What is Mortgage Insurance? How Does it Work?

Mortgage insurance is essentially financial protection for the lender. If the borrower defaults on payments or cannot make the payments outlined in their contract with the lender, then mortgage insurance can protect them. 

How Does it Work? 

Mortgage Insurance can function differently depending on the agreement you have in place. Either it functions as a regular premium payment, or a lump-sum payment made when the lender signs the mortgage agreement. Some borrowers do not have a choice and are made to purchase PMI if they have greater than an 80% loan-to-value ratio. However, this stipulation can usually be waived after the borrower pays off 20% of the principal balance. 

There are four main types: Private Mortgage Insurance (PMI), Mortgage Life Insurance (MLI), Mortgage Title Insurance (MTI), and Qualified Mortgage Insurance Premium (QMIP). 

Private Mortgage Insurance (PMI) 

PMI protects a lender or property owner from catastrophic financial loss due to defaulted payments from the borrower. 

PMI is usually required because of a high loan-to-value ratio. In layman’s terms, this means that the borrower has to pay PMI if their down payment only covers 20% of the house and their equity is only 20% of the property value. 

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Qualified Mortgage Insurance Premium (MIP) 

If you purchase a US Federal Housing Administration (FHA) mortgage, then you will have to pay this premium. Unlike PMIs, MIPs are required even if your down payment is bigger than 20% of the house cost. Also, unlike PMIs, MIPs are fixed no matter what your credit score is. However, there is a 5% increase in price if your down payment is lower than 5% of the cost of the house.  

MIP payments involve both a closing cost when you finalize your mortgage agreement and a series of monthly payments as well.  

Mortgage Title Insurance (MTI) 

This occurs whenever the sale of a house is rendered invalid because of some issue with the title. Essentially, this means that if the seller did not actually own the property at the time of the sale, the borrower will not incur heavy losses. 

Before a mortgage can be considered closed, some sort of advocate will perform a title search. This process is meant to discover any liens on the property that could stop the sale of the house. More importantly, it confirms whether the property actually belongs to the seller. However, sometimes important details can be missed, hence why MTI is so important. 

Mortgage Life Insurance (MLI) 

On the other hand, mortgage life insurance is put in place to protect the lender if the borrower happens to pass away before paying off all their mortgage payments. A borrower can also choose not to pay this insurance, but this involves a lengthy process of forms and waivers and potential risks. 

MLI rates can either be a fixed rate or drop as the mortgage balance decreases. MLI may pay off the lender or the heir to the loan depending on the policy made beforehand. 

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