Applying for home loans to pay for a property can be daunting. This is especially true for first-time homebuyers or prospective buyers without much credit built up, in which case qualifying for loans often ends up being difficult. One way to ease the process along is to pay some extra cash for mortgage insurance, which can help qualify homebuyers for loans they might not otherwise receive. For your convenience, here's an overview explaining what mortgage insurance is, and the details of how it works.
Put simply, mortgage insurance is insurance that protects the lender's investment. Unlike the more commonly understood homeowner's insurance, which protects the homeowner from a variety of damages, mortgage insurance protects the lender's investment in case the borrower defaults on the mortgage loan. You may also see mortgage insurance referred to as mortgage guarantee, home-loan insurance, or mortgage indemnity guarantee.
How It Works
Unlike other types of insurance, with mortgage insurance the person paying for the policy, in this case the homeowner, is not the beneficiary. Although you the home-buyer are responsible for making mortgage insurance payments, the policy protects the lender. In most cases, the cost of mortgage insurance will be added on to the monthly payment you make to the lender or to your costs at closing, or both.
There are several different types of mortgage insurance depending on who you borrow money from, and they each have slightly different rules and details. Here are some of the most common types of loans where mortgage insurance is involved:
Conventional (Private) Loan:
If you get a conventional home loan, your lender will generally arrange a mortgage insurance plan with a private company. Private mortgage insurance rates can vary greatly depending on your credit score and the down payment made on the property, but in general, if you have good credit you'll generally get cheaper rates than FHA loans. Usually, private mortgage insurance payments are monthly.
If you get a loan from the FHA (Federal Housing Administration,) then your mortgage insurance payments are made directly to the FHA. Unlike with other types of loans, mortgage insurance is required for all FHA loans, but mortgage insurance with the FHA also costs the same regardless of your credit score, which can be extremely beneficial for new homeowners or those with low credit scores. However, the price does increase if your down payment is less than 5 percent, and there is an upfront cost for the insurance as well as the monthly cost. For more information, go online to the FHA website.
U.S. Department of Agriculture loans have a mortgage insurance program that is very similar to FHA loans, but usually a bit cheaper. Like with FHA loans, there is a cost at closing along with the monthly cost. With both USDA and FHA loans, if you cannot afford the initial upfront cost for mortgage insurance, you can add the cost into your mortgage. However, by doing this, you will increase both the amount of your loan as well as your overall costs for mortgage insurance.
If you're a veteran and receive a loan from the Department of Veterans' Affairs, they provide a VA guarantee that replaces mortgage insurance and functions in essentially the same manner. The primary cost you will pay in this case is an up-front "funding fee" which varies depending on your type of military service, down payment status, disability status, and other factors.
Home Buyer Benefits
Typically, the reason that you'll decide to pay for mortgage insurance is to qualify for loans that you couldn't otherwise receive. For example using mortgage insurance, you could qualify for a conventional loan with a down payment well under 20%. Because mortgage insurance protects the lender's investment, they are usually much more likely to award a loan if mortgage insurance is provided. While this will increase costs to you, it can be well worth the extra money if you can't afford the property without a loan. In addition, if you receive an FHA or USDA loan, it is required that you pay for mortgage insurance.
The good news is that in most cases, once you (the homebuyer) reach a certain equity level, which will generally be pre-determined by your lender, you may be able to cancel the mortgage insurance. There is also the Federal Homeowners Protection Act, which requires mortgage insurance coverage (for a primary residence) to be cancelled as soon as your balance drops to 78 percent of the original property value. Finally, if your loan balance reaches 80 percent of the original value, you can request cancellation of mortgage insurance payments. The rules for borrower-requested cancellation vary by state and other factors, so if you're wondering whether or not you are eligible for cancellation, contact the company you make mortgage payments to.