Mortgage Insurance: What It Is and When You Need It
For those unfamiliar with the term “mortgage insurance” it can sound a bit like it’s an insurance policy that will make the monthly mortgage payments should someone get laid off from work or fall ill. But it’s not that. Instead, while it is indeed an insurance policy it’s in favor the lender who approved the loan but typically paid for by the borrowers. There are two types of mortgage insurance today, mortgage insurance for government-backed home loans and mortgage insurance for conventional loans.
There are three government-backed loan programs, VA, USDA and FHA mortgages and each carry mortgage insurance. The VA loan mortgage insurance has one policy and it is rolled into the loan. USDA, or Rural Development Loans, carry two policies, one that is rolled into the loan amount at closing and an annual premium made in monthly installments. FHA loans also have two policies, one rolled into the loan and the other in the form of a monthly payment. Mortgage insurance will remain on these loans until the loan is retired with a refinance and into a conventional loan.
Conventional loans underwritten to Fannie Mae and Freddie Mac guidelines also can require mortgage insurance but the loans aren’t government-backed. It used to be that conventional loans required a greater down payment of at least 20 percent of the sales price or more. Without such a down payment, borrowers couldn’t qualify for a conventional mortgage. However, in the late 1950s an insurance company introduced a private mortgage insurance policy that allowed borrowers to make a smaller down payment than the minimum required. The policy pays the lender the difference between 80 percent of the sales price and the actual down payment. If the borrowers made a down payment of say 10 percent, the private mortgage insurance policy would represent the other 10 percent. With a 5.0 percent down payment, the policy would represent 15 percent of the sales price.
Over time, private mortgage insurance is required to be automatically removed when the loan balance naturally amortizes down to 78 percent of the original sales price of the home. This is by statute. Or, the borrowers can pay down the mortgage to the 80 percent level and ask the lender to remove the insurance policy. The lender will then review the application to remove mortgage insurance, order an appraisal to verify the current market value and make the determination that mortgage insurance is no longer needed.
Buyers can also avoid private mortgage insurance by taking out a series of two separate loans, a first and a second mortgage. The first mortgage would be at 80 percent of the value of the property (eliminating the need for mortgage insurance) and taking out a second mortgage for the difference. If the buyers made a down payment of say 10 percent of the sales price, there would then be a first mortgage at 80 percent of the value of the property and a second loan at 10 percent. If you’re considering either a government-backed or conventional mortgage and aren’t sure how much to put down, work with your loan officer to discuss your options. You don’t have to make a 20 percent down payment if you don’t want to.