There is more to homebuying than the mortgage. There are property taxes that the government requires on homes. There is also the interest on the loan. Some homebuyers need to pay HOA (homeowners’ association) fees to their neighborhood. All of these add a small amount to the total monthly payment that the homeowner makes on their property.
Some homebuyers also have to pay for private mortgage insurance, or PMI. Not every homebuyer needs to pay for PMI, but those that do should prepare to pay a few hundred extra dollars in addition to their monthly mortgage payment.
Introduction to mortgage insurance
For those buying a home, a mortgage is a large sum of money that is borrowed to buy the home with the intent of paying it back. For the lender, however, it is an investment. Every lender is investing in the borrower, because they believe that the borrower’s risk profile indicates that they will be able to pay back the loan over time.
Lenders trust borrowers to pay back the loan. But if the borrower is unable to, the lender has a backup plan – they can sell the home, and use the money from the sale to recover their losses.
The problem for lenders, however, is that these homes don’t always sell for the amount of the mortgage. When a borrower doesn’t pay back a loan, the value of the home decreases, which in turn means that the lender could take a substantial financial loss from selling the home.
In order to protect both the borrower and lender from this cost, some lender programs require borrowers to obtain “mortgage insurance” – an insurance payment the lender receives to compensate for the home selling for less than is owed by the borrower.
Who needs mortgage insurance?
With the exception of VA loans, mortgage insurance is required on all homes with a loan-to-value (LTV) ratio of more than 80%. LTV is the amount of the mortgage relative to the value of the home. For example: If your home is worth $200,000, and your mortgage is $180,000, then your LTV is 180,000/200,000, or 90%, and you would be required to provide private mortgage insurance.
For those that have made a 20% down payment on their conventional loan, no mortgage insurance is required. For those that made less than a 20% down payment, you will still need private mortgage insurance until your mortgage has dropped below the 80% threshold.
Mortgage insurance protects both the lender and borrower
Mortgage insurance is not just insurance for the lender. For the borrower and their family, it ensures that if something unfortunate happens, the borrower is not responsible for any additional amount owed on the home if the home sells for less than the mortgage.