The Whys and Hows of Mortgage Insurance

You’ve likely heard the term “mortgage insurance,” but you still may be wondering what the heck it’s all about. In fact, this is very different from other forms of insurance you’re used to, such as property or hazard insurance.

It works this way: Under certain circumstances, a lender may take out mortgage insurance to cover the lending company in the event that the borrower defaults on the mortgage; as the borrower, you pay the premiums. Typically, mortgage insurance is taken out on a loan where the down payment is low or the borrower’s credit is less than ideal.

Conventional mortgage insurance

Conventional mortgages – those using Fannie Mae or Freddie Mac guidelines – require insurance when there is less than a 20 percent down payment. The closer the down payment to 20 percent, the lower the monthly premium. The insurance (and the monthly payments) can be removed when it is shown that there is now sufficient equity in the property and it’s no longer required.

FHA mortgage insurance

FHA has two types of mortgage insurance: One that you pay (or finance) at closing, and one you pay on a monthly basis. The first is called the “Upfront Mortgage Insurance Premium,” and the second, the “Annual Premium” (although it is paid monthly.)

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

Unlike Fannie and Freddie, this 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 you were to finance into another FHA mortgage within a few years, you would get a partial credit toward the mortgage insurance on the new loan, depending on how long it’s been since you last financed.

If this sounds complicated, contact your mortgage professional to translate it for you.

The Benefits- and Challenges – of 15-Year Mortgages

Acquiring a 15-year mortgage, as compared to the traditional 30-year variety, has both benefits and challenges. Take this imaginary $100,000 loan as an example:

For the 30-year loan, we’ll assume a rate of 5.00 percent; the monthly payment, excluding taxes and insurance would be $536.82. Because the rates for 15-year mortgages are typically lower, we’ll use 4.75 percent as a rate. This gives us a monthly payment of $777.83 – a difference of $240.91 per month.

While this is no small difference on a monthly basis, it’s a big difference over the long term. The total amount you will pay for the 15-year loan is ($777.83 x 180 months), or $140,009.40. The 30-year mortgage, however, will set you back ($536.82 x 360 months) $193,255.20. This is a difference of $53,245.80, or over half of your original loan amount.

If you are unable to afford the 15-year payment each month, but would like to reduce the mortgage balance more quickly, you can always get the 30-year loan, and make the equivalent of one extra payment per year.

In this scenario, you could add one-twelfth of your payment ($44.74 per month) to $536.82, and shave off almost seven years from the end of the loan.

Despite the slightly higher payment, the advantage of this solution is that if one month your financial situation is especially tight, you could make the regular payment, then catch up the following month.

Discuss your options with your mortgage professional, who will help you pick the term that’s best for you.