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Mortgage Insurance

Definition

Mortgage insurance is a policy that protects lenders against losses that result from defaults on home mortgages. If the borrower defaults on the loan, the insurer will pay the lender. This insurance is typically required for borrowers who make a down payment that’s less than 20% of the home’s purchase price.

Phonetic

The phonetics for the keyword “Mortgage Insurance” is: Mortgage: ˈmɔːrɡɪdʒInsurance: ɪnˈʃʊərəns

Key Takeaways

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  1. Mortgage Insurance is a financial product that reimburses lenders for losses if a homeowner is unable to pay their mortgage.
  2. It is usually required when homebuyers make down payments less than 20% of the home’s value, thus it protects lenders against the risk associated with low down payment mortgages.
  3. Although it adds to a borrower’s costs, the ability to get a loan with a low down payment can make homeownership possible for more people.

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Importance

Mortgage insurance is an important term in business and finance because it provides financial protection to lenders and investors in case of a borrower’s default on a mortgage loan. Typically, it’s a requirement for homebuyers who make a down payment of less than 20% of the home’s purchase price, as these loans are considered higher risk. The importance of mortgage insurance lies in its function to safeguard the lender, ensuring they can recoup losses in the event of a foreclosure. Consequently, it allows lenders to approve loans that they might otherwise consider too risky, thereby promoting homeownership for individuals who cannot afford a significant down payment.

Explanation

At its core, Mortgage Insurance is designed to address the risks lenders face when borrowers can’t make their mortgage payments. The primary purpose of Mortgage Insurance is to protect lenders from potential losses if a borrower defaults on their mortgage. This insurance allows financial institutions to offer loans to individuals who might otherwise be seen as high-risk, with less than a 20% down payment. It adds a level of security and assures lenders that the money they lend will be recovered in some way, even if the borrower can’t meet their obligations.Moreover, Mortgage Insurance plays a big role in accessibility in the housing market. By reducing the risk for lenders, it lowers the threshold for those wanting to buy a home, opening the door for buyers who may not have the typically sizable down payment saved up. By safeguarding the interests of the lender, this coverage makes home ownership achievable for a wider range of potential homeowners. However, it’s essential to note that Mortgage Insurance benefits the lender more than the borrower—it protects their investment, not the borrower’s home.

Examples

1. Example 1: John bought his first home costing $200,000. Unfortunately, he only had a down payment of 10% ($20,000) which had an effect on his loan-to-value ratio. In this case, his lender would require him to pay for private mortgage insurance (PMI) to protect the lender in case John was unable to make payments on the mortgage. This private mortgage insurance might cost John around $100 a month, and will be terminated only when his loan-to-value ratio drops at or below 80%.2. Example 2: Sarah has a Federal Housing Administration (FHA) loan for a recently purchased residential property. The FHA requires an upfront mortgage insurance premium (UFMIP) which is usually 1.75% of the base loan amount. Besides this, Sarah also needs to pay an annual MIP, which varies depending on the length of the loan, the loan amount, and the loan-to-value ratio.3. Example 3: Tony and Linda are a couple who have recently bought a new home with a high-ratio mortgage, implying they have paid less than 20% of the purchase price as their down payment. Due to this, when they went for mortgage approval at a bank in Canada, they were required to purchase mortgage insurance from the Canada Mortgage and Housing Corporation (CMHC). This premium was added to their mortgage balance which they will pay off over the lifetime of their mortgage.

Frequently Asked Questions(FAQ)

What is Mortgage Insurance?

Mortgage Insurance is a policy that protects lenders against losses that result from defaults on home mortgages. Typically, borrowers are required to pay for this if they make a down payment that’s less than 20% of the home’s purchase price.

Who pays for Mortgage Insurance?

Generally, the borrower pays for Mortgage Insurance. It can either be added to their monthly mortgage payment or paid in a lump sum at closing.

Is Mortgage Insurance required for all types of mortgages?

No, Mortgage Insurance is typically required for conventional loans where the borrower is making a down payment of less than 20%. Other types of loans like VA or USDA loans do not require Mortgage Insurance.

Can Mortgage Insurance be cancelled?

Yes, once the borrower’s equity in the home reaches 20%, they can request to have the Mortgage Insurance cancelled. Automatically, it gets dropped when the loan-to-value ratio reaches 78%.

How is the cost of Mortgage Insurance determined?

The cost of Mortgage Insurance is primarily based on the size of the down payment and the borrower’s credit score. The lower the credit score and down payment, the higher the cost.

Will Mortgage Insurance protect me if I can’t make my mortgage payment?

No. Mortgage Insurance protects the lender, not the borrower. If the borrower defaults on the loan, the insurer will compensate the lender for the loss.

What is PMI?

PMI stands for Private Mortgage Insurance. It is a type of mortgage insurance that is used with conventional loans, where the borrower pays for it.

How can I avoid paying Mortgage Insurance?

It can be avoided by making a down payment of 20% or more, obtaining a VA loan (if eligible), or getting a piggyback loan, where you take out a smaller loan to cover the amount of the mortgage above 80% of the purchase price.

Related Finance Terms

  • Private Mortgage Insurance (PMI)
  • Loan-to-Value Ratio (LTV)
  • Mortgage Default
  • Federal Housing Administration (FHA) Insurance
  • Mortgage Insurance Premium (MIP)

Sources for More Information

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