When you’re purchasing a home and taking out a mortgage loan, you may hear the term “mortgage insurance” thrown around. Mortgage insurance is a type of insurance that protects the lender in case you default on your loan. While it is an added cost for borrowers, it can make it easier to qualify for a mortgage loan and provide additional protection for lenders. In this article, we will discuss the role of mortgage insurance and when you may need it.
What is Mortgage Insurance?
Mortgage insurance is a type of insurance that protects lenders from financial losses in the event that a borrower defaults on their mortgage loan. There are two main types of mortgage insurance: private mortgage insurance (PMI) and government mortgage insurance.
Private mortgage insurance is typically required for borrowers who are putting down less than 20% of the home’s purchase price as a down payment. Private mortgage insurance is provided by private insurance companies and is paid for by the borrower in the form of a monthly premium. The premium amount is based on the loan amount, down payment, and credit score.
Government mortgage insurance is offered through government programs such as the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). These programs provide mortgage insurance to borrowers who may have difficulty obtaining a loan from traditional lenders due to their credit score, income, or down payment amount.
When Do You Need Mortgage Insurance?
Mortgage insurance is typically required when a borrower puts down less than 20% of the home’s purchase price as a down payment. This is because lenders consider borrowers with a lower down payment to be at a higher risk of defaulting on their loan.
In some cases, borrowers may be able to avoid mortgage insurance by taking out a second loan, known as a piggyback loan. A piggyback loan is a second mortgage that is taken out at the same time as the first mortgage and is used to cover a portion of the down payment. This can help borrowers avoid mortgage insurance, but it can also result in a higher monthly payment due to the additional loan.
Benefits of Mortgage Insurance
While mortgage insurance may seem like an added cost for borrowers, it can provide several benefits, including:
- Easier qualification: If you don’t have enough money saved for a 20% down payment, mortgage insurance can make it easier to qualify for a loan.
- Lower interest rates: With mortgage insurance, lenders are able to offer lower interest rates because they are protected from financial losses in case of default.
- More affordable monthly payments: By spreading the cost of the mortgage insurance premium over the life of the loan, borrowers can enjoy more affordable monthly payments.
- Protection for lenders: Mortgage insurance protects lenders from financial losses in the event that a borrower defaults on their loan, which can help to ensure that lenders continue to offer affordable mortgage loans.
Drawbacks of Mortgage Insurance
While mortgage insurance can be beneficial for borrowers and lenders, there are also some drawbacks to consider, including:
- Added cost: Mortgage insurance is an added cost for borrowers and can increase the total cost of the loan.
- Difficulty cancelling: In some cases, borrowers may have difficulty cancelling their mortgage insurance, even after they have built up enough equity in the home to avoid it.
- No protection for borrowers: While mortgage insurance protects lenders, it does not provide any protection for borrowers in case of financial hardship or job loss.
Conclusion
Mortgage insurance is a type of insurance that protects lenders from financial losses in the event that a borrower defaults on their mortgage loan. It is typically required for borrowers who are putting down less than 20% of the home’s purchase price as a down payment.