Mortgage insurance

Mortgage insurance protection has been in existence since 1954.  Mortgage Guaranty Insurance Corporation (MGIC) became the first mainstream company to offer mortgage insurance on high risk loans.  Over the years mortgage insurance products have evolved into a multi-billion dollar business and have helped lenders expand the number of mortgage products currently being offered on residential properties.  The purpose of mortgage insurance is to provide protection for the lender in the event that a borrower defaults on a home loan. 

In today’s changing market lenders are less willing to take on risk.  Mortgage insurance companies will provide lenders the guarantee they need in order to lend money on loan parameters that exceeds their initial risk thresholds.  For example, before mortgage insurance became available, people (who were in the market to buy a home) needed to invest at least 20% of the purchase price, as a down payment before being approved.  As you can see, loan amount on homes prior to mortgage insurance would not exceed 80% of the purchase price.  When mortgage insurance was factored in it provided the additional protection needed on the remaining 20% of the purchase price.  This allowed home buyers to borrow well above the original 80% risk threshold allowed by lenders.  Over a very short period of time people began to purchase homes that they may not have previously qualified for.

Mortgage insurance protects the lender for losses in the event a loan defaults.  Lenders will obviously have some recourse, by securing the property and selling it at auction.  However, in high risk loans the auction price will more than likely yield a lower price than the total amount borrowed.  This is where mortgage insurance takes control.  Mortgage insurance will provide lenders added protection on the upper 20% of the remaining equity in the home.  Typically, when a home is sold at auction below the amount borrowed, it will be the upper 20% of the original loan amount that will be in jeopardy for any losses.  In the event a loss is recorded, mortgage insurance will step in and pay out the difference lost between the original loan amount and the final auction price.

Mortgage insurance fees will be required by the lender at the time of closing.  These fees will typically be added back into the loan amount as an upfront fee, a monthly payment obligation, or a combination of the two.  Exactly how much will be required varies greatly from one borrower to the next.  Mortgage insurance companies will determine their fees based on the level of risk associated with the home loan, the higher the risk the higher the fee.  Each loan type has a specific mortgage insurance characteristic tied to it.  Conventional loans, FHA loans, and VA loans, will all have different mortgage insurance requirements. 

Conventional loans will require mortgage insurance for any loans where the loan-to-value ratio is above 80%.  This means that if you borrow more than 80% of the actual home value or purchase price, mortgage insurance will be required.  On Conventional loans, your mortgage insurance fees are paid monthly.  The fee will show up on your monthly payment statements as an itemized fee collected in connection to your normal monthly mortgage payment.  The total amount withheld varies, depending on the risk, but will normally fall between .25% - 1.25% of the total loan amount.  You will then divide the annual mortgage insurance obligation by 12, which will give you your monthly mortgage insurance payment.

Homeowners may also elect to pay their mortgage insurance through the interest rate provided by the lender.  This is known as Lender Paid Mortgage Insurance.  Lender Paid Mortgage Insurance is insurance for your loan paid by the lenders themselves.  In return for this insurance, lenders will require a higher interest rate.  Interest rates will typically be about .5% higher using this option over the traditional monthly mortgage insurance option.

FHA and VA programs differ slightly in how they collect for mortgage insurance.  Both programs have an upfront mortgage insurance fee, but only FHA has an included monthly fee, in addition to the upfront fees.  The upfront mortgage insurance fees collected on FHA loans will range from 1.25% - 2.25%.  The monthly fee will also range slightly, from .5% - .55%, annually.  The actual fee calculations will vary depending on the level of risk associated with the loan

VA loans (like FHA loans) are federally insured, but are insured through a different mortgage insurance fund; therefore, different fees are collected for mortgage insurance on a VA loan as opposed to an FHA loan.  The most obvious difference between the two is that VA loans do not have a monthly mortgage insurance fee.  Instead, all of their mortgage insurance fees are collected upfront.  The upfront mortgage insurance fee collected on a VA loan will range from 2.15% - 3.3%, depending on the number of times an applicant has used their VA eligibility.  The upfront VA mortgage insurance fee can also be reduced, if the borrower decides to put any additional funds down.  For example, with a 10% down payment, the upfront mortgage insurance fee will be reduced to 1.25%. 

Mortgage insurance does not have to be a complex topic, and there will always be someone available to explain it to you.  Mortgage insurance has made it easier for home buyers to buy a home today then ever before.  Without the protection guarantees offered through mortgage insurance, our real estate market would have never had the opportunity to grow in the capacity it has.