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What is Home Mortgage Insurance?

What is Home Mortgage Insurance?

Home mortgage insurance can be better understood by examining the differences between private mortgage insurance and mortgage life insurance.
Aparna Iyer
Home mortgage insurance can refer to either mortgage life insurance or private mortgage insurance. However, there are significant differences between the two. While the former is a voluntary insurance policy that is purchased by people intending to make provisions in anticipation of permanent disability or death, the latter may be compulsory for people desirous of seeking a mortgage loan.

Private Mortgage Insurance

Private mortgage insurance (PMI) is purchased by the borrower as a compensation for the inability to equip himself/herself with the requisite down payment for procuring a mortgage loan. The down payment is usually 20 to 25% of the purchase price of the home. The borrower pays a premium for the insurance that is provided by a private company. A few lenders also provide Lender Paid Mortgage Insurance, although for the sake of discussion, we are limiting ourselves to the more commonly available Borrower Paid Mortgage Insurance.

Private mortgage insurance limits the lender's exposure to financial loss as a consequence of the borrower defaulting on the mortgage loan. The cost of PMI includes closing costs and the ongoing monthly principal and interest payments.

According to the new rules laid down by Fannie Mae and Freddie Mac, it seems that borrowers who are providing a down payment of 20 to 25% to avoid purchasing PMI, are not really benefiting in the form of low interest rates. The interest rate charged on the loans sanctioned to these borrowers mirrors the rate charged to people procuring private mortgage insurance. This is because both Fannie Mae and Freddie Mac consider borrowers who are parting with the minimum down payment, as likely to default as those purchasing PMI.

Loan to value, is the ratio between the amount of primary mortgage and the appraised value of the property. As per the Homeowners Protection Act of 1998, borrowers have the right to request a cancellation of their PMI, provided the loan to value ratio is 80% and the loan originated prior to July 29th, 1999. For loans that are current, the loan to value ratio is set at 78%. For others, the PMI will be terminated once the remaining term of the loan is 50% of the original duration.

Mortgage Life Insurance

The other type of home mortgage insurance is purchased by a homeowner, willingly, in order to ensure that the mortgage on the house is repaid in the event of the borrower succumbing to death or being incapacitated because of some disease. In other words, the borrower purchases mortgage life insurance so that his survivors are not burdened by mortgage payments. Although this is advantageous in some ways, it may not make sense to buy a life insurance policy with such a narrow scope. It may be a better idea to buy a policy that can provide the beneficiaries with a lump sum payment that can be used by the survivors as deemed appropriate. People who are interested in purchasing a life insurance policy but are constrained on account of the lack of finances, may consider buying a Term life Insurance Policy as against a Whole Life Insurance Policy. A mortgage life insurance policy may be advisable for people who are unable to qualify for other life insurance policies on account of health reasons. The restrictions in terms of health on such a policy is usually less as compared to other life insurance policies.