What is mortgage insurance?
It’s a financial guaranty that insures lenders against loss in the event a borrower defaults on a mortgage. If the borrower defaults and the lender takes title to the property, the mortgage insurer (MGIC, for example) reduces or eliminates the loss to the lender. In effect, the mortgage insurer shares the risk of lending the money to the borrower. (Mortgage insurance should not be confused with mortgage life insurance, which provides coverage in the event of a borrower’s death, or homeowner’s insurance, which protects the homeowner from loss due to damage from fire, flood or other disaster.)
Who is mortgage insurance for?
All home buyers can benefit. It allows them to become homeowners sooner, and it dramatically increases their buying power — excellent benefits from a buyer’s perspective. First-time buyers can use a low down payment to help them afford their first home, or to purchase a more expensive home sooner. Repeat home buyers can put less money down and gain significant tax advantages because they will have more deductible interest to claim. They can also use the cash they would have used for a large down payment for investments, moving costs or other expenses.
What does mortgage insurance do for borrowers?
Without the guaranty of mortgage insurance, lenders normally require a borrower to make a down payment of at least 20% of a home’s purchase price, which can mean years of saving for some borrowers. This large down payment assures the lender that the borrower is committed to the investment and will try to meet the obligation of monthly mortgage payments to protect his investment. With the guaranty of mortgage insurance, lenders are willing to accept as little as 5% or 10% down from borrowers. Mortgage insurance fills the gap between the standard requirement of 20% down and an amount the borrower can more easily afford to put down on a purchase. A low down payment also allows borrowers to purchase more home than they might otherwise be able to afford. Without mortgage insurance, a borrower who has saved $10,000 for the required minimum 20% down payment would only be able to purchase a $50,000 home.With mortgage insurance (and income and credit permitting), the borrower could make a down payment of only 10% and purchase a $100,000 home with the $10,000! Or put $7,500 down on a $75,000 home and use the remaining $2,500 for decorating, investing, or buying a car or major appliance. Mortgage insurance broadens a borrower’s options.
Who pays for mortgage insurance?
Generally borrowers do. An initial premium is collected at closing and, depending on the premium plan chosen, a monthly amount may be included in the house payment made to the lender, who remits payment to the mortgage insurer. MGIC offers flexible premium plans for borrowers:
- Annuals. The borrower pays the first-year premium at closing; an annual renewal premium is collected monthly as part of the total monthly house payment.
- Monthly Premiums. The cost is slightly more than traditional mortgage insurance plans but monthly premiums dramatically reduce mortgage insurance closing costs. Borrowers pay for mortgage insurance monthly as part of their total monthly house payment but only need to pay one month’s mortgage insurance premium at closing, rather than one year’s.
- Singles. The borrower pays a one-time single premium (instead of an initial premium and renewal premiums). Since single premiums are typically financed as part of the mortgage loan amount, no out-of-pocket cash is used for mortgage insurance at closing.
These plans offer the choice of refundable or nonrefundable premiums. A refundable premium allows the borrower the opportunity to receive money back on any unused portion, in the event that mortgage insurance coverage is discontinued before the loan is paid in full. The cost for a nonrefundable premium is slightly less than that of a refundable premium, thereby giving the borrower a small savings. If coverage is discontinued on a loan with a nonrefundable premium, the borrower has no opportunity for a refund.
Is there anything else important to know?
No. Just remember, with mortgage insurance, borrowers can increase buying power, put less money down and purchase a home sooner. It’s as simple as that.
PCBDaily 
So in today’s climate, when the property value becomes ‘upside down ‘ or if a homeowner walks away or unable to pay anymore, due to circumstances, even with PMI, how is that that they can still come after you for the money? Isnt that what the PMI is suppose to do?
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Ray
PMI protects the borrower not you so therefore if there is a loss then yes they can get you. Typically however if you do a short sale that is all settled before you go to the closing table and you know what your exposure is. There are exceptions as in Wells Fargo, they will do the short sale if you agree to go to their recovery department after wards and settle with them. When I am doing a short sale and discover they have PMI it is not usually good news to me or the seller!!!
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When you say PMI protects the borrower , you mean the mortgage insurer, right? I took it that the borrower and the buyer or homeowner is the same. Thank you for your columns Karen. Its always interesting and informative.
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I personally think there’s a few other issues to consider in what is an insightful post. Yes one can buy mortgage insurance, you can by lot’s of insurance, but guess what, it’s not free. In fact my guess is that the premiums are calculated in such a way that the insurance company expects to make a profit. So if it costs say $100 a month to pay for this insurance, that’s $100 a month that’s not going down on the principal of your mortgage. So there’s an opportunity cost associated with this. Mostly likely the cost of this is also going to be borrowed and added to the mortgage, thereby making your debt obligation higher. Essentially your buying insurnance to allow you to borrow money, with you guessed it, borrowed money.
Secondly, most of the problems in the housing market, related to people over-leveraging and buying properties they really can’t afford in the first place. Is assisting someone in this process a good thing? People always have to consider that leverage is a two way street. If you’re highly leveraged both your risk of gain AND LOSSES is enhanced.
Add these caveats to the above article and you have a balanced view.
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The insurance companies should make a profit. Why else would they be in business?
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Of course they should, but the point is, that this isn’t a costless undertaking and like almost any financial decision, the are pro’s and con’s shoud be studied.
I felt when reading this that it was slanted and the con’s weren’t adequately addressed and there was an underlying assumption that real estate would rise. Hence the arguement that it’s better to buy a $100,000 with 10% down, then a $50,000 with 20% down. If property values rise that’s fine, if they fall by say 10% you’ve wipped out your equity in the first senario
(ie value of property equals $90k, mortgage equals 90K and have 1/2 of it left in the second senario. ie value of property is 45K and the mortgage is 40K) In addition, there would be a significant difference in the monthly mortgage obligations between the two, with the first option also adding the insurance premiums to the monthly obligations. One has to be reasonably sure the cash flow of the property or the cash flow derived from your employed can deal with this.
Not that it matters, but I am a financial advisor and deal with these type of issues on an ongoing basis. Albeit, I’m Canadian, but the choices and issues are pretty similar.
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apologies for my butchering the english language in my last post.
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