What Is Mortgage Insurance For?

Not too long ago, getting a mortgage generally meant coming up with a 20 percent down payment in addition to having a good credit score and showing that your income was sufficient to make the payments. Although the freewheeling days of 0-percent-down mortgages are starting to looking like ancient history, there are still plenty of borrowers who get mortgages without the standard 20 percent down payment. The advent of mortgage insurance helped pave the way for more flexible mortgage terms for borrowers.

Use

When a borrower wishes to take out a mortgage to purchase or refinance real estate without putting at least 20 percent down, the lender may require the borrower to purchase mortgage insurance. For conforming FHA loans, mortgage insurance premiums are 1.75 percent for purchases and refinances. The FHA was set to begin charging risk-based premiums (where riskier borrowers pay higher premiums) in the summer of 2008, but that was postponed indefinitely due to the real estate market bubble bursting.

Function

In the event of a default on the mortgage, private mortgage insurance (PMI) compensates the lender for losses related to the mortgage. The mortgage insurance company becomes a creditor on the real estate for the amount paid out as a result of the insurance.

Premium Types

There are two basic kinds of mortgage insurance premiums. There are up-front mortgage insurance premiums and an annual insurance premium, which is usually paid monthly by the borrower along with the monthly payment of principal and interest. Up-front mortgage insurance premiums must be paid at the beginning of the loan period and are often collected as part of the closing process.

Significance

Mortgage insurance allows borrowers to finance a home or refinance a home without the need to save up a large amount of money for a 20 percent down payment. This is especially important, because housing prices have risen such that a borrower could need a $50,000 or $100,000 down payment to purchase a median-priced home in some markets, putting home ownership out of the reach of many.

Misconception

Even though the borrower pays for mortgage insurance premium, the insurance provides no protection or benefits for the borrower except for allowing him to get the loan in the first place. In the event PMI becomes payable due to default, the insurance compensates the lender, not the borrower.

History

Until 1999, the borrower paid mortgage insurance premiums for the life of the mortgage regardless of how much equity had been built up in the home. In 1998 Congress passed the Homeowners Protection Act of 1998, which established rules under which mortgage insurance could be canceled once a certain amount of equity was reached in the home and a history of good payments had been established. In 2008, borrowers were allowed to deduct the cost of mortgage insurance for the first time, provided the loan was for the main home and certain income limits were met.