If you’re planning to buy your first home, you’ll likely need to take out a mortgage. And you might have heard about mortgage insurance during your research. But what is it exactly, how does it work, and how can it benefit you? Let’s take a look below.
What Is Mortgage Insurance?
Mortgage insurance is an insurance policy that protects the lender in case you default on your mortgage payments. In both the U.S. and Canada, it’s a prerequisite for loan approvals if your down payment is below 20%. This is perceived as a risk by the lender, and as a result, they will require the added premium as a form of compensation.
Lenders have different rates for their mortgage insurance, which is typically calculated as a percentage of your loan amount. Depending on the policy, mortgage insurance can either be paid upfront as a lump sum or added to your mortgage and paid in monthly or yearly installments.
How Can You Avoid Mortgage Insurance?
The easiest way to avoid mortgage insurance when taking out a loan is by making a down payment that’s at least 20% of your home’s purchase price. However, that may not always be possible.
One workaround option is getting a secondary loan that will cover up to 10% of the loan amount. This, paired with a 10% down payment, will place you within that 80% loan-to-value ratio that lenders are looking for. Some lenders might also agree to drop the mortgage insurance in exchange for higher interest rates. Similarly, private insurers are also an option, although their interest rates are usually higher than those offered by your main lender.
The hard truth is that, without a 20% down payment, you will have to contend with an added expense when taking out a loan. So, avoiding mortgage insurance essentially comes down to replacing it with other types of added costs.
Is Mortgage Insurance Worth It?
Saving up for the 20% down payment is one of the main hurdles homebuyers face and one of the reasons they may postpone buying a home. Being able to drop that down payment to as low as 5% can be a real lifesaver, even if the trade-off is mortgage insurance.
The main drawback to mortgage insurance, however, is its long-term costs. On average, the cost of your mortgage insurance is a small percentage of the loan amount. However, it can add thousands of dollars to your yearly bills. This premium will be added to your mortgage, and like the mortgage itself, it is subject to interest. It’s also worth mentioning that mortgage insurance doesn’t help you build equity in your home.
Many homebuyers aren’t overly fond of mortgage insurance, but the truth is that it does have its benefits. On one hand, it protects the lender. On the other, it makes buying a house more feasible if you don’t have enough funds for a substantial down payment. And the best part is that it doesn’t even have to be permanent.
Once you’ve built sufficient equity in your home, or if a reappraisal shows that your home has increased in value, you can talk to your lender about canceling your mortgage insurance. If the closing costs are in your favor, you can also get rid of mortgage insurance by refinancing.
What Is Mortgage Life Insurance?
When applying for a loan, your lender may suggest an added premium to help your loved ones make mortgage payments if you pass away before the loan is paid off. Some lenders might also offer coverage in case of serious illness or an accident that results in disability. If the policy-holder passes while the mortgage is still in effect, the death benefit will be used to cover the mortgage debt. This policy is called mortgage life insurance or mortgage protection insurance.
The main thing to keep in mind here is that mortgage life insurance is neither mortgage insurance nor life insurance. In some aspects, it’s similar to mortgage insurance as it protects the lender should you default on your payments as a result of death. However, unlike mortgage insurance, it’s not required for loan approvals in case of down payments of less than 20%. And unlike life insurance, your loved ones are not direct beneficiaries, although the policy can help them keep up with the payments.
The key takeaway here is that mortgage insurance is mandatory if your down payment is below 20%. Mortgage life insurance, on the other hand, is optional. Whether you opt for it or not is entirely your choice. However, it’s best to weigh out its pros and cons when comparing it to life insurance.
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent and real estate broker.