Let me dispel one of the biggest myths in homebuying: Mortgage insurance is something you must avoid at all cost.
That is incorrect, and here is why. Mortgage insurance makes it possible to purchase a home even if you can’t make the traditional 20 percent down payment. The insurance allows you to keep more of your cash and achieve homeownership.
Now that you understand why mortgage insurance plays a key role, let’s break it down on a more technical level.
Mortgage insurance protects the lender for losses suffered if the borrower defaults on the payment. Mortgage insurance is typically included in a monthly mortgage payment.
While conventional and FHA loans have mortgage insurance, they are structured differently.
On a conventional loan, private mortgage insurance (known as PMI), the lender automatically cancels PMI when LTV (loan to value) reaches 78 percent or 22 percent equity in the property. Loan to value means the amount borrowed in proportion to the original market value (based on appraisal at the time of purchase) of the property.
Homeowners can petition to cancel the insurance by requesting a new appraisal if they believe they now have 20 percent equity in the property based on current market value (e.g.: renovations).
Here’s one more acronym for your alphabet soup: Lender Paid Mortgage Insurance (LPMI). On a conventional loan, LPMI is when the lender pays your mortgage insurance but charges you in a form of higher interest rate (usually an additional .25-.5 percent).
To cancel any form of mortgage insurance, homeowners must be current on their mortgage payments.
“Mortgage insurance is a substitute for cash or equity,” said Dana Abernathy, regional team leader with National MI. “The insurance allows a customer to buy a home at today’s rates versus waiting and saving 20 percent.”
According to The Urban Institute, mortgage insurance providers are financially stable and even stronger in the wake of the housing crisis thanks to tighter risk management standards. As well, the insurance allows more people to qualify for homeownership.
Still, it’s important to understand what mortgage insurance won’t do. It won’t pay off the mortgage in the event the borrower dies, loses a job, becomes disabled, experiences a hazard (e.g.: fire) or suffers fraud in the loan origination.
The next time you hear the words “mortgage insurance,” don’t grimace at the thought of more insurance payments in your life. Think of the term as a way to become a homeowner sooner than you ever thought possible.
Featured photo: Pictures of Money (Flickr)