What is Mortgage Insurance and How Does it Work?
Meaning of mortgage insurance
This type of insurance that compensates the lenders of mortgage loans or bonds when the borrowers are not able to meet their obligations. It is also known as mortgage default insurance and mortgage indemnity guarantee.
Mortgage insurance protects mortgage lenders by compensating their losses when borrowers fail to repay in certain conditions, such as default or death, depending on the policies.
How does mortgage insurance work?
Home buyers applying for a loan are required to pay mortgage insurance on USDA or FHA mortgage. Even private lenders require a mortgage insurance if the borrower is required to pay less than 20 percent as down—something that’s called private mortgage insurance or PMI.
Mortgage insurance works differently in different situations. The borrower of the home loan pays the insurance premium and they might have to bear an extra cost every month or might have to pay it upfront. Here’s how this insurance works:
1.Mortgage insurance on FHA loans: Borrowers taking out mortgages through the FHA program are required to pay the FHA Mortgage Insurance Premium (MIP). This payment entails both an upfront cost when the mortgage is taken out and a yearly cost. The rate is somewhere in the ballpark of 0.45 to 1.05 percent of the outstanding balance. If the borrower pays more than 10 percent down, then the payments end at the end of the 11th year
2.Loans with less than 20-percent down payment: Conventional lenders require borrowers to pay the PMI if they pay less than 20 percent of the purchase price of the home as down payment. They can cancel the PMI if the equity of their property reaches at least 20 percent. However, this process varies from lender to lender.
The federal agency accepts borrowers with credit scores as low as 500 and down payments as low as 3.5%. Hence, every borrower who takes an FHA mortgage must purchase qualified mortgage insurance, regardless of the value of the down payment.
3.The Veteran Administration loans: Some widows and veterans are eligible to get loans with no down payment at attractive rates under the Veterans Administration. They require a funding fee in the range of 1.25 to 3.3 percent of the loan amount. Borrowers have to make an upfront payment but can also seek exemption depending on their life’s circumstances.
4.USDA loans: The U.S. Department of Agriculture provides loans that don’t require any down payment to promote the real estate market in rural and suburban areas. The mortgage program requires both an upfront and an annual payment. The upfront fee is 1 percent of the loan amount, and the annual payment is 0.35 percent of the outstanding amount, which can also be paid monthly.
5.Mortgage Life Insurance: mortgage life insurance protects the heirs or the lenders when borrowers die while carrying loans.The insurance policy does not limit how the beneficiaries can use the coverage. The coverage amount of personal life insurance does not usually decrease.
Also read: Borrowing Against Your Life Insurance Policy
mortgage life insurance should not be confused with personal life insurance. The coverage of mortgage life insurance can only be used to pay back the mortgage balance. Thus, the amount of coverage declines due to amortization.