Who Benefits from Mortgage Insurance? Not You!
This insurance is paid by you to benefit the bank upon your default. If you are required to have mortgage insurance, the reason is because the bank wants that protection. The insurance is designed to pay for all or most of the loss incurred by the bank if you were to default on the loan and your property was foreclosed.
In general, mortgage insurance is required when the amount of the home loan is greater than 80% of the value of the home. As an example: If the loan was $90,000 and the value of the home is $100,000, then the loan would be 90% of the value of the home and mortgage insurance may be required.
One noteworthy exception to the 80% rule: If you get a remodeling loan, like when you locate a property and buy it to fix- up, or a complete construction loan. The Lender may use the finished value of the home to determine if mortgage insurance is required. If that future value is such that there is at least 20% equity in the property, they will not require you purchase mortgage insurance.
The reason why 80% is used as a benchmark is that banks feel that the cost of foreclosing is about 20% of the value of the property. That means: if you buy a house with 20% or greater down, there is no need for mortgage insurance because your down payment is sufficient to cover any potential foreclosure losses. The same is true for refinances: If your equity is less than 20% of the appraised value of your home, you may be required to pay mortgage insurance.
There are two types of mortgage insurance regardless of the home type you buy: The one that the Borrower pays and the one that the Bank pays. Most people are familiar with mortgage insurance paid by the Borrower. You see a separate charge on your mortgage statement each month for the insurance. The one paid by the Lender is much more subtle.
Most Lenders that offer “no mortgage insurance loans” for loans above 80% of the value of the property are indirectly charging you the cost of the mortgage insurance. One indirect method is by increasing the interest rate of the loan to offset the cost of the mortgage insurance. For example: Take a loan that would normally require mortgage insurance. That loan with mortgage insurance may have a 6% annual interest rate while a loan “without” mortgage insurance may have an annual interest rate of 6.5%. The difference is that a higher interest rate on a “no mortgage insurance loan” generates a greater profit to the Mortgage Company. That additional profit can offset the higher risk of potential loss caused by a default of the mortgage. In short, the mortgage company self insures itself against loss by charging you an above market rate loan.
Let’s look at some advantages and disadvantages of one versus the other. Mortgage insurance paid by the Borrower is not tax deductible while mortgage interest is tax deductible. When the Lender pays the mortgage insurance (or in actuality assumes the risk) by charging you a higher interest rate, that “higher” interest is tax deductible.
With Borrower paid mortgage insurance, that insurance can be removed. In general, the insurance is removed (or you request the Lender to remove it) when the loan reaches 80% of the value of the home. It is not important how this happens. You can pay down the loan or the property can go up in value or both. The key is this insurance can be removed. In the case of Lender paid mortgage insurance, the Lender is charging a higher interest rate. There is no mortgage insurance to remove. The only way to reduce the interest rate is to completely refinance the loan!
The grid below gives you a basic breakdown of advantages versus disadvantages for both types.
Mortgage Insurance Made Simple
|Borrower Paid Insurance||Lender Paid Insurance|
|Insurance Easily Removed||Yes, when loan is 80% of Value||No, loan needs to refinanced|
|Cost of Removing Insurance Premium||cheap… small fee and/or pay for an appraisal||Expensive, loan needs to be refinanced to remove the hidden insurance cost|
|Getting the loan approved||Harder… The insurance company and the mortgage company both need to approve your loan||Easier. You only need the approval of the mortgage company|
|Mortgage Insurance Tax Deductible||No||Yes|
Paying for mortgage insurance or having the Lender pay for it depends on your preference. What is important to note is that if the loan would have needed mortgage insurance and you get a “no mortgage insurance loan” you are paying for it one way or another.
Hope this helps and Take Care