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:
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.