What is Mortgage Insurance?
Introduction
Mortgage Insurance is an insurance policy that covers the lender’s risk from defaulting borrowers. Mortgage insurance is also known as Private Mortgage Insurance (PMI) or Lenders Mortgage Insurance (LMI). The lender purchases the policy to protect himself and passes on the premium to the borrower added on to the monthly mortgage payment.
Conditions Where LMI Applies
The primary condition where mortgage insurance applies is where the down payment for the mortgage is less than 20% of the property’s (which is under mortgage) value.
A mortgage has to meet the conditions set by the Federal National Mortgage Association for it to be covered by mortgage insurance. Parameters are set for the borrower qualification, size of the mortgage as well as the nature of the property for which loan is requested. Insured mortgages that meet these conditions are eligible for resale in the mortgage-backed security market. This way, the lenders can sell older mortgages and issue more loans.
Ways to Pay
Many lenders incorporate the mortgage insurance cost directly into the mortgage. This method is called capitalization. Capitalized premiums are eligible for additional tax deduction in jurisdictions where one can apply for tax deduction on one’s mortgage payment.
A good number of borrowers are unable to make 20% down payment so that they can steer clear of the mortgage insurance premiums. Lenders created a financing method called 80-10-10 to help such people. In the 80-10-10 method, the primary mortgage remains 80% of the value of the property and the down payment is brought down to 10%. Additional funds come from a second mortgage which holds a higher interest rate than the first mortgage. Eliminating mortgage insurance helps the debt being paid back faster. Further, when the borrower’s equity reaches 20% of the total value, the mortgages get combined without mortgage insurance coming into the picture. This model has another variant called 80-15-5 for people who can make only 5% down payment.
|