The general idea behind insurance of any kind goes something like this: You pay money in exchange for a promise for money if something happens. Mortgage insurance is no different — except, in the case of mortgage insurance, you are not the one who actually gets the money if something happens.

The idea behind mortgage insurance is relatively simple: an insurance entity agrees to insure against default on a loan in exchange for premium payments made by you. So – you pay the premiums and should you default, the insurance company will actually pay your lender.

Usually this is the point where people ask “do I have to pay mortgage insurance?” and the answer is — no, not if you put enough money down and pick the right loan program.

On conventional loans, the insuring entity is usually a “private” mortgage insurance company and on FHA or government loans, the insurance company is FHA. Regardless of who you make your mortgage insurance payments to, do not be confused and think you are making mortgage insurance payments to your lender – you are not. The entity that you are making your mortgage insurance payments to is an insurance company (or the government) and is not a lender.

Conventional loans use Private Mortgage Insurance – also known as PMI

When you buy a property using conventional financing, you will be required to put down a 20% down payment or purchase private mortgage insurance. When you have mortgage insurance on conventional loans, you can usually get your lender to drop your private mortgage insurance once you reach a 20% equity point in your property – and conventional loans allow for property appreciation when making the calculation.

If you think that you have 20% equity in your property and want to stop paying monthly private mortgage insurance, the first step is to contact your lender. Each lender has different procedures in place, but normally you can expect to get an appraisal done on the property and have some kind of form to fill out and submit to the lender. Specific questions about the process should be directed to your current lender because each lender is slightly different in their requirements for dropping PMI.

Lender Paid Mortgage Insurance

For conventional loans, there is also something called LPMI – which is short for Lender Paid Mortgage Insurance. The way that Lender Paid Mortgage Insurance works is that the lender agrees to pay the Private Mortgage Insurance in exchange for a slightly higher interest rate. LPMI programs were very popular a couple of years ago, now they are fairly rare to find.

FHA loans use Mortgage Insurance underwritten by the Federal Housing Administration

The way that mortgage insurance works for FHA loans is really in two parts: 1. Up Front Mortgage Insurance Premium (also known as UFMIP) and then Monthly Mortgage Insurance (also known as MMI or MI). Up front mortgage insurance premium is usually 1.5% – 3% of your loan amount (depending on which FHA program you are participating in) and is required to be paid up front, although it can be financed into the loan. The Up front mortgage insurance premium is amortized over a period of 5 years and should you refinance into a new FHA program during those 5 years, FHA will allow you to use whatever is left in your UFMIP account as a credit towards setting up a new loan.

FHA monthly mortgage insurance is figured at a factor of .55% of your loan amount paid monthly. So for a $100,000 FHA loan, the annual monthly mortgage insurance due would be $550 and it would be paid monthly – or about $46 per month. FHA monthly mortgage insurance must be paid until you have paid down the loan to 80% of what was originally borrowed – it does not factor in property appreciation at all. So if you borrowed $100,000 originally, you would be required to pay monthly mortgage insurance until you reached a loan amount of $80,000.

Popular Loan Programs That Don’t Require Mortgage Insurance

Not all loan programs require mortgage insurance – some of the popular loan programs that do not require any mortgage insurance include:

• VA loans
• USDA loans
• Home Path loans

Is mortgage insurance a bad thing? Not really. When you purchase mortgage insurance, you can actually buy more home than you otherwise would be able to afford – because it increases your buying power. First-time buyers can use a low down payment to help them afford their first home, or to purchase a more expensive home sooner. Repeat home buyers can put less money down and gain significant tax advantages because they will have more deductible interest to claim. They can also use the cash they would have used for a large down payment for investments, moving costs or other expenses.

If you use any of the mortgage calculators to calculate what your mortgage payment will be, they will do a great job of calculating what the principal and interest will be on your loan.

But did you know that there is more to your monthly mortgage payment than just your principal and interest?

In mortgage-speak, you will sometimes hear the acronym “PITI” which stands for Principal, Interest, Taxes and Insurance. While many people focus on trying to save money with getting the lowest rates and fees on their loan, don’t overlook the opportunity to save possibly hundreds of dollars on your loan with taxes and insurance as well.

Principal and Interest
Principal and Interest is the amount of money that you pay towards the principal balance of the loan each month and the interest that is associated with that principal at a given interest rate. The principal and interest portion of your payment is just s simple math calculation that arrived at using the interest rate of your mortgage note, the principal amount of your loan and the number of years your mortgage is amortized for.

Taxes
Here is a relatively little-known piece of information – you may be able to save money on your annual tax assessment if the value of your property has went down down. If your property value has gone down and you think that the county assessors office has not accurately reflected this in your tax bill, there are processes in place where you can appeal the amount of taxes that are to be due. Check with your local county assessors office to see what the appeals process is if you want to contest the assessed value of your property because you think it has went down recently.

Insurance
There are two types of insurance: homeowners insurance and mortgage insurance. The best way to save money on your homeowners insurance is to shop around using a homeowners insurance quote service that will possibly help you pay less each month by finding a provider who can give you the same coverage you are getting now for less. You might be surprised how much you can save just by shopping around a little bit for the best deal.

Mortgage Insurance. Mortgage insurance is the money that the lender requires you pay if you are below a certain loan-to-value ratio on your home. The best way to save on mortgage insurance is to work toward getting enough equity in your property that the lender will no longer require it on your loan. How much you pay for mortgage insurance has to do with how much equity that you have in the property — more equity means that you will pay less for mortgage insurance. If you put as little down as possible, you will pay more for mortgage insurance.

Remember – when shopping for a mortgage, there is more to saving money each month than just getting the lowest “PI” possible — don’t forget to shop for the “TI” part as well, you might be surprised how much you can save!

• Split Premium Insurance—In this option, the borrower purchases a portion of the insurance by either paying out of pocket or financing, and then pays a smaller amount on the monthly premium. Some find this option attractive because it offers flexibility for the homebuyer and the lender.  Mortgage payments may even be lower because the premium can be paid by a third party or at closing.  Borrowers may also benefit from a split premium tax write-off.

• Standard annual premium—This option requires that a certain amount be paid at closing, usually the total cost of the first year of insurance.  Some borrowers like the standard annual premium because they get the insurance cost out of the way in the first year, and the renewal in the second year and beyond often leads to lower monthly payments.  Some companies offer tax benefits for choosing this plan as well.

More thoughts

Remember, mortgage insurance is designed to get buyers into homes faster by avoiding a large down payment.  Keep in mind the following when you’re choosing a certain type of mortgage insurance:

• The home loan amount
• Estimated monthly payments
• Local housing trends

With careful consideration of your personal circumstance, along with the benefits and disadvantages of each type, you can choose the mortgage insurance that is right for your home.