How Today’s Mortgage Insurance Works

As you likely know, mortgage insurance is taken out by a lender to cover the lending company in the event the borrower defaults on his or her mortgage; the borrower pays the premiums. Typically, mortgage insurance is applicable when there is a low down payment, or when the borrower’s credit is less than ideal.

There have been some recent developments in mortgage insurance, so here is a summary of the way it works now.

Conventional mortgage insurance

Conventional mortgages, meaning those to which Fannie Mae or Freddie Mac guidelines apply, require insurance when the client’s down payment totals less than 20 percent. The closer the down payment to 20 percent, the lower the monthly premium, and the insurance can be removed once the borrower has sufficient equity in the property, as it is no longer needed.

The increase in value may result from a significant appreciation to the property due to improvements, an upward market shift, or because the borrower pays down the mortgage ahead of schedule. Then, if the borrower feels the value of property is sufficiently high that mortgage insurance is no longer required, he or she petitions the lender.

FHA mortgage insurance

FHA actually encompasses two types of mortgage insurance: One the borrower pays (or finances) at closing, and one is paid monthly. The premium at closing is called the “Upfront Mortgage Insurance Premium”, and the other is called the “Annual Premium”, although it is paid monthly.

Both premiums are a percentage of the loan amount, and are the same whether the borrower is putting down the minimum (3.5%) or much more.

Unlike Fannie and Freddie’s premiums, the FHA’s mortgage insurance will remain on the mortgage until it is paid off, refinanced, or the property is sold. The upfront premium is non-refundable, but if the borrower were to finance into another FHA mortgage within a few years, they would get a partial credit toward the mortgage insurance on the new loan, depending on how long it has been since they last financed.

FHA challenges

The FHA has had a number of premium increases in the last few years, making these loans more expensive to obtain.

By their own admission, they are having financial challenges, and are passing a lot of this expense on to the consumer.

One example of this is the requirement mentioned above. As recent as 12 months ago, borrowers had the option of removing mortgage insurance or having it fall off after time. Now, the mortgage insurance must continue for the duration of the loan, which, along with higher premiums, makes FHA mortgages less desirable.

The reason why many people go with FHA loans is that the down payment and credit requirements are much lower than those of conventional mortgages.

However, this may change as premiums jump; borrowers may be inspired to better manage their credit, knowing they will want to go with conventional mortgages in future.

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