This article contrasts Private Mortgage Insurance (PMI) and mortgage protection insurance with information and advice about:
- Private Mortgage Insurance
- Mortgage (payments) protection insurance
- Whether it’s worth purchasing mortgage protection insurance
- Understanding mortgage insurance policies
Many home buyers are required to take out Private Mortgage Insurance (PMI) when they purchase their home. However, there is some confusion about what this insurance policy does, and whom it protects. In this article, we explain the differences between PMI and mortgage (payments) protection insurance. Although the latter isn’t mandatory, is it something that you really need?
Private Mortgage Insurance (PMI)
Private Mortgage Insurance (PMI) is compulsory for all home buyers who don’t put down at least 20% in a down payment. It benefits the home buyer since they qualify for a larger loan than they would have without it. The problem is that with much less equity in their home, they represent a greater risk for lenders in cases when they default on their mortgage repayments and which leads to a foreclosure sale. In other words, PMI protects the lender against financial loss – and not the borrower as some people think.
Types and costs of PMI
Private mortgage insurance is available from privately-funded companies and government agencies (most notably the Federal Housing Administration). The cost of PMI varies with private providers taking into account factors like the size of the down payment, the borrower’s credit score and so on. It ranges from 0.5%-5% of the original loan amount. Firms with private capital don’t usually ask for upfront payment, and so the insurance is paid on a monthly basis.
FHA private mortgage insurance is the same price for all FHA loans although there might be a slight increase for those with down payments of under 5%. It also tends to be slightly more expensive than insurance purchased from privately-backed firms. Some of this insurance is often included in the upfront closing fees with the remainder paid in monthly installments. However, if the buyer doesn’t have the money, it can be rolled over into the mortgage.
How do you cancel PMI?
Once you own over 20% of equity in your property, your PMI will be canceled automatically (according to the terms of the Federal Homeowners Protection Act). You will be given its termination date in writing in a PMI disclosure form when you originally take out the loan.
If you have made additional mortgage repayments in this period, your outstanding balance might have dropped more quickly than calculated. In this case, you can ask in writing to have your PMI cover canceled. You must be up-to-date with all mortgage payments, prove you possess no junior liens on the property (such as a second mortgage) and provide evidence that the value of your home hasn’t fallen. In exceptional circumstances (such as in cases of balloon payment or interest-only mortgages), you can ask for final PMI termination even though your share of the home hasn’t reached 78%.
Mortgage (Payments) Protection Insurance
When some home buyers think about PMI, they are often confusing it with mortgage protection insurance. This is an optional private insurance policy. Depending on its terms, you and/or your family will have your mortgage payments paid for a set period if you lose your job; can’t work because of injury or a medical condition, or have the entire mortgage paid off (in case of death.)
The cost of Mortgage Protection Insurance
The premiums for mortgage protection payments insurance are calculated according to your age, your state of health and the LTV (loan-to-value) ratio of your mortgage. Before you think about buying mortgage protection insurance, you should consider the other insurance coverage you already have in place. If you already have short- or long-term disability insurance, then mortgage protection insurance is unnecessarily doubling up on insurance cover. Similarly, if you have an emergency fund in place (covering around 6 months of your household expenditure), this insurance might be superfluous.
The main advantage of mortgage protection insurance is that it is a ‘guaranteed acceptance’ policy. If you have pre-existing medical conditions or are in a high-risk profession, you might find disability insurance impossible to get, or the premiums are too high. In this case, mortgage insurance protection is the ideal solution.
One of its main drawbacks, however, is that there’s no flexibility with this type of insurance. If something were to happen to you, the payment would go automatically to the lender. Although your home would be paid for, what about the other day-to-day household expenses? In this sense, the lender is the main beneficiary rather than your family. In this situation, life insurance might be the better option.
Mortgage payment insurance is also a declining-benefit policy. This means that as you pay off your mortgage, the insurer will have to pay out less and less as time goes by. However, your premiums will stay the same.
The premiums for mortgage protection payments insurance are calculated according to your age, your state of health and the loan-to-value ratio of your mortgage.
You should also check the terms and conditions of the policy extremely carefully. Some policies will only cover the mortgage principal and interest (and no other fees) while some will only pay out for a very limited period (1-2 years) in case of job loss or inability to work. Would this be sufficient?
Conclusion – Understanding mortgage insurance policies
Because of the confusion between their names, it’s important that you understand the differences between these two types of policies. One is compulsory while the other isn’t. Think carefully before taking out mortgage protection insurance, and weigh up all the pros and cons for your personal circumstances. Obviously, you want a degree of protection for you and your family, but you must make sure it’s the right financial product for your needs.