Need to Know: How Mortgage Insurance Works

Chances are you know you’ll need homeowners (property) insurance when purchasing a home, but are you familiar with mortgage insurance (MI)?

MI is quite different from your homeowners policy, and it works differently: It’s what lenders use to insure themselves should you, the borrower, default on your loan.

MI also behaves differently in conventional (Fannie Mae) mortgages and FHA mortgages. On a conventional mortgage purchase transaction, for example, MI is only required if you are putting down less than 20 percent. In this case, you’ll pay a premium that is based on the amount of down payment, meaning if you put 15% down, you’ll pay a lower premium than if you had a 10% down payment.

With FHA there are actually two MI payments. The first is called an “upfront premium,” and is paid at closing-either by financing it or by paying it out of your pocket. The other is combined with your monthly mortgage payment.

FHA MI tends to be more expensive than conventional mortgage insurance, but the benefit to borrowers of having an FHA mortgage is that the qualification guidelines are less restrictive.

There is another significant difference between conventional insurance and FHA MI: In conventional, you may be able to have the MI removed at some point in the loan’s life by paying down the principal or if the property value increases.

With FHA, MI remains in place for the life of the loan or until you sell the property or refinance into some other type of mortgage program, such as conventional. This is a fairly recent change, and under some circumstances, older FHA mortgages may be grandfathered; those borrowers may be able to have the MI removed.

If you need any other information on mortgage insurance or help deciding whether to go with a conventional or an FHA mortgage, talk to your mortgage professional.