Back to Basics: What is Mortgage Insurance?
When many of us first entered the mortgage industry, we eventually had the same question, “what is mortgage insurance?”
If we all asked that question, you’d better believe that your borrowers will ask the same thing.
To answer this question, let’s start by defining what mortgage insurance is not.
Mortgage Insurance Is Not….
We’re willing to bet that when many borrowers hear you mention “mortgage insurance,” they call upon their knowledge of other insurance in their lives like home, auto, and health insurance. Borrowers know that these types of insurance cover them in case a tree falls on their home, they get into a car accident, or they break their leg.
But, mortgage insurance doesn’t cover borrowers when they can’t make their mortgage payment, a conclusion they’re likely to draw with their understanding of insurance. Instead, it covers the lender. Borrowers may not understand this initially, so it’s important for you to understand what MI is…and what it isn’t…so you can explain it to your borrowers in basic terms.
What Is Mortgage Insurance Then?
Mortgage insurance provides an added layer of protection for you, the lender, in case a borrower defaults on their mortgage. Fannie Mae, Freddie Mac, and other investors generally require mortgage insurance with less than 20% down. So, if your lending institution wishes to sell a loan with a low down payment to the GSEs, you have to meet their guidelines which includes having MI.
In the event of a borrower default, MI covers part of the associated losses. Here’s how it works:
When you add MI to a loan, you select the coverage level, i.e. the percentage you can recover in the event of a default. Coverage levels range from 6% to 35% depending on the loan’s LTV and if you want to sell the loan on the secondary market. Below is an example of a loan covered with MI.
| Home Price | $300,000 |
| LTV | 90% |
| Loan Amount | $270,000 |
| MI Coverage | 25% |
| Amount Covered by MI in Event of Default* | $67,500 |
*Assumes all claims conditions are met.
MI Benefits You AND Your Borrower
You now know the answer to “what is mortgage insurance,” but how does it benefit you? We know with mortgage insurance, lenders get to write less-risky loans where the down payment is less than 20%. What that means is with mortgage insurance, you get to originate more loans for more people without increasing your exposure.
Even though MI covers you, not the borrower, borrowers still get a huge benefit from MI which is that they don’t have to wait so long to save for a 20% down payment. Putting less than 20% down also allows them to keep more money in their bank account. With more liquid capital, borrowers may be better equipped to handle financially straining situations which might have otherwise caused them to fall behind in their mortgage payments.
Ultimately, mortgage insurance helps facilitate the movement of the mortgage industry. It allows more borrowers to participate earlier and it reduces risk for lenders so they feel more confident in originating loans to borrowers with low down payments.
How Do I Pay for MI?
Mortgage insurance comes in two basic forms – lender paid MI (LPMI) and borrower paid MI (BPMI). As you might imagine, the names reflect who pays for the premium.
With LPMI, your organization pays the upfront cost of the MI. To cover that cost, most mortgage lenders increase the mortgage rate.
With BPMI, the borrower pays the mortgage insurance through their escrow account. There are many payment structures including monthly and annual premium.
We’ll cover MI payment structures in a later blog post.
Nothing Wrong with Going Back to Basics
Whether you’re completely new to the mortgage lending space or are a tenured professional, there’s never anything wrong with recapping industry basics. Remember, at some point we’ve all asked what is mortgage insurance.
In a nutshell, mortgage insurance is an added layer of security on a loan when a borrower wants to put less than 20% down. MI not only covers you, but it also helps borrowers buy a house faster and sooner. Also, there are many structures to how and when mortgage insurance is paid for.
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