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Mortgage Insurance – How It Works When Buying a Home

Mortgage InsuranceMortgage insurance is a product intended to protect the lending institution, the homebuyer. If you take out a loan to buy your home, as most people do, it is likely that you will be required to obtain mortgage insurance.

The amount you are able to deposit on your new home is the determining factor. If you put down less than 20% of the total cost of the property then your lender will require either public or private mortgage insurance (PMI).

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When exercised, the lender is compensated with a payment from the insurer if a covered home loan holder falls behind on payments ad ends up not honoring the terms of the loan. The defaulting of the given mortgage becomes the trigger that allows the lender to file a claim for recovery.

Background

Mortgage insurance has been around for a long time. The product first appeared just before the turn of the century around the 1880s. The first state regulation of this product was enacted in the state of New York about 15 years later.

Mortgage insurance gained popularity and continued to be sold and used through the late 1920s until 1929 when the stock market crashed.

When the stock market went belly up, the mortgage insurance market got sucked down with it because financiers were packaging the insurance policies into securities and selling them to investors, much the same way financiers did with mortgages up until 2007 when the stock market crashed again.

Private Mortgage InsuranceAfter the country recovered, the federal government itself became the main insurer of mortgages beginning in 1934. However, the private market didn’t get back into the picture until well after World War II with the surge of soldiers settling down and buying homes in the 1950s. Wisconsin led the breakthrough allowing private mortgage insurance again in 1956. California followed soon after in 1961 with its own set of mortgage insurance laws.

How it Works

The insurance product is triggered by a consumer initiating the process for buying a residential home. Applying for a home loan, the buyer states he is willing to provide a down payment of $10,000 on a $200,000 home. This equates to 5% of the total cost. Because the down payment is less than 20% of the total purchase price, the lender requires that the buyer also pays for private mortgage insurance on the loan provided, otherwise known as PMI.

An insurer will create a policy that will come with a price tag, referred to as a premium. This added cost will become part of the mortgage payment the buyer will have to pay each month once the home is bought. The insurance policy will continue until the loan payments made, plus down payment, equals more than 20% of the outstanding debt. Then the PMI will typically stop, and the mortgage monthly payment will be reduced to just loan payment afterwards.

The insurance policy won’t necessarily cover the entire loan amount provided. Many policies are limited to maybe 25% of the total home loan financed. However, it does provide the lender some partial recovery should the buyer default on the loan. The remainder of the loan is frequently recovered from selling the home itself, which is regularly used as loan collateral.

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Public vs. Private Insurance

Family Mortgage InsurancePublic mortgage insurance involves policies provided by a federal government program, specifically the Federal Housing Administration. Homebuyers involved in these programs pay a charge equaling 1% of the final home purchase loan approved. The insurance can end up being paid by the approved lender working with the FHA or by the homebuyer himself. The same kind of program also exists for borrowers eligible for home loans through the Veterans Administration.

In comparison, private mortgage insurance or PMI is provided by private financial insurers who work directly with mortgage lenders. The cost of the insurance can be much higher than a public policy, reaching as much as 6% of the final approved loan in some cases. The homebuyer’s credit score and the involved loan to value ratio tend to be the metrics used to figure out the percent charged. The payment schedule for the premium is also broken out, typically on a monthly basis and added to the mortgage payment.

Cancelling Mortgage Insurance

Pursuant to federal law enacted under the Homeowners Protection Act of 1988 home buyers who use mortgages with insurance are allowed to ask for it to be ended when certain conditions are met.

Generally, the trigger for ending mortgage insurance occurs when the homebuyer’s equity level reaches 22% of the approved loan value.

Additionally, many lenders are also allowed to require that the two years prior have had no issues of late payments.

Mortgage Insurance When Buying A HomeInsurers themselves can also arbitrarily cancel an existing policy if the company determines, and can prove, that they were misled or that fraud occurred. Loan misrepresentation provides very strong grounds to let an insurer out of its contractual obligation with a lender if found out. However, an insurer is not allowed to dump existing policies as a group or an entire pool just because it wants to get out of a risky position industry-wide. Carte blanche cancellations are violations and material breaches of contract.

While there is no selection process allowed for homebuyers in determining which insurer actually provides mortgage insurance on a specific home loan, homebuyers can choose who provides them homeowners insurance to protect the property purchased.

And with so many companies available, it makes sense to compare notes. This can be easily done by using Internet insurance comparison sites, many of the free, to search and compare potential policies available and their possible premiums. Doing so allows a consumer to find the best homeowner’s insurance policy available for his needs.

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