What is Mortgage Insurance?Posted on: November 28, 2008
As a loan officer who has over one thousand loan closings within the last five years, I have fielded numerous questions from first time home buyers, but the question most asked has to do with mortgage insurance: what is it, why do I have to have it, and how long do I have to keep paying it?
Mortgage insurance is a financial guaranty for the lender that will help to reduce or eliminate a loss in the case of a default by the borrower, and it is almost universally required on loans where there is less than twenty percent equity. That means if you are purchasing a home with less than twenty percent down or refinancing to more than eighty percent of your homes value, you are going to be required to pay mortgage insurance. In other words, mortgage insurance spreads the risk between the lender and the insurance company.
The next question I get about mortgage insurance is, “Why do I have to have it?” The answer to that is simple: without mortgage insurance, many lenders would not be able or willing to accept the risk of lending without having twenty percent equity, making it significantly more difficult for customers to purchase a home, or use their home equity to consolidate debt or make an addition to their home. So while it may seem like you do not gain any advantage by having to pay mortgage insurance, it may be the factor that is allowing you to gain approval for your loan. In addition, a bill was passed in 2007 that allows people to write off their mortgage insurance on your taxes, just like you would for the mortgage interest that you pay. There are income restrictions on this provision, so check with a tax professional to see if this would benefit you.
Finally, the question comes up, “When can I stop paying mortgage insurance?” The answer to that will vary depending upon how your mortgage is worded, but there are a few general guidelines that are pretty universal. If you have a conventional mortgage, you are going to need to pay the mortgage insurance for at least the first year of your loan. If you have paid down the balance below eighty percent of the original purchase price or value, you can send a written request for the lender to remove the insurance (a lot of contracts say you can request the removal at eighty percent, they are required to remove it when the balance gets to seventy-eight percent). Some lenders will also allow you to pay for an appraisal, and if your home has risen in value to give you the twenty percent equity, they will also remove it. If you have an FHA guaranteed loan, you are going to be required to pay the monthly mortgage insurance for at least the first five years of the loan, and in order to have it removed you need to have the loan balance down to eighty percent of the original purchase price or value; they will not allow you to go off of what the appraised value is.
Mortgage insurance may seem to be an unnecessary monthly cost to many first time home buyers, but it is in fact what allows most people to purchase their first home. With the law that allows homeowners to write this cost off their taxes, it has become a little more consumer friendly as well.