with the information you need to make an informed decision.

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