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.