Mortgage Insurance Definition

When you’re purchasing a home, it’s important to consider mortgage insurance. It’s a type of insurance that protects lenders in case of default by the borrower. Without it, lenders may not be willing to loan money to borrowers who are considered high risk. If you’re not familiar with mortgage insurance, this article will guide you through everything that you need to know about it.

What is Mortgage Insurance?

Mortgage insurance is a type of insurance policy that protects the lender in case the borrower defaults on the loan. It’s typically required when a borrower makes a down payment less than 20% of the purchase price of the home. It’s also required for some government-backed loans such as FHA loans. Mortgage insurance can come in different forms, but they all serve the same purpose: to protect the lender from financial losses if the borrower stops making payments.

Private Mortgage Insurance (PMI)

Most commonly, mortgage insurance comes in the form of private mortgage insurance (PMI). PMI is typically required for conventional loans when the borrower makes a down payment less than 20% of the purchase price of the home. The borrower pays a premium for PMI, which is added to their monthly mortgage payment.

The cost of PMI varies depending on the size of the down payment and the loan amount. It can range from a few dollars to hundreds of dollars per month. The borrower pays PMI until they have built up enough equity in the home to reach a loan-to-value (LTV) ratio of 80% or less.

Federal Housing Administration (FHA) Mortgage Insurance

Federal Housing Administration (FHA) loans also require mortgage insurance, but it’s called mortgage insurance premium (MIP). MIP is required regardless of the size of the down payment. The borrower pays an upfront premium at closing, and then a monthly premium in addition to their mortgage payment. The cost of MIP varies depending on the size of the down payment, loan amount, and the term of the loan.

Veterans Affairs (VA) Mortgage Insurance

VA loans do not require mortgage insurance, but they do have a funding fee. The funding fee is a one-time fee that’s paid at closing or rolled into the loan. The fee varies depending on the size of the down payment, whether the borrower has used their VA loan benefit before, and whether the borrower is active-duty military or a veteran.

How Does Mortgage Insurance Work?

When a borrower makes a down payment less than 20%, mortgage insurance is required to protect the lender in case of default. If the borrower stops making payments, the lender can file a claim with the insurance company to recoup some or all of the losses. The insurance company then pays the lender the amount of the claim, up to the policy limits.

If the borrower has paid down the mortgage balance to a loan-to-value (LTV) ratio of 80% or less, they can request to have the mortgage insurance removed. Once the LTV ratio reaches 78%, the mortgage insurance will automatically be removed.

FAQ

What is the purpose of mortgage insurance?

The purpose of mortgage insurance is to protect the lender in case the borrower defaults on the loan. Without mortgage insurance, lenders may not be willing to loan money to borrowers who are considered high risk.

When is mortgage insurance required?

Mortgage insurance is typically required when a borrower makes a down payment less than 20% of the purchase price of the home. It’s also required for some government-backed loans such as FHA loans.

How much does mortgage insurance cost?

The cost of mortgage insurance varies depending on the size of the down payment, loan amount, and the type of mortgage insurance. PMI can range from a few dollars to hundreds of dollars per month, while MIP and VA funding fees are one-time fees that are paid at closing.

When can mortgage insurance be removed?

If the borrower has paid down the mortgage balance to a loan-to-value (LTV) ratio of 80% or less, they can request to have the mortgage insurance removed. Once the LTV ratio reaches 78%, the mortgage insurance will automatically be removed.

Can mortgage insurance be tax deductible?

In some cases, mortgage insurance premiums may be tax deductible. This applies to PMI for conventional loans and MIP for FHA loans. However, there are income limits and other restrictions that apply. It’s best to consult with a tax professional to determine if you’re eligible for the deduction.

Is mortgage insurance optional?

Mortgage insurance is typically not optional if the borrower makes a down payment less than 20% of the purchase price of the home. However, VA loans do not require mortgage insurance.