Mortgage Insurance is a topic most people have heard of but many don't understand. What is mortgage insurance? Who pays for mortgage insurance? Is mortgage insurance required? Who does mortgage insurance protect? These and other questions are answered in this article.
Mortgage insurance is to protect lenders from potential loss when a buyer secures a mortgage on property they are purchasing. This insurance is in place to minimize potential loss from buyer default when a high portion of the purchase price is being borrowed. Therefore, to offset the risk of default losses, lenders require Mortgage Insurance when the Loan-To-Value (LTV) ratio is over 80%.
Down Payment ÷ Purchase Price = LTV
The Value used in lenders' LTV calculations is the lower of contract price or Appraised value.
The higher the LTV over 80%, the higher the Mortgage Insurance.
Both conventional and government-insured (FHA and VA) mortgage financing programs include some type of Mortgage Insurance when buyers put down less than 20%.
On conventional (non government-insured) mortgages, private insurance companies issue policies (Private Mortgage Insurance or PMI) to protect the lender against default loss. If a borrower defaults on their loan, the PMI company pays the lender a portion of their documented loss, based on the terms of coverage placed when the mortgage began. As such, the lender and the PMI company still take a loss but that loss is minimized. Approval from the Mortgage Insurance provider is required in addition to lender approval.
PMI premiums are based on :
- amount of down payment (3% to 19%)
- type and use of the property (primary or second home)
- terms of the mortgage (30-year, 15-year, ARM)
- creditworthiness (FICO score) of the borrower.
PMI premiums can be paid upfront (single premium) at closing, in monthly payments along with PITI, a combination of both (split premiums), or lender-paid. Lender-paid MI carries a slightly higher interest rate. These payments do not contribute to the buyers equity in the property.
At this time, Mortgage Insurance premium payments on a qualified residence are still tax deductible (as is Mortgage Interest) as long as deductions are itemized. This MI deduction is scheduled to expire on December 31, 2018 unless it is renewed by Congress. Buyers should contact their CPAs or tax professionals for details and applicability to their personal financial circumstances.
LTV is reduced during the life of the loan as the home owners mortgage payments increase equity in the home and outstanding balance on the mortgage. As more principal is paid, the LTV ratio decreases.
On conventional mortgages only, borrowers who started their mortgages with MI may ask the lender for MI removal when LTV decreases to 80%, and by Federal law (the Homeowners Protection Act) it must be removed when LTV reaches 78%, providing that mortgage payments are current and there have been no late payments.
Borrowers also pay MI on government-insured mortgages from the FHA (Federal Housing Administration), a division of the US Department of Housing and Urban Development (HUD). In this case it is called Mutual Mortgage Insurance (MMI) which is paid directly to that government agency.
Buyers pay both upfront (UFMIP) and monthly Mortgage Insurance premiums on FHA-insured mortgages.
NOTE: FHA/HUD does not lend money to buyers, they insure loans made by independent lenders as long as buyers qualify to FHA standards.
The UFMIP can be wrapped into the loan amount and will be paid along with the monthly mortgage payment (PITI) and the separate monthly MI. Mortgage Insurance premiums on FHA mortgages enable the FHA to insure loans for buyers with:
- lower down payments
- lower credit scores
- higher Debt-To-Income ratios
Here's a chart that outlines the main differences between these two types of Mortgage Insurance:
Veterans Administration (VA) mortgages also have a form of Mortgage Insurance called the Funding Fee, similar to FHA's UFMIP. VA loans do not have a monthly MI payment, and the Funding Fee can also be wrapped into the loan amount.
Like the FHA, the VA does not lend money for home purchases, it guarantees a portion of repayment to the independent lender.