Mortgage insurance can refer to two types of insurance you may need to purchase when you purchase a home. The first type is usually voluntary and is a type of life insurance policy. If you are permanently disabled or die, this insurance policy kicks in to completely pay your mortgage, thus leaving you or survivors without the obligation of paying for a mortgage.
The second type of mortgage insurance is much more common and may be called personal mortgage insurance (PMI) or lender’s mortgage insurance (LMI). Both PMI and LMI and usually non voluntary insurance fees are tacked onto the purchase of a home if you take out a very large loan, called a jumbo loan, or if you cannot place at least 20% down when you purchase a home. In the event that you cannot pay the loan, PMI protects both the lender and borrower.
For instance, if the home loses value and the bank must foreclose on the mortgage, PMI steps in to protect the lender from owning money to the bank after the home is sold. In other words, if the mortgage value exceeds the sale price, the previous owner has no more obligation to the loan. This protects the borrower, but also the lender, since the company is compensated for the difference in price between the mortgage value and the sale price.
There are different ways in which mortgage insurance may be attached to a loan. The total, usually about 1.5% of the value of the loan may be added by the lending agency and be part of the monthly payment, or alternately, borrowers can pay an additional premium each month on top of their monthly payment. Several changes in laws have changed the way PMIs are paid for. For instance, borrowers are only required to carry PMI, according to the Homeowners Protection Act of 1988, until they have at least 20% equity in the home. If you put down 10% upfront, you’d only need to carry PMI until you had another 10% equity in the home, so your overall total amount paid in mortgage insurance could be greatly reduced over time.
Another way some borrowers avoid paying personal mortgage insurance is to take out a second loan to pay for the down payment of 20%. This avoids the additional fees of the insurance and allows owners to get into a house for less money down. Given the housing crisis beginning in 2007 in the US, it is expected that most lenders will respond by tightening rules on down payments. This option may not be open to most borrowers, and some lenders may require a specific down payment amount in cash, not a second mortgage, before offering to lend money.