
What is a Mortgage?
Before we dive into Mortgage Insurance, let’s re-visit the definition of a mortgage. A more in-depth article about mortgages can be read here.
A mortgage is a loan that is obtained by a borrower from a mortgage provider in order to buy real estate such as a house, commercial building, or land. The borrower repays the loan to the lender in periodic regular payments that consist of Principal and Interest payments over a period of time.
The real estate property serves as the collateral to secure the loan. That is, if the borrower defaults on loan payments, the lender can foreclose on the property to collect on the defaulted payments.
What Is Mortgage Insurance?
The risk to the mortgage provider is that the borrower defaults on the loan. Mortgage Insurance is an insurance policy that protects the mortgage lender in the event that the borrower defaults on the loan.
Here are 3 types of mortgage insurance:
1. Mortgage Title Insurance
Mortgage Title Insurance protects the lender against financial losses in the event that there is a problem with the real estate title and the real estate transaction is considered invalid.
This may occur in the event of fraud in which the seller of the real estate does not hold title to the property. Or the property has a lien on it and the seller cannot sell the property without the lien being removed from the property.
This event is rare as a title company normally performs a thorough title search. This search verifies who the title holder of the property is and whether there are any liens on the property.
2. Private Mortgage Insurance
A conventional mortgage usually requires a borrower to make a down payment of 20% of the real estate value in order to obtain a mortgage.
In the event that the borrower does not or cannot make this 20% down payment, the borrower is generally required to obtain Private Mortgage Insurance or PMI.
Private Mortgage Insurance protects the lender from the borrower who does not have the financial ability to make this 20% down payment.
Some borrowers may instead make a down payment of as little as 5%. Other borrowers put almost no money down.
An example of primate mortgage insurance can be seen in Canada:
Canada Mortgage and Housing Corporation (CMHC)
In Canada, if a homebuyer wants to buy a home with a down payment of less than 20%, he is required to make a down payment of at least 5%, and it is mandatory that the homebuyer obtain mortgage loan insurance.
This enables the borrower to get a mortgage of up to 95% of the purchase price of a home.
To get mortgage loan insurance, the borrower must make a minimum down payment based on the purchase price of the home as such:
– If the home costs $500,000 or less – a minimum down payment of 5%
– If the home costs more than $500,000 – a minimum down payment of 5% on the first $500,000 and 10% on the remainder
– If the home costs $1,000,000 or more – mortgage loan insurance is not available
Qualified Mortgage Insurance Premium
In the United States, when a borrower obtains a U.S. Federal Housing Administration-backed mortgage, he is required to pay a form of insurance called a qualified mortgage insurance premium. This is mandatory for all FHA mortgages.
3. Mortgage Life Insurance
There is always the risk to a mortgage lender that the borrower dies while he still owes money on the loan.
Mortgage life insurance is a term life insurance policy that would cover the unpaid mortgage debt in the event of the death of the borrower.
The term of the life insurance policy is matched to the term of the mortgage. The death benefit is reduced each year to correspond to the updated outstanding mortgage balance as the borrower makes the mortgage payments.
Decreasing Term Insurance
This is a mortgage life insurance policy in which the amount of the policy decreases with the outstanding balance of the mortgage. And when the outstanding mortgage balance is paid off, the life insurance policy also goes to zero.
Level Term Insurance
This is a mortgage life insurance policy in which the amount of the policy does not decrease. This is appropriate in the case of interest-only mortgages where the borrower is not paying down the principal of the mortgage. Thus, the outstanding mortgage balance remains unchanged.
How Mortgage Insurance Works
Mortgage life insurance is tied to the real estate mortgage transaction and is relatively easy to obtain.
– It can be obtained at the exact same time as the borrower is applying to obtain a mortgage.
– It can be obtained with no medical examination required.
It provides peace of mind to the borrower’s family. The borrower’s inheritors do not have to worry about how to pay off the mortgage after the borrower is deceased.
Mortgage insurance premiums can be paid in a small payments over time or or it may be capitalized into a lump-sum payment at the time that the mortgage is obtained.