Since the credit crisis and mortgage market collapse, many potential homebuyers are learning about mortgage insurance. Mortgage insurance is purchased in order to protect the lender in the event that the borrower defaults. The borrower typically pays the insurance premiums along with their monthly mortgage payments. Mortgage insurance is offered through companies in the private sector, or through the government.
When do you need mortgage insurance?
Mortgage insurance is designed to pay off the mortgage in the event of a default. If the borrower is delinquent on their payments, the mortgage lender will be reimbursed. Note that it is not the lender’s duty to pay the mortgage insurance premiums― since the borrower presents the risk for default, the borrower is responsible for paying the insurance.
Not every needs to pay for mortgage insurance. For the most part, lenders want to see a Loan-to-Value Ratio (LTV) of at least 80% ― thus, if you make a down payment of 20% (meaning you only have to borrow 80% of the home’s price), you will not have to pay for mortgage insurance at all. On the other hand, if you are subject to mortgage insurance, it can usually be canceled once your LTV ratio reaches that 80% mark.
Unfortunately for most people, it is difficult to save up for a large down payment. As an alternative, you may consider taking out a second mortgage (or “piggyback loan”) to bring the first mortgage’s LTV ratio down to 80%. However, keep in mind that second mortgages generally come with higher interest rates and may end up costing you more in the long run (than simply paying for mortgage insurance).
If you are getting a government mortgage loan, such as an FHA Loan, mortgage insurance is a necessity. All FHA home loans require borrowers to obtain mortgage insurance for the lender’s protection. The borrower must pay an upfront mortgage insurance premium (usually 2.25% of the loan amount) and an ongoing fee (annual premium of 0.5% of the loan amount). In order to be able to cancel FHA mortgage insurance, your LTV ratio must reach 78% and you must have been paying the insurance premiums for at least 5 years. (Note that the rules are slightly different for FHA loan terms of 15 years or less.)
If you have to pay mortgage insurance, you should monitor your LTV ratio so you know when it reaches 80%. Some lenders will automatically cancel mortgage insurance, but others may continue quietly charging you for the premiums. Don’t be afraid to speak up and alert the mortgage lender. It is a good idea to keep track of your loan balance and the amount of equity you’ve built, so that your mortgage insurance can be canceled as soon as you’re eligible.