Mortgage Insurance

Mortgage insurance, also called PMI, is the insurance homeowners pay when they do not have an adequate down payment for their homes. This insurance affords some protection for the lender and goes away as the mortgagee pays down some of the loan.


1. Paying For Mortgage Insurance

Chances are you will not have any say in finding your mortgage insurance, or PMI, policy. Instead, your lender will choose the policy. Many people get confused by PMI because it does not work the same way as other types of insurance. You, as the homeowner, are paying for the mortgage company's insurance policy. While that may seem unfair, it is the price you are paying for the lender giving you money without any proof that you will pay.

The lender chooses a mortgage insurance company for all their mortgagees who do not put down the required payment. This mortgage insurance company will have a fairly standard policy regarding how much each homeowner will pay, and this payment typically is based on the value of your home and no other factors.

Escrowing the mortgage insurance, which means paying a portion of the premium monthly with your regular mortgage payment, usually is the only option you have. While you can choose not to escrow taxes or homeowners' insurance, you will need to pay the mortgage insurance directly to your lender each month, and then he or she pays the insurance company using your money.

Mortgage insurance may seem unfair, but it allows some people who otherwise would not be able to save a down payment to purchase a home on their own.

2. Understanding Mortgage Insurance Versus Homeowners' Insurance

Mortgage insurance and homeowners' insurance are not the same, though it is easy to confuse the two. Homeowners' insurance is something you get on your own. It requires calling around and getting quotes, then choosing the best policy. Homeowners' insurance covers your costs if something happens to your house, such as a break-in, or some natural occurrences, such as tornadoes, destroy your home.

Mortgage insurance, on the other hand, is insurance for your mortgage company in case you default on your mortgage. This insurance, also called private mortgage insurance (PMI), is a type of insurance people are required to get if they do not put down an adequate down payment, which typically is 20 percent of the cost of the home. In times past, few people got PMI because most lenders did not permit less than a 20 percent down payment, but during the recent housing boom, this type of insurance became commonplace.
The mortgage lender needs some assurance that he will get his money back if you cannot keep up on the payments for your loan. Mortgage insurance is a way to help ensure the expense for your lender. Mortgage insurance typically is a percentage of the cost of your home, and it can get very expensive for larger homes, making a down payment even more attractive for you.

3. Getting Required Mortgage Insurance

For most homeowners, there is little they need to do in order to get mortgage insurance. The lender typically has the insurance policy already set up as a standard part of the lending agreement in cases where the homeowner does not have an adequate down payment. The homeowner has little choice in the matter, but that does not mean she cannot ask questions.

Your mortgage broker should explain the PMI process and how much you can expect to be paying before you begin looking for a home. Because mortgage insurance can add a fairly hefty sum to the monthly payment you will be making, educating yourself about the policy the mortgage broker uses is necessary to help you estimate the home you can afford.

Ask your mortgage broker now about any questions you have. You also can ask for documents related to the mortgage insurance, including how much you will pay, how it will be collected, and when it will stop. Knowing these policies ahead of time can save you a significant amount of money and stress in the long run because you will be making your mortgage decisions based on a full picture.

Beyond knowledge, though, you should need to do little for your mortgage insurance. Chances are good that your lender will take care of the details for you.

4. Getting Rid Of Mortgage Insurance Through Payment

The simplest, but longest, road to getting rid of your mortgage insurance it to pay down the loan over time. When you first get any loan, only a very small percentage, perhaps even five percent, of your payment goes to the principal of the loan. As you make your monthly payment, the amount of the interest you need to pay goes down. Over time, a substantial portion of your payment is going toward the principal of the loan.

When the remaining balance on the principal of your loan reaches 80 percent of the purchase price, you may request that your lender drop the PMI. Some lenders have this plan in place automatically, while others require your action to start the process. Many lenders will grant this request if borrowers have made all payments on time.

Should your lender deny the request, you will need to continue paying until you reach 78 percent of the price you paid. At this point, a federal law steps in. The Homeowners Protection Act requires lenders to drop mortgage insurance once homeowners reach this point in their mortgage repayment. There are exceptions, but as long as your loan is in good standing, you should be fine. Knowing when you reach this threshold is important because you can make sure your lender complies with the law.

5. Getting Rid Of Mortgage Insurance Through Creative Lending

The housing boom created what many in the financial sector call "creative lending." People using this term typically mean it in a negative way, but used correctly, creative lending practices can benefit the borrower. One of the most common loans is the 80/20 loan. In this loan, the borrower gets two mortgages. One is for 80 percent of the purchase price; the other is for 20 percent. By getting this loan, the borrower appears to the 80 percent loan that he is making a down payment, thus eliminating the need for mortgage insurance.

The primary issue with the 80/20 loan is that the borrower may find the second loan's interest rate negates the savings in PMI, although the homeowner could work hard to pay off the smaller loan in a shorter period of time.

One alternative for people who have some down payment is the 80/10/10 loan. This loan works the same way, except the second 10 percent is the down payment the homeowner is making. The 10 percent loan allows the borrower to avoid mortgage insurance, and the cost of interest will not eat into the savings as much. Both these options are useful when used properly, but they can be abused to give someone a more expensive home than he or she can afford to purchase now.

6. Getting Rid Of Mortgage Insurance Through Increased Valuation

Although mortgage insurance initially is based on the amount of the price mortgaged, new homeowners can get out of mortgage insurance by getting the value of the house increased. The easiest way to do this is with significant renovation. By adding a room, a paved driveway, or remodeling a kitchen, the homeowner can have the house reassessed. In fact, many areas require the property to be reassessed for tax purposes if a major renovation project is completed.

Once major work is done and the house's value goes up, the homeowner can and should ask to have the mortgage insurance re-evaluated. In some cases, the lender refuses based on a clause requiring the homeowner to keep the property for a certain amount of time before eliminating mortgage insurance.

In many cases, though, the homeowner finds that increasing the valuation, or property tax value of the house, to 120 percent or more of the original price will convince the lender to drop the mortgage insurance. Should you approach a mortgage lender with the time-length clause, then you can consider refinancing the mortgage, which may eliminate that problem. Understanding the terms of your mortgage before you purchase is one of the best ways to make sure you can use the valuation of your home to eliminate the added payment of mortgage insurance quickly.

7. Avoiding Mortgage Insurance

The easiest way to avoid mortgage insurance is to put down a hefty down payment. In previous decades, lenders expected prospective homeowners to put down 20 percent of the asking price for any home they purchased. On a $100,000 home, you would need $20,000 saved to cover the down payment. As housing prices grew in relation to income, however, lenders began to relax these restrictions. Some required only 10 percent or even no down payment.

The caveat for buyers without the 20 percent down payment is that they need to do something to help the lender get some guarantee of getting the money back should the borrower default. That is where mortgage insurance comes in. A policy for the lender that the homeowner will pay, mortgage insurance is an easy way for the lender to feel okay about making the loan and the homeowner to be able to get a more expensive house.

To avoid mortgage, then you need to do one of two things. The simplest is to save up a good down payment before you make the home purchase. The second option is to buy a house needing work and do the needed repair jobs quickly. Getting the house appraised at a value about 120 percent of what you paid means you can get avoid mortgage insurance.

8. Refinancing With Mortgage Insurance

Refinancing a home is a fancy way of saying that you are getting a new loan. If you have had your home a few years, some of the money you pay every month is going toward the principal of your mortgage. Though it does not start out as much money, over time it does become a larger portion of your monthly payment. At some point, you may consider refinancing. People typically refinance for two reasons. Some want to tap into the equity, or money they have paid toward their home, in order to get cash for other expenses. Others simply want a smaller monthly payment and refinance only to cover the principal remaining on their current loan.

The PMI insurance can pose a bit of a dilemma. Some policies are based on the homeowner agreeing not to refinance the home for a certain period of time. Homeowners who refinance before this time is up may find themselves paying penalties. As the homeowner, you need to evaluate the situation and determine if you will save more by paying the penalty.

Refinancing may rid you of mortgage insurance. If you are refinancing for a smaller amount, and you have 20 percent equity once it goes through, then you will no longer need to pay PMI, which will lower your payment even more.

9. Estimating Mortgage Insurance

Mortgage insurance is not based on your credit or other factors related to your ability to repay. It is unlike other types of insurance in that way. Your car insurance is based on your driving record. Your health insurance may be based on your overall health. For mortgage insurance, though, the cost is determined using two factors. First, the amount of your down payment factors in. Second, the amount you are refinancing factors in.

Most mortgage insurance policies, which your lender and not you will be selecting, require you to pay from one-half to one percent of the value of your home. One percent of a $200,000 home is $2000. This annual premium for PMI will amount to around $160 per month added to your mortgage. The exact percentages for your mortgage depend on the home's purchase price and do not take any other factors into account.

The amount PMI adds to your monthly payment can be steep, as you can see from the example. This cost is in addition to your regular payment, and typically is included in the amount you are paying to your mortgage company. Getting out of PMI, which can take a while, can save you a significant amount of money over the life of your loan. Paying extra will reduce the time you pay PMI.
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