Do we all need mortgage insurance?

August 2, 2012

When you purchase a new home and enter a new mortgage agreement, there are many things that need to be accomplished. Homeowners’ or mortgage insurance is a type of personal insurance which you may need to take out when you apply for a mortgage. A mortgage is essentially what you borrow and then pay off when you have not bought your house outright; as such, nasty situations can result if the borrower becomes unable to repay the mortgage, and the lender cannot recuperate the costs after acquiring and selling the property. Mortgage insurance is designed to protect borrowers and lenders when these unfortunate situations result.

Mortgage insurance costs

Mortgage insurance is usually paid on a monthly basis, and the overall cost of the insurance will depend on the size and type of the mortgage in question, the portion of the home value which is mortgaged, and any applicable premiums.

Different types of mortgage insurance

The two main types of mortgage insurance are mortgage protection insurance (MPI) and private mortgage insurance (PMI). MPI is a type of insurance which makes mortgage payments for you on the occasions when you are unable to do so. One type of MPI is mortgage unemployment insurance, which makes payments for you if you find yourself out of work. Other types include life insurance and critical illness insurance, which help pay the remainder of your mortgage in the event of death and critical illness, respectively. Whereas MPI protects you against specific unfortunate life events, PMI is an insurance “high-ratio” borrowers must pay to protect lenders in the event that borrowers are unable to make their mortgage payments.

How to work out if you need mortgage insurance (PMI)

When you take out a mortgage, you will be notified whether or not you will need to take out a form of PMI called borrower-paid mortgage insurance. You can also determine on your own whether you need this insurance by calculating your loan-to-value ratio (loan amount divided by house value). This ratio will vary according to how much of the mortgage has already been paid off, and the size of the down payment made at the start. Usually, if the LTV ratio is brought below 80% (for example, if you have paid 30K off, leaving 120K loan amount on a 150K home), then borrower-paid mortgage insurance may no longer be required. This is because once you have paid for a certain percentage of your home, the risk involved for the lender decreases, and the chances decrease that the lender will lose money after the process of foreclosure and property recuperation. The LTV is also affected by the market price of your home, such that LTV will decrease as the market price of your home increases. Instead of directly paying for this insurance yourself, many lenders will pay it for you (lender-paid PMI) but then add premium costs to your mortgage to make up for it.

The Answer

Do we all need mortgage insurance? The answer is depends on a combination of what your lender requires (PMI), and how you personally assess and choose to mitigate your risks for being unable to make your mortgage payments (MPI). That said, life can be full of risks, and because a mortgage is such a substantial piece of one’s finances, a good mortgage insurance package can make all the difference when the going gets tough.



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