What is Mortgage Default Insurance?
Mortgage default insurance is a way lenders protect their investments. It is taken out by the lender in case the borrower defaults (fails to make a payment) on their mortgage. This is also known as private mortgage insurance (PMI). Lenders often require default insurance on loans where the down payment is less than 20%. Moreover, PMI will cost a flat rate until you reach 20% equity, the mortgage is paid off, or you can refinance.
How Does it Work
The insurer is a separate entity from the mortgage lender. Although the lenders often collaborate with one PMI company, they are not the same.
You pay a premium for the insurance to the PMI company. In the event of a default, they reimburse the lender. This works to the benefit of the lender. Avoid PMI whenever possible. However, if you cannot offer significant collateral (often in the form of a down payment), then circumstances may necessitate signing off on PMI. Many homeowners have default insurance when they purchase their home and choose to refinance and eliminate the said insurance once circumstances have improved.
PMI is somewhat of a necessary evil. It is either profit for the PMI company or to pay someone else's mortgage.
That being said, it can help you get a mortgage if you cannot provide 20% of the loan. so although it should be avoided, if you are required to purchase PMI or wait to buy the house, it is worth considering
How Much Does Mortgage Default Insurance Cost?
On average, PMI rates are between .3% and 1.9% of the loan paid each year. This is on top of the interest payments and existing loan.
The cost of your PMI depends on the size of the downpayment and credit score. A better credit score will help in the PMI process and guarantee better rates. Try and raise your credit score as much as possible.
Even if you plan on getting PMI, still, make as large a down payment as possible. The bigger the down payment, the less risk is being taken by the lender, so you will have lower PMI payments. Plus, you will reach that 20% equity mark faster, meaning less time paying for default insurance.
What are the Types of Mortgage Default Insurance?
There are four primary categories.
- Single Premium Mortgage Insurance: This insurance is paid at once. This way, you avoid recurring insurance premiums. Most often, this insurance is paid in full at closing, but in special circumstances, it can be rolled into the mortgage.
- Borrower Paid Mortgage Insurance (BPMI): This is the most common mortgage default insurance. BMI is paid via a premium on top of the mortgage until reaching 22% equity. Once that said equity is reached, the lender will cancel the BPMI. If you are up to date on payments and have a good history, you can request cancellation at 20%.
- Lender Paid Mortgage Insurance: With LPMI, the lender covers the insurance; however, it implies higher interest rates. This payment will not be canceled at 22% equity, because it is a part of the mortgage premium. The only way to lower it is by refinancing. You may have lower payments with LPMI, meaning you can qualify for a larger loan.
- Hybrid Mortgage Insurance: This is the least common insurance. Also known as split payment insurance, this is a combination of SPMI and BPMI. With this, you will a lump sum upon closing, then you will have monthly payments. This is best for buyers who cannot produce the full sum at closing but need lower payments to qualify.
Is Mortgage Default Insurance Required?
Mortgage default insurance is legally required in Canada and the majority of the time in the United States, assuming that the home buyer has less than 20% equity. If the down payment is greater than 20%, then mortgage default insurance would be redundant.
If the downpayment is smaller, it is unavoidable most of the time.
I Have Mortgage Default Insurance. Do I Need Homeowners Insurance?
Affirmative. Mortgage default insurance pays the lender in the event that you default on the mortgage. Homeowner's insurance provides coverage for damages to the home and legal liabilities and protects your belongings.
Both will be required for most mortgages with a downpayment of less than 20%. Even with a larger downpayment, lenders often require homeowner's insurance.
What is the Difference Between Mortgage Default Insurance and Mortgage Life Insurance?
Mortgage life insurance (also known as mortgage protection insurance) protects your heirs from inheriting your debt. In the event of your passing, mortgage life insurance will absolve whatever debt remains.
Mortgage default insurance only protects the lender. In the case that you default, the company pays the lender the insured amount. Your home will still be foreclosed.
Mortgage default insurance protects lenders' investments with low equity. It can be paid in a lump sum, by the lender through a raised interest rate across the life of the loan, or in installments until 20% equity is reached on loan. It differs from both mortgage life insurance and homeowners insurance.