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Mortgage Insurance 101

Mortgage insurance is an insurance policy designed to compensate lenders in the event the owner defaults on his or her mortgage loan. Traditionally, mortgage lenders used this policy to reduce their risk. Mortgage insurance allowed many borrowers to purchase homes with less money down. As unemployment rises and the job market continues to stagnate, foreclosures are on the rise and mortgage insurance companies have tightened their guidelines. Many companies have stopped offering insurance because they cannot afford to pay out the premiums they secured. However, no one has suffered more than the middle class because they are required to have larger down payment amounts and are required to pay higher monthly premiums.

Mortgage Insurance Overview

If the home buyer applies for a loan that requires less than 20 percent down, all mortgage lenders will require they purchase mortgage insurance. If the borrower defaults, the insurance provider will pay the mortgage lender.  Mortgage insurance premiums are added to the monthly mortgage payment and are typically financed into the loan amount.

Government Insurance

FHA is a part of the Housing and Urban Development and insures lenders against default. FHA requires a minimum down payment amount of 3.5 percent for single family homes up to $625,500. The maximum loan amount will vary depending on where the borrower lives.

In order to qualify, borrowers have to meet the standard FHA credit qualifications, which are more lenient than those offered by most private mortgage insurance providers. Government insurance policies have both upfront and monthly premiums. Upfront costs can be financed into the loan amount and are typically 2.5 percent of the loan amount. The monthly premium costs are included as part of the monthly payment, those amounts are typically .55 percent.

For example, if a borrower is purchasing a home of $200,000, the upfront financed mortgage insurance will be $5000. The monthly premium amount will be $91.67. Both amounts are required to be paid with the loan as a condition of the loan.

Private Mortgage Insurance

Private mortgage insurance is issued by a variety of private companies. Each company will establish their guidelines and requirement to issue coverage. Additionally, the coverage amounts will vary. Generally, the rates range from 1.5% to 6% of the principal of the loan per year. The rates may change over the years. Depending on the loan, the rate payments may be monthly, annual or some combination of both. In many cases, they are included in monthly mortgage payments.

With private mortgage insurance, the borrower has the right to terminate the loan once he or reaches 22% equity. The lender is required to help the borrower through the process and answer any questions that may arise. An appraisal report will be required to establish market values.

Lender-Paid Private Mortgage Insurance

As the name implies, lender-paid private insurance is different from private mortgage insurance in one important respect - the policy is purchased by the mortgage lender, who makes insurance payments and other obligations. Lenders offer the insurance for borrowers that do not qualify for private mortgage insurance coverage. Lenders increase the rate of a loan to defray the cost of the insurance. For example, instead of allocating a 7 %, a borrower with lender paid MI will have an 8.5 % rate.

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