Mortgage insurance is protection for the lending agency. It does not protect the one taking out the mortgage. The insurance does give buyers more purchasing power.
Mortgage insurance is typically required on most Federal Housing Administration and U.S. Department of Agriculture loans. Lenders require private mortgage insurance on mortgages if the borrowers are making less than 20 percent of a down payment. This is also the case with refinanced mortgages.
Benefits for Borrower and Lender
Buying a home can be a stressful time. Knowing the pluses and the minuses in taking out a loan can ease some of the concerns. Ultimately, buying a home is a long-term investment.
Mortgage insurance does have benefits for the borrower and the lender. The benefits for the borrower include the ability to borrow more than what they would normally qualify to borrow since the insurance reduces the risk to the lender. It's much like a safety net in the mortgage world.
How Lenders Benefit
The benefit to the lender is the protection it provides in the event that the borrower falls behind on payments or goes into foreclosure and is unable to make the mortgage payments at all. Foreclosure usually results in losing the home. The only way to avoid paying for mortgage insurance is to make a larger down payment that is greater than 20 percent of the loan's value.
Private mortgage insurance is an additional charge, so there is more to pay. The fees can vary from 0.3 percent to 1.5 percent of the original loan amount. The amount can depend on the amount of the down payment and the insurer's rate among other considerations. This is calculated and included in the monthly mortgage payments or paid at closing. Falling behind on payments can have negative effects on credit scores.
Does the Insurance Last Throughout the Mortgage?
The good news is private mortgage insurance (not FHA-insured or from the Department of Veterans Affairs) doesn't last forever on conventional loans. Known as the loan to value ratio, once the loan balance drops to 78 percent of the value of the home, the mortgage insurance automatically drops off. The borrower can request that the mortgage insurance premiums be dropped once the loan reaches 80 percent of the home's value. This requires keeping up with the current loan balance and value of the home, but is worth it because it can save money.
FHA-insured loans currently require mortgage insurance throughout the duration of the loan. In order to eliminate the monthly premium, the loan would have to be refinanced to another type of mortgage. The USDA loans require a monthly premium and an additional fee at closing. These upfront fees can usually be rolled into the monthly payments if necessary. For VA loans, which are designed for military veterans and their families, there is no mortgage insurance requirement. However, an upfront funding fee is usually required at the time of closing. The amount of the fee varies much like mortgage insurance. It's based on factors including type of military service, disability and the down payment.