Mortgage Insurance explained
Mortgage insurance can be confusing, especially if you’ve never had to buy it before. We’ll walk you through what mortgage insurance is, how much it costs, and how it works.
What is Mortgage Insurance?
Mortgage insurance is a line of credit that pays off your mortgage if you die or can no longer make payments due to permanent disability. You pay for this peace of mind by giving the company money upfront in the form of premiums (monthly or annual). The more likely-seeming the event—that you will die or be disabled and unable to work—the higher your premium.
Mortgage insurance also gives you more flexibility over the mortgage—you can, for example, change the payment schedule or make larger payments when the money is available. Your premiums are deducted from your monthly mortgage payment.
How Much Does it Cost?
The cost of insurance depends on a number of factors, including the kind of loan you have, how much is borrowed, where you live (city/region), and how much coverage you need. Generally speaking, mortgages with less than 80 percent LTV can cover about 80 percent of losses and loans with less than 95 percent LTV can cover about 70 percent of losses. We’re basing these numbers off standard FHA loans because they’re available in most areas and have very little extra fees.
The amount of money you pay for mortgage insurance depends on how likely it is that you will die or be disabled and unable to work. Use the table below to find out how much you would pay per month—these numbers are based on pricing from IMFA Mortgage Insurance.
Let’s take a look at some examples:
Example 1: This is a $300,000 FHA loan with 80 percent LTV. The monthly premium would be about $450 (25% of the loan balance). We’re using IMFA’s average rates, which are posted here:
Example 2: This is a $350,000 FHA mortgage with 95 percent LTV. The monthly premium would be about $800 (50% of the loan balance). We’re using IMFA’s average rates (which are posted here):
Example 3: This is a $500,000 conventional loan with 80 percent LTV—the same example as in Example 2. The monthly premium would be about $1,200 (25% of the loan amount).
How Does it Work?
Mortgage insurance is an agreement between you and the mortgage company to cover you in case of loss. It’s the same agreement you have with your car insurance and your health insurance—you are covered by the company if you are disabled or die.
If you default on your mortgage, the mortgage insurance company pays off the lender. Then, it collects from you using one of two methods:
Liens
Insurance claims against designated assets
In either case, when they collect from you, they must give money to beneficiaries specified in your policy (your spouse and children). If there aren’t any beneficiaries or assets to collect from, they go after any other assets that could be used to pay off the loan (cars, furniture, bank accounts).
Pros and Cons of Mortgage Insurance
Mortgage insurance can be very useful for people who cannot afford the down payment needed to keep their conventional loan payments the same as they would be with a higher down payment. Here are some reasons why you might want to buy mortgage insurance:
It lowers your monthly payments by spreading the cost of the mortgage over many years.
You don’t need a 20% down payment. For example, if you borrow $100,000, you only need to pay 5% down ($5,000). This makes it easier to qualify for a loan.
During the life of your loan, you can get extra payments from the insurance company when you have extra money—for example, during tax season. These payments will reduce the amount of money you owe over time.
If you want to move or refinance, mortgage insurance gives you more flexibility with your loan.
Here are some reasons why mortgage insurance may not be right for you:
You need a 20% down payment—it makes little sense to buy mortgage insurance just to get that 80%. Instead, save up for the 20% down payment and then get your mortgage without it.
You have a high risk of default—for example, there’s a chance you may lose your job or get seriously ill in the future. While mortgage insurance can help keep your monthly payments stable, it does not change what happens if you die or become disabled. That’s why it’s important to save up enough money for the 20% down payment. If you don’t and have to rely on mortgage insurance, your monthly payments could skyrocket.
You need to refinance or move in the future—buying home insurance through 1031 exchange (see Chapter 7) may be more cost-effective for you than buying mortgage insurance.
You don’t have enough money in your savings account to cover 20% of your loan. For example, you could save up $25,000 ($500 per month for 25 years) for the down payment and then buy mortgage insurance with the rest of your inheritance (say, $750 a month).
How Does Mortgage Insurance Work?
Let’s say you have a mortgage with an 80 percent LTV and someone dies or they suffer from a long-term disability that prevents them from paying their mortgage—what happens? If they can no longer make payments due to permanent disability, the mortgage company will try to collect from other types of assets in their name—their house, cars, and bank accounts. They’ll also contact the Delaware Department of Insurance (DelDUI) to see whether you have any life insurance that could be used to pay off the loan.
If they don’t have enough life insurance, they’ll try to get additional money from other assets—car, furniture, and bank accounts. Part of their collection efforts is done by serving a notice on you—they give you a document called a Statement of Mortgage Position. It explains the circumstances surrounding your mortgage and how much money can be collected in case you die or become disabled.
Conclusion: FHA Mortgage Insurance
If you’re still inclined to buy mortgage insurance, here are some things to consider:
It’s often the only way you can qualify for a conventional or FHA loan. If you don’t have much money saved up and want a regular mortgage, mortgage insurance isn’t available for your type of loan. However, there are plenty of other options, such as 1031 exchanges (see Chapter 7), where you can exchange your home for cash without selling it. 1031 exchanges also give you more flexibility with your loan—you can refinance your loan into another type of mortgage or move easily when the market starts to pick up again.