What Is Mortgage Insurance For?

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Mortgage insurance is a type of insurance bought by a mortgagor which protects the lender from potential losses in the event that mortgage payments cannot be satisfied. It also covers losses resulting in cases when overall costs cannot be recouped through foreclosure. It is often referred to as "lenders mortgage insurance" (LMI) or "private mortgage insurance" (PMI).   

How much does mortgage insurance cost?

The calculation for mortgage insurance depends on many factors, including the following: total value of the loan, loan term and type, the coverage amount, and the amount of the home value that is financed. The most definitive factor in determining mortgage insurance rates, however, is the size of the down payment made when the mortgage is issued.  Any buyer who puts down less than 20% will be required to purchase mortgage insurance.

What are the benefits of paying mortgage insurance?

Though having to purchase this insurance may be an added expense, it opens many doors because it allows borrowers to buy a home with less money down. This can be especially desirable to a potential buyer who believes they have found exactly the right property without having to wait several years to accumulate enough for a substantial down payment.

The Homeowner's Protection Act

The Homeowner's Protection Act is a federal law which mandates that lenders and borrowers disclose vital information about mortgage insurance on properties purchased on or after July 29, 1999. The information that lenders must disclose at a mortgage closing include the following: the date on which the right to request insurance cancellation may be made, the requirement that mortgage insurance will be automatically eliminated and the date on which this will occur, exemptions to cancellation, and an initial amortization schedule. The law also states that mortgage insurance payments may be canceled when the mortgage has been paid down to 78 to 80% of the original purchase price. 

Premium types and rates

The types of premiums available to consumers will vary, but the typical range of rates is between 0.50% and 0.90% of the loan value. This rate will also be determined by evaluating the borrower's credit rating and debt to income ratios.

Misconceptions about mortgage insurance

It is important to remember that the primary beneficiary of mortgage insurance is the bank. Some consumers tend to think that mortgage insurance is protection for their home in same way as homeowner's insurance when this is simply not the case.  However, there are some other incentives to purchasing mortgage insurance, for example, it is now tax deductible in the United States. 

In the end, mortgage insurance is designed to protect lenders more than borrowers. Though this may strike the average consumer as unfair, it is important to remember that banks have lost millions in the recent housing and foreclosure crisis and therefore need to be protected from losses. 

Another common misconception about mortgage insurance is that it is always available. In certain situations, potential borrowers will be barred from mortgage financing because they cannot get an affordable rate on mortgage insurance. If this is the case, they may have to wait until their financial situation improves.