Mortgage Insurance 101
Let’s talk mortgage insurance.
Navigating the world of home buying may seem like a labyrinth. With all the different loan options available, plus the other multiple, possibly confusing steps in the process, it’s conceivable you might not even be aware of the need for mortgage insurance. While many people tend to avoid private mortgage insurance (PMI) because of the negative stigma associated with it, it is actually quite helpful for aspiring homeowners who don’t have a ton of money to use for a down payment.
It isn’t to be confused with homeowners insurance, often also a requirement by lenders for their borrowers. While homeowners insurance protects a house from damage due to fire or theft, mortgage insurance protects a lender from a possible default from their borrower.
What’s the Point of Mortgage Insurance?
When a lender provides a home buyer a loan, there’s a risk of the borrower being unable to pay it back. Mortgage insurance guards lenders in this sort of event and is usually required for borrowers who place less than 20 percent of their home purchase price as down payment—putting less money down signals to a lender that a borrower might be at-risk of not paying back the entire loan. Lenders will typically be more confident with a borrower who appears more financially stable, like those who place more than 20 percent down.
Though it may appear that mortgage insurance only benefits the lender, that’s not necessarily true: It also helps home buyers who cannot afford a large down payment to qualify for a loan. This is done by adding a monthly premium to a borrower’s mortgage or through a single, upfront expense. In the end, the upfront cost of the home is reduced while monthly payments are made slightly higher. There are also additional means of paying for mortgage insurance, including ones that place the burden on the lender.
Types of Mortgage Insurance
There are four main types of private mortgage insurance—and non-private insurance, which we’ll get into later. Each type comes with benefits tailored for particular situations.
Borrower-Paid Mortgage Insurance (BPMI)
Borrower-paid mortgage insurance, which is what most people refer to when they talk about “PMI,” is the most common type of mortgage insurance. With this type, payment for the insurance is added onto a borrower’s regular monthly mortgage. This type can also be canceled, once you acquire 22 percent equity in your home. Borrower-paid mortgage insurance is aimed at those who might not know how long they’ll be keeping their mortgage or living in their house.
Lender-Paid Mortgage Insurance (LPMI)
With lender-paid mortgage insurance, a lender pays the entirety of their borrower’s mortgage insurance premium up front and then raises their mortgage interest rate to cover the cost. In other words, you’re still paying for the insurance, just through a higher mortgage rate. Unlike BPMI, LPMI cannot be canceled. This kind of insurance may be good for home buyers who plan on staying in their house for a longer period of time, like five to ten years.
Single Premium PMI
Borrowers who don’t want to deal with additional costs included in their monthly payments can opt for single premium PMI, which allows them to pay their premium upfront in a lump sum. This type of mortgage insurance can prove cheaper in the long run; however, it is non-refundable. It can also help qualify buyers for larger mortgages, as lenders use a comparison of monthly income to monthly debts to determine eligibility. Eliminating another monthly payment means a buyer may be able to get a bigger loan.
Split Premium PMI
A split premium PMI allows a borrower to pay a piece of their insurance premium up front, with the remaining cost split up over monthly payments. By paying a portion of the insurance cost upfront, a buyer will see their remaining payments discounted. This type of insurance isn’t common, but it’s an option for those who may find it attractive.
Mortgage Insurance Premium (MIP)
This type of mortgage insurance is used exclusively for FHA loans. The Federal Housing Administration assigns borrowers either an upfront cost at the time of closing or monthly premium installments. The cost of an MIP depends on both the duration and balance of the loan.
If you still have pressing questions about mortgage insurance, don’t hesitate to contact On Q Financial. Our mortgage experts are always ready and willing to help with any and all uncertainties.
About the Author
Before opening On Q Financial in 2005, John Bergman originated and funded 450 units a year as a loan officer. He founded the company with just $1M of personal life savings—committed to his vision for building the best independent mortgage organization in the industry.View John's Profile